Startups, hedge funds and venture funds will soon be able to advertise, or otherwise “generally solicit,” when they’re raising money. While that might open up new doors for investments, corporate and securities lawyers are issuing a few words of caution.
The Securities and Exchange Commission voted last week to adopt a piece of the JOBS Act which would remove a ban on general advertising for private securities offerings that are exempt from the lengthy process of SEC registration under rule 506 of Regulation D. That means that when the newly adopted rule goes into effect (likely this fall), companies and funds will be able to use social media, websites or other avenues to let the world know they’re fundraising. But with that comes more rigorous back-end work and the disclosure of more information that startups need to consider.
Those that choose to generally solicit will be subject to changes in the content of Form D’s, which are filed with the SEC as notice of exemption, and the process by which they do that. For example, companies will be required to file the Form D at least 15 days before they begin soliciting, and update the details of the offering within 30 days of completing it. They will also have to submit any materials used in general solicitations to the SEC and provide additional details, including what kind of securities were issued, how the company will use the proceeds, or, if it’s a fund, information about the investment adviser.
Perhaps the most cumbersome of the changes for companies that choose to solicit will be the requirement that they take reasonable steps to ensure that their investors are in fact accredited — that they have a net worth of more than $1 million (excluding their homes) or have a salary higher than $200,000. “Reasonable steps” could mean reviewing IRS forms showing an investor’s income, or verifying the value of his assets by looking at bank or brokerage statements.
“This type of an inquiry is much more intrusive than has been typical for angel investors in the past,” said Joseph R. Martinez, a corporate and securities lawyer with MBBP in Waltham, Massachusetts. “I think it could scare away both experienced angel investors and folks new to the game. It also could add a bit more overhead to the financing process.”
Sean Schantzen, a former securities attorney who co-founded equity crowdfunding platform Healthfundr, noted that he’s already heard a few companies say they are building out systems to automate that verification process, so that companies can make sure they’re staying compliant.
But there’s also the inherent personal component of angel investing that Martinez worries could get lost. “One of the great benefits to a company of having an angel investor can be that (he) often provides practical advice to the company and acts as a bit of a champion for the company in the community,” Martinez said. “That type of relationship is born out of the traditional model where companies seek out angel investors through personal connections and the company and the investors truly get to know each other. In the near term at least, I think that that personal touch may be lost in a scenario where companies find investors through the web.”
Angel investor Shirley Gee thinks that the short-term excitement about direct solicitation will eventually give way to recognition that one-on-one contact between investors and entrepreneurs is still a better model. “There will always be a place for exchange of capital for short-term needs and at low-level increments, but complicated deals will still need professional stewards,” she wrote in an email.
Schantzen also emphasized that this new rule creates two distinct paths for 506 exemptions — with general solicitation and without. The extra step of verifying investors will apply only to those who do solicit, and will likely keep those who don’t need to do so away from soliciting.
Another thing that won’t change with the rule is that investment is still limited to accredited investors; Title III of the JOBS Act that would allow equity crowdfunding for the general public is likely at least a year away, Schantzen said.
Fundable made the infographic below on the new rules.
[Featured image credit: BigStock Photos]