Rule 502(b): What You Must Give Non-Accredited Investors in a Friends-and-Family Round

When Rule 502(b) applies

Friends-and-family rounds often include a parent, a sibling, or a former colleague who is not an accredited investor. That one fact can change the paperwork for the whole round.

Rule 502(b)(1) states the trigger: if the issuer sells securities under Rule 506(b) to any purchaser that is not an accredited investor, the issuer must furnish the information specified in Rule 502(b)(2) to that purchaser a reasonable time prior to sale (17 CFR § 230.502(b)(1)). The same paragraph states that the issuer is not required to furnish the specified information when it sells under Rule 504, or to any accredited investor (17 CFR § 230.502(b)(1)).

Rule 506(b) itself limits the round to no more than 35 purchasers in any 90-calendar-day period, or the issuer must reasonably believe there are no more than 35 (17 CFR § 230.506(b)(2)(i)), and accredited investors are excluded from that count (17 CFR § 230.501(e)(1)(iv)). In practice, the limit operates on non-accredited purchasers. Each non-accredited purchaser, alone or with a purchaser representative, must also have enough knowledge and experience in financial and business matters to evaluate the merits and risks of the investment, or the issuer must reasonably believe so immediately before the sale (17 CFR § 230.506(b)(2)(ii)).

Rule 506(c), the general-solicitation alternative, is a separate exemption with its own requirements and is outside the scope of this post.

What the information broadly consists of

For an issuer that is not subject to the Exchange Act reporting requirements of section 13 or 15(d), which describes most startups, Rule 502(b)(2)(i) requires the issuer to furnish information to the extent material to an understanding of the issuer, its business, and the securities being offered (17 CFR § 230.502(b)(2)(i)). It has two parts:

• Non-financial statement information. If the issuer is eligible to use Regulation A, it must provide the same kind of information as would be required in Part II of Form 1-A. If it is not eligible, it must provide the same kind of information as required in Part I of a Securities Act registration statement on the form the issuer would be entitled to use (17 CFR § 230.502(b)(2)(i)(A)).
• Financial statement information. Rule 502(b)(2)(i)(B) distinguishes offerings up to $20 million from offerings over $20 million. For offerings up to $20 million, it requires the financial statement information specified in paragraph (b) of Part F/S of Form 1-A. For offerings over $20 million, it requires the information specified in paragraph (c) of Part F/S. The rule also specifies applicable accounting standards, including provisions for foreign private issuers. The company must identify and satisfy the applicable requirements; a narrative description of its finances is not a substitute (17 CFR 230.502(b)(2)(i)(B)).

A written disclosure document, often called a private placement memorandum or PPM, can organize the required information and financial statements. Rule 502(b) requires the specified information and related steps; it does not require a document bearing that particular title.

Exhibits required to be filed with the SEC as part of a registration statement or report generally need not be furnished to each non-accredited purchaser if the contents of material exhibits are identified and those exhibits are made available on written request a reasonable time before purchase. The rule excepts an annual report to shareholders and portions of that report incorporated by reference into a Form 10-K from this accommodation (17 CFR 230.502(b)(2)(iii)).

Related requirements in Rule 502(b)(2)(iv) through (viii)

The core disclosure is not the whole requirement. The following paragraphs add obligations that may apply before the sale or at other specified times.

Information given to accredited investors. Before selling to a non-accredited purchaser in a Rule 506(b) transaction, the issuer must furnish a brief written description of any material written information about the offering that it gave to any accredited investor but did not previously deliver to that purchaser. On the purchaser's written request, the issuer must furnish any portion or all of that information a reasonable time before the purchase (17 CFR § 230.502(b)(2)(iv)). If the issuer gave accredited investors a deck or data-room memo containing material written information about the offering that the non-accredited purchaser has not received, this requirement applies.

The opportunity to ask questions. The issuer must make available to each purchaser, a reasonable time before purchase in a Rule 506(b) transaction, the opportunity to ask questions and receive answers about the terms and conditions of the offering, and to obtain any additional information the issuer possesses or can acquire without unreasonable effort or expense that is necessary to verify the accuracy of the information furnished under Rule 502(b)(2)(i) or (ii) (17 CFR § 230.502(b)(2)(v)). The text says "each purchaser," so it is not limited to non-accredited investors.

Business combinations and exchange offers. In addition to information required by Form S-4, the issuer must provide each purchaser with written information about transaction terms or arrangements materially different from those for other security holders. For a business combination, the information is due when the plan is submitted to security holders; for an exchange offer, it must be provided during the transaction and before sale. The rule also permits qualifying non-reporting issuers to satisfy specified portions of Form S-4 through the information required by Rule 502(b)(2)(i) (17 CFR 230.502(b)(2)(vi)). This requirement is relevant when the transaction is a business combination or exchange offer, rather than an ordinary cash financing.

Resale limitations. Before selling to a non-accredited purchaser in a Rule 506(b) transaction, the issuer must advise the purchaser of the limitations on resale in the manner described in Rule 502(d)(2). That disclosure may be contained in the other required materials (17 CFR § 230.502(b)(2)(vii)).

Certain pre-offering communications. If the issuer used written communications or a broadcast script under Rule 241 within 30 days before a sale to a non-accredited purchaser in a Rule 506(b) transaction, it must provide those materials to the purchaser a reasonable time before the sale (17 CFR 230.502(b)(2)(viii)).

Antifraud rules apply in every round

Even in an all-accredited round, where Rule 502(b) does not require the specified information, two antifraud provisions still apply. Section 17(a)(2) of the Securities Act reaches obtaining money or property in the offer or sale of securities by means of an untrue statement of a material fact or a misleading omission (15 U.S.C. § 77q(a)). Rule 10b-5(b) makes it unlawful to make an untrue statement of a material fact or omit a material fact necessary to make statements not misleading, in connection with the purchase or sale of a security (17 CFR § 240.10b-5). Neither provision is limited to a formal disclosure document.

Planning the round

Founders who address Rule 502(b) early can plan the offering around the applicable requirements. Some limit a Rule 506(b) round to accredited investors, while still complying with the prohibition on general solicitation and the other exemption conditions. Others include eligible non-accredited purchasers and prepare the required information and financial statements. Either approach benefits from planning before offers and sales begin. Where Rule 502(b) requires information before a sale, delivery must allow a reasonable time—not simply occur moments before money changes hands.

The financing instrument is a separate decision. Our post on SAFEs versus convertible notes walks through the tradeoffs between the two.

How we handle these questions

Accord & Shield Legal drafts startup financing instruments such as SAFEs, convertible notes, and investor documents. Securities questions are handled through the firm's of counsel, including exemption analysis and disclosure requirements; see our page on securities law support for startup financings. The firm's securities of-counsel: Arizona law practice temporarily authorized pending admission under Rule 39(b). Supervision by Nadine Deeb, a member of the State Bar of Arizona.

If you are planning a friends-and-family round, you can read more about how the firm approaches securities matters or schedule an initial consultation to discuss your company, proposed transaction, timing, and the scope of potential legal work.

This article is general information, not legal advice. Securities rules depend on the specific facts of your offering and your investors. Consult a qualified attorney about your situation.