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What is this 506(c) thing I keep hearing about? Should I do it?

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Oct 11, 2023
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Oct 11, 2023
Question: What is this 506(c) thing I keep hearing about?

SEC Rule 506(c) covers General Solicitation - in essence publicly advertising that a Fund is raising money (via social media, public speaking, etc.). 

This is in contrast to SEC Rule 506(b) for private placements - this is the regulatory framework Funds traditionally raise under (privately), and which we strongly, strongly recommend. 

Question: Sounds great, so shouldn’t VCs (like me) fundraise under 506(c)? 

TL:DR - NO

Question: Why the heck not?

First and foremost - generally soliciting for fundraising for an enduring VC firm has a very low probability of success. As a professional money manager, LPs will hire you to take care of their hard earned capital. LPs who are wealthy enough to participate in your fund ($100K per LP minimum for a Fund I, rapidly scaling up from there), are not looking online for random money managers that they don’t know or trust. They simply don’t need to - and it’s an extremely risky endeavor.  

It is up to you, the fund manager, to find (or network your way) such LPs - and then crucially convince them you will do a great job professionally managing their money for the next 10 to 15 years. Trying to fundraise online for $10K checks is not effective from a time or cost perspective - even with emerging fund sizes of say, $5M (never mind certain regulatory limits on how many investors can be in a Fund). 

Fundraising under 506(c) also increases costs, administrative burden and LP friction. As a 506(c) fund, you (or a 3rd-party vendor) must affirmatively verify the accreditation status of each and every LP you accept into the Fund (no exceptions and no take backs).

As you can imagine, this takes additional time and money - not to mention it creates a lot of friction with your potential LPs, who will need to provide personal/confidential documents to a third-party vendor or loop in their attorneys, accountants or similar professional service providers to assist. This can extend the time it takes to close an LP by weeks to even months in some cases - some also just pass due to the friction. This situation becomes even more problematic with large check LPs who are often unwilling to provide tax information to your back office team (or a third-party vendor) to verify accreditation.

Finally, general solicitation often appears unprofessional to limited partners and removes the exclusivity of your offering, and is often perceived as desperate by experienced LPs.

Question: But people do so on AngelList, so why can’t I? 

AngelList is a great platform for syndicating deals out to amateur investors. AngelList owns and manages the vehicles, and it is typically not a viable option for enduring VC firms. 

While some investors on AngelList may also invest into your Fund, as a general matter LPs often do not overlap with the archetype LPs necessary for a VC fund because: 1) they like doing deal by deal investments instead of having a manager do this for them and 2) they generally do not have the capacity to make the minimum investment commitment which starts at ~$100k for a VC fund.

"Angel’List is a platform that’s designed for angel investors, and those angels that want scale their practice. Most of the best practices that apply to angel investors do not apply to founders of enduring VC firms - they are fundamentally different. 

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