- By James Han
- August 20, 2013
- 27 minute read
The recently passed JOBS Act changes the investing game dramatically for small startups hoping to make it big. Fundraising experts Jim Fulton and Kiran Lingam as discuss the changes the JOBS Act brings to the landscape, including: crowdfunding, the ability to have more investors, and the option to solicit investors in advertisements (previously outlawed by the SEC). But don’t solicit quite yet! Some of these changes don’t take place until September 23rd.
Kiran Lingam, General Counsel, SeedInvest (@kiran_lingam)
Jim Fulton, Partner-in-Charge, New York, Cooley LLP (@fultonjf)
LINGAM: Hello everybody, welcome to our panel on entrepreneurship and what every entrepreneur needs to know about the new JOBS Act regulations and changes to laws regarding general solicitation. My name is Kiran Lingam, I’m General Counsel at SeedInvest.
SeedInvest is a technology platform allowing companies and groups to facilitate online funding transactions in accordance with the new rules that we’ll talk about today. It’s a pleasure to have Jim Fulton here today from Cooley, a leading law firm for entrepreneurs and startups. Jim.
FULTON: Thanks, Kiran. Great to be with you, folks. I’m a partner at Cooley, one of the leading firms in United States providing legal services to entrepreneurs and emerging growth companies that’s not just startups but companies through public offering and beyond. Real happy to be here with Kiran and you all today to talk a little bit about the JOBS Act.
LINGAM: I’m just going to run through a brief outline of what we’re going to talk about today. I’ll give you some flavor of what we’re going to cover and then where we’re going to go. Jim will go over the background and current law – how things are now and what the current law is.
We’ll then jump into what the new rules are, what’s changing, and what you’ll be able to do. And then pretty closely tied to that will be the new requirements and legal hurdles that you’ll need to comply with in order to take advantage of the new rules. We’ll then go ahead and talk about whether you – if you want to do things the way things have always been done, whether you can still do that, or other concerns you need to be aware of. And then we’ll finish with actionable steps for startups based on these new rules and how you guys can leverage what’s going on.
FULTON: And you’ll have the opportunity to type in questions that we’ll try to answer as we go along the way. Not quite sure we’ll be able to get all the questions, but we’ll do our best working with the General Assembly team here to try to be able to address as many questions as possible in the time allotted. So, Kiran, I’m going to go ahead and get it started on the background.
For those of you who’ve worked at a startup before or have raised money for a startup, chances are that you have relied on Regulation D as your exemption from the registration requirements of the securities law. That the regulation is a safe harbor.
There’s a general rule in the Securities Act of 1933 that prohibits selling securities other than by means of a registration statement, but that rule, that statute, has a provision that says other than those that are made via public offering. So the SEC promulgated Regulation D as a safe harbor for companies to go about raising money and have a peace of mind of knowing that their offering fits within one of the exclusions outlined in Regulation D.
There’s actually three main parts of – three main safe harbors in Regulation D. Some of you may have heard of Rule 504 offerings which are limited to very small offerings made by shell corporations. We’re not going to talk too much detail about those rules other than to offer a little bit of advice before someone tells you “Oh, just rely on Rule 504.” There are some very specific requirements that need to be made, including if you already generated and circulated the business plan, you’re not going to be eligible to rely on the Rule 504 offering.
I wanted to focus on the JOBS Act. Rule 505 is similar to 504, which is the higher dollar limit on money that you can raise. And then currently and until September 23rd when the new regulations take effect, Rule 506 as it’s currently in place, is the safe harbor most often relied upon by startups, venture capital funds for that matter, and really all means of public and private corporations raising money and private offerings.
An unlimited amount of money can be raised selling to accredited investors. And what we have now, thanks to the JOBS Act and thanks to the SEC’s promulgation of a new Rule 506(c), is for the first time a safe harbor that will within very limited circumstances we’ll talk about, provide that you can advertise or use a general solicitation to raise money in an offering that would be exempt from the registration requirements under 506(c).
506(b), the current Rule 506, has a very strict, no general solicitation rule. I thought I would talk a little bit more about some of the key aspects of 506 as it’s currently constructed by means mostly of enabling you to contrast with the new rules as they become available. So what’s the first no.
Well, the first no is no general solicitation. That’s the main change between 506(c) and the old 506, 506(c) will permit general solicitation. Under the 506(b) which most people have relied on in the past, there’s no general solicitation.
What does that mean? It means a lot of different things. It doesn’t mean – just mean you can’t take out an ad in a newspaper, it also means you can’t stand up on a stage in front of a group of people and say, “I’m here to raise money,” and we’ll talk about that towards the end as we get into some more of the practicalities of what you can and cannot do as an entrepreneur.
So the idea of a general solicitation is not limited to advertising. It’s really limited to any broad-based dissemination of your fundraising. And again, we’ll get into a little more details of what that means.
Accredited investor, what is the concept? Well, it has both an income and a net worth requirement, and currently, most companies and the securities lawyers that represent them rely on self-certification. If and when you’ve ever invested in a startup or your startup raised money, there’s an accredited investor certification usually built into the representations and warranties that the investor is making for decades that has served companies as their protection and the means by which they relied on determining whether they qualified under 506, that all their investors were accredited investors.
Going forward, under 506(c), the rules are going to be different, and we’ll talk about that. And then the last thing to keep in mind about a Rule 506 offering is it does require a Form D to be filed. The Form D, the information that’s been required on a Form D has changed over the years. Actually, most recently within the last couple of years. But suffice to say, even though you’re making a private offering, if you’re going to rely on Regulation D, you’re going to need to file a Form D that announces to the world that you’ve raised capital.
One of the questions I often get asked is “Well, gee, we’re a stealth company. We don’t want to have anybody know that we raised $5 million dollars. Yeah, that’ll tip off the competitors. The VCs are okay with keeping everything on the QT until we’re ready to do our big launch in four months.” Truth of the matter is, Rule 506 offering does require filing of a Form D and Reg. D requires that it be filed within 15 days of the offering being completed.
So companies that do stay stealth are doing so at the risk of potentially having the SEC come back to them and ask them why they’re not in compliance with the 15-day filing requirement. Not saying a lot of companies don’t do it because they do, but when I say ‘do’, I mean, they don’t file their Form D on time. But, again, the default rule is to get it filed within 15 days to be in full strict technical compliance with Reg. D.
So why don’t we go ahead, Kiran, and transition over to talk a little bit… We know we got the background now on the old rules. So let’s maybe go ahead and talk about what everybody’s here to talk about, which is how the new rules affect the landscape.
LINGAM: I think what we’re all here to talk about is Title II of the JOBS Act and the new rules and what you’re going to be able to do now under the new rules. So just backing up and talking about the JOBS Act. The JOBS Act was passed April 5th 2012 based on large public support and demand upon our President and Congress to help create jobs.
And so the JOBS Act did a number of things, not just lifting the ban on general solicitation. It also made it easier for companies to go public. It called for the SEC to implement rules for crowdfunding, which we’re not going to talk about today, but will also be a pretty interesting topic probably in the next six to twelve months. The main point that we’re going to talk about today is the lifting of the ban on general solicitation which Jim just covered what general solicitation is.
So the JOBS Act did two things that’ll kind of open it up for broader financings. One is the lifting of the ban on general solicitation, and two, it raised the shareholder limit before you have to file public reports like a public company from 500 shareholders to 2,000 accredited investors.
So the combination of those two things will theoretically facilitate broader offerings to accredited investors. Imagine being able to raise, for a medical device, $10,000 dollars each from a thousand doctors by promoting and advertising in medical email lists, journals or newsletters. So theoretically, those type of offerings will be possible under the new rules.
So what can you do under 506(c) with general solicitation? You will be able to talk about your offering in public seminars, send out email blasts, push your offering out on Facebook, LinkedIn, Twitter. You’ll be able to run television ads. So you will be free to talk about your offering. That is the big change if you use 506(c).
I just want to reiterate that there are still two types of offerings. Many companies will choose to operate under the way things have been running for the past several decades where you cannot use general solicitation. So you’re going to have to make a choice on whether you want to use general solicitation, and that choice is going to come down to whether all of the additional regulatory requirements are going to be worth it for you.
And so, with that, maybe we can jump into some of the additional things that you’re going to have to do in order to take advantage of general solicitation. So the biggest change, as Jim mentioned in his introduction, up until now you needed to be an accredited investor but an investor can basically check a box and say “Hey, I’m accredited.” That’s no longer going to be sufficient under 506(c). And so you’ll now have to take “reasonable steps” to verify accredited investor status which self-certification isn’t sufficient.
FULTON: The actual requirement for there to be this greater scrutiny of the accredited investor status isn’t something that was in the JOBS Act at the beginning. It’s something that the SEC passed down when it passed the implementing regulations. There are those who have characterized it as the Congress giveth and the SEC taketh away in terms of opening up this general solicitation, you know, permitting general solicitation.
There’s definitely a feeling amongst some experts and commentators that the actual [clamp] down on the accredited investor certification process was one of the ways the SEC was trying to make it more challenging to rely on the general solicitation exemption.
One of the other points that’s important to understand as we’re thinking about the general solicitation and whether you would want to do it and you’d want to rely on a 506(c) offering is, do you really want investors who you don’t have a pre-existing relationship with and you don’t really know who they are. One of the jobs that we do, counseling startup companies and arranging angel investors, includes counseling them to be careful who you’re letting in as an investor.
I think anybody whose raised money before from a group, a broader group of people that includes people that they don’t know, is likely to have had a rude surprise of just what the character and who the people are that they’ve actually decided to get into business with. And it’s important… Myself, personally, I’d find it incredibly challenging to take money from people that I didn’t already know, understood what they were getting themselves in for, understood that this is a risky venture, and also, I have a reasonable understanding that they knew that and they knew that their job as investors was to be passive investors, not partners in our endeavor. And I’ve got countless stories that I can tell folks offline about angel investors who invest $5,000 dollars and think they somehow now have a management say in the company.
So something irrespective of whether you’re in a 506(b) offering or a 506(c) offering going forward, sort of knowing your investor is, I think, really important if you’re going to have a stockholder base that’s not only supportive but also isn’t meddlesome, and even worse, taking up a bunch of your time. If you have a thousand shareholders and only 5% of them want to get an update every month, that should start adding up the time that you’re going to have to spend answering to those folks or at least pretending not to ignore them, is going to be a pretty big chunk of time. And my guess is if you’re running a startup, time is one of your most precious commodities.
LINGAM: With a thousand shareholders, there are going to be a lot of challenges and this is going to be a new style of offering. Effectively, you have a lot of the problems of a public company but you’re a young startup, you’re a private company. My take is that there will be solutions to these problems and technology will be a key way that people will be able to overcome some of these challenges in terms of facilitating communication among investors, streamlining your reporting, and just handling sort of all the things that come along with having so many shareholders.
So you can view it as a negative and a lot of people do view it is a negative to have a lot of shareholders. But if you are able to capture value from your shareholders and get them to refer you customers, get them to refer you employees, get them to re-tweet all your posts or write your blog post, they can also be a great source of value if managed properly.
FULTON: What you guys and others are doing around innovation, to me, that’s going to be the fundamental benefit associated with 506(c) and the ability to use general solicitations is it’ll enable new and innovative platforms. I mean, much like Kickstarter did for what I consider really good for product-oriented companies, really good for game-related companies, really good, I think, for artistic endeavors. Hopefully, SeedInvest and other platforms that are not working on trying to harness technology, as well as, social media, will be able to help unlock the power of the platform.
For me, it’s fun because we get to actually counsel a lot of those startups who are actually looking to kind of innovate in this space. In New York City in particular, for those of us here, given its heavy concentration in the finance industry over the years, has shown that there’s a lot of really talented, thoughtful people who are coming up with important ways to innovate in this space.
But why don’t I go ahead for a minute and talk about – okay, so you are going to go on your own and do a 506(c) offering. Congratulations, you’re going to be a pioneer. What do you need to know about accredited investor? Well, there’s a couple of safe harbors that have been implemented that SEC has promulgated that says how do you assure yourself that your efforts to verify their accredited investor status are reasonable.
And I will just walk you through. One is that the attorney or CPA, or some investment or broker-dealer certifies, “Yes, this is a client of mine, and they are in fact an accredited investor.” I actually think that’s one that you’ll probably see. If you’re an attorney for Warren Buffett, it’s probably not going to be too big of a stretch for you to be able to provide to an angel-backed company that Warren Buffett’s an accredited investor.
I would posit on my own that a reasonable step to verify that Warren Buffett’s an accredited investor would be a self-certification and the SEC hasn’t said that’s not the case. And we’ll talk a little bit about the non-safe harbor ways I think you might be able to get yourself to satisfy an accredited investor status.
The next two items, tax returns, bank statements, credit reports, W-2s, I mean, what that really means is that for those investors that you’re going to be actually getting their personal financial data. I happen to believe that that’s not going to be a means that we’re going to find too many people finding big success with the friction there. Not to mention, people’s privacy concerns. Seem to me to be pretty overpoweringly negative to be thinking that a startup, and again, keeping it mind that this is for the public – to rely on the general solicitation.
So you have the problem if you really don’t know each other that well, there’s no pre-existing relationship most likely, and your first communication with them or one of your first formal communications is going to be “Please send me your tax returns and your W-2s for the last two years,” seems far-fetch that that’s going to gain much traction.
And then the last way – and this is an important exception and an important safe harbor – is if you’ve got somebody who’s already an investor in your company, and they then are going to invest in around that you’re trying to qualify in your 506(c), and they’re going to self-certify again that they’re accredited investor, that’s going to work.
So I think that’s a pretty powerful statement by the SEC that they’re not really trying to change your existing relationships. But as they say, they’re really trying to protect the public going forward in requiring this enhanced verification procedures.
LINGAM: How does this affect raising money from friends and family?
FULTON: It’s a good question. If they truly are friends and family and you have a pre-existing relationship with them, then I believe you’re going to be able to continue to rely on their self-certification and you would presumably use a 506(b) offering, which is not going to come under the same kind of scrutiny as you would have and will have with the 506(c) offering, as I noted earlier.
The SEC is particularly interested, and we’ll talk more about the filing requirements. They really do want to monitor how the general solicitation permissibility develops in the market. But for 506(b) offerings where you know the people and they’re willing to certify that they’re accredited investors, I’m not nearly as concerned that you’re going to have to go get your mother-in-law’s W-2s or your father-in-law’s tax forms.
LINGAM: Great point, and that also highlights the distinction between the two types of offerings now. But if you’re doing a close-knit, offering to people you know, that puts you kind of in the old way of doing things versus the new way, which is more of a broader offering, going out to the public. But we’ll touch on that a little bit later.
Another good question is: can you generally solicit non-accredited investors? So while non-accredited investors can see your solicitation, they will not be able to invest. And so that’s a key point. You can push your message out to anybody, but when it comes time to invest, you’re going to have to take all of these reasonable steps to verify that they’re accredited so non-accrediteds cannot invest in this sort of new regime. When we get the crowdfunding in a year, that’s a different story, but that’s also a different panel.
FULTON: Yeah, and I’ll point out, you know, tying it back to the old rules. Under our old Reg. D offering or what will be a 506(b) offering, you were able to sell to unaccredited investors up to 35 of them, although most securities law practitioners were particularly keen on keeping that number a lot lower than that, if for no other reasons than suitability concerns. But you’re still going to be able to rely on that.
The one key takeaway there, and I probably should have prefaced everything here before, is make sure you’re getting securities law advice from somebody who understands what they’re doing before you start an offering, before you solicit or you start circulating a business plan. As I’ve mentioned before, 504 may be a perfectly valid way for you to go about soliciting money, particularly when you haven’t circulated a business plan yet, especially from friends and family.
If you talk to a securities lawyer and get their counsel before you end up starting down a road that has now disqualified you. Same thing with unaccredited investors, you can have them in your offering but there’s information disclosure requirements that those folks are required to – they’re required to obtain certain information about your company. And again, you’re going to want to get advice and counsel well before submitting or starting your solicitation.
LINGAM: It’s important to talk to a securities lawyer that kind of knows this space and particularly is paying attention to what’s happening with 506(c) before you start using any of these rules because it is a change to 80-year-old securities law. So it’s going to be new for a lot of the lawyers out there. It’s important to sort of press your lawyer and just be very careful before you start trying to make use of these new rules.
FULTON: I think that maybe transition over to some of the hurdles and some of the requirements that are now going to be put into place. Maybe you could start touching on the first of those, which is the new Form D filing timeline requirement.
LINGAM: What we just talked about was the accredited investor verification standard, and that is going to go into effect. That is a final rule. Everybody will have to comply with that before using general solicitation.
What I’m about to talk about are proposed rules that the SEC has asked for comment on, and so they’re not necessarily final and they are likely not to be in effect on September 23rd but they can go into effect shortly thereafter. And so the takeaway from this is these are the things you’ll have to be concerned about if you want to start planning your financing and deciding whether to use the new rules or the old rules.
These are some of the things you might have to comply with under the new rules. My suspicion is that these might change based on a lot of public feedback to the SEC on how these might make things difficult. But if you have strong feelings on these rules, you should submit a comment to the SEC. They’re very open to hearing comments from the public.
FULTON: I mentioned at the top, a number of the stakeholders here have been particularly vociferous in objecting to what they perceive as the SEC overregulating what was meant to be a liberation from regulation. And it would not surprise me at all to see the SEC potentially soften some of the proposed rules that Kiran is about to go over.
LINGAM: I think the one that’s going to really be a trap for a lot of people if this goes into effect is the requirement that you have to file an Advance Form D, 15 days BEFORE you start any general solicitation. And that means, if you go and start talking about your offering and you have not filed an Advance Form D, then you will have violated securities law and you’ll then be subject to very harsh penalties that we’ll talk about in a second.
So that is a trap that people need to be really aware of. Just because you see some other company advertising doesn’t mean you can just copy that. You’re going to need to talk to your lawyer, get something on file 15 days before you start doing anything. And as we’ll cover in a second, the proposed penalties here are very harsh.
The second pretty tough proposed rule is the requirement that you’re going to have to file any written general solicitation materials with the SEC no later than the day that it’s pushed out. So that means if you sent a tweet at 11:59 p.m, you will have needed to pre-file that tweet with the SEC before you sent that tweet, which the logistics of that are a little mindboggling. Then again, the penalty for violating that provision is pretty harsh.
Similarly, you have to attach lengthy legends to any general solicitation materials that you push out. Again, it’s hard to imagine how you can attach a page of legends to a tweet. These proposed rules, I think there are some logistical challenges and they are proposed rules.
A key point here is that the penalty or the proposed penalty for breaching these rules is that you are barred from using Rule 506 (both b and c) for a year after you cure your error. So if you missed a Form D, you’d be barred for a year after you made the file and fixing that.
FULTON: It may not sound like an overly harsh penalty, but you know, in the startup world, I mean, you might have to raise money several times in a twelve-month period of time. So, you know, inadvertently running foul on one of these things. I mean, it could be death for a company. I know it sounds melodramatic but if you can’t raise money and you can’t keep the lights on, you can’t keep the contractors paid, that’s a real significant penalty. But maybe we should – do you have any more questions?
LINGAM: If general solicitation is permitted on September 23rd but the Form D laws aren’t finalized, does that mean you can generally solicit on September 23rd?
FULTON: If you wanted to rely on Rule 506(c), following the letter of the rules there, the regulations in effect would not require the filing of the general solicitation materials. Again, I would urge caution for those who are wanting to try it. Personally, would want to see several months and hopefully a couple of dozen folks worked their way through the process and see how the SEC reacts before I’d be comfortable having my clients rely on it. But it will be interesting.
But, yes, the short answer to the question is 506(c) on September 23rd is not going to require you to file your general solicitations. It still will require the filing of a Form D though, so keep those in mind and make sure you’re working with counsel to make sure you’re very strictly following all the requirements of 506(c), including the Form D filing requirement, because the SEC left no ambiguity about it. They are going to be very, very vigilant on these 506(c) offerings and they’re going to be looking to see how the practice develops.
LINGAM: So September 23rd is going to be an interesting day because these proposed rules won’t be in effect. So I suspect many will wait and see what happens. Some may want to take advantage of maybe a window of opportunity where they can generally solicit without the burden of these rules. I believe the rules do say that compliance is measured from the effective date of a new Form D rule. So if you’re conducting your offering before the effective date of the new rules, then those won’t apply to your activities before the rules are in effect. It may get interesting to see what happens if an offering is ongoing, sort of before and after the effect of the rules.
Another related question is: can you realistically do this without a lawyer? And I doubt it. A good lawyer is going to be key. Technology is going to help, but, yeah, these are unchartered waters/
FULTON: This is as good a time as any to reiterate what we talked about and maybe talk about a little bit more also. The role that new intermediaries are going to play here when it comes to 506(c) is probably going to be the most significant development that comes to play here. Not just a platform to sort of get the solicitation to the right people who then hear it, who then can execute in a transaction that is not so cost-prohibitive as to render the transaction cost more than the money that’s being raised.
And we talked about if you got $10,000 from a thousand doctors, I mean, that’s a lot of money and I’m sure you could probably even generate without a very robust platform means of making that cost-effective. But what about raising a hundred dollars from a thousand people? Almost impossible to do cost-effectively relying on a lawyer and a paralegal of any way, shape or form. Just the paper work cost alone would – to get the stock purchase transaction documented could easily dwarf the amount of each individual investment.
And even if it doesn’t dwarf it, it’s certainly going to be a significant percentage of each of the stockholders. I often remind early stage entrepreneurs that stockholders, you can’t even divorce them. I mean, once they’re your stockholders, until you can convince them to sell their stock, you’re stuck with them and they’re stuck with you essentially, unless they can find somebody to buy their shares in a method that complies with the securities laws.
But every single time you amend your charter, you’re either going to have to send them a stockholder consent or you’re going to have to provide them with a notice. So you start to see in a lifecycle of a company the number of times you’re going to have to touch these people, creates an inherent sort of net present value of administrative overhead that you have to take into account when you’re thinking about trying to raise smaller sums from larger groups.
Again, a plug for the myriad amount of companies that are trying to innovate here. I think the only viable solution that’s going to be able to harness this is going to be platforms that are creative, that don’t exist or are only starting to exist right now.
LINGAM: I think maybe we’ve touched on this a couple of times a day but I think one of the more interesting pieces of this is the interaction of the old way and the new way. The SEC intended to preserve the old way of doing things with Rule 506(b). It’s basically trying to keep hands off on the way things have been happening before to avoid disruption in startup and other financings as they’re occurring. So they intended to leave the old regime in place in 506(b), and 506(c) would be this new way of doing things.
FULTON: So does that mean you can just sort of say “I’m going to ignore 506(c) and rely on 506(b)”?
LINGAM: I think the answer to that is “not exactly.” The introduction of this new type of offering, 506(c), is putting pressure on the definition of general solicitation. And there’s a big question on whether things that people have been doing, that have been largely ignored by the SEC and others, will now be scrutinized as general solicitation.
FULTON: I mean, we’re in a position now where there’s two areas that cause me concern as a practitioner in the field and advising my clients. The first is a closer scrutiny by the SEC, and frankly, by people in general, or whistleblowers in general, on just what constitutes a general solicitation.
The second is going to be around the accredited investor definition. I mentioned earlier, the SEC guidance, it gave us those safe harbors but it also gave us just a general guide to what’s reasonable. And as I mentioned, Warren Buffett, or one of the super angels, Ron Conway, Marc Andreesen, investing individually, Eric Schmidt, those are individuals that they need no introduction, and so the sort of self-certification process there might be inherently reasonable.
Friends and family, I mean, you know they have a house on the Hamptons or a lakefront property in Tahoe. Again, self-certification, probably not going to be unreasonable. But keep in mind that the farther afield you get from people, that it’s very easy to get yourself convinced that their self-certification is worth something. The farther you get from that, the farther scrutiny that you might get. And notwithstanding the fact that 506(b) is supposed to be the same old, same old, I just have a feeling the SEC is going to take a look at a lot of the 506(b) offerings to see if there’s anything that they find in there and the practice in there, and whether they’re satisfied with it.
LINGAM: For those companies out there that are about to participate in a demo day or pitch event — what do you think they should do and what are some concerns?
FULTON: It raises the question of – is what people are doing now, in fact, to general solicitation. And, Kiran, I know you brought to my attention cases where the state regulators have taken an interest in these demo days and pitch events. So much so that I think it’s imperative that startup companies now participating in these type of events absolutely refrain from making public statements about “We’re here to raise $300,000 dollars, and come see me for our term sheet if you want to take a look.”
I think you’re going to have to adopt a much more pre-IPO CEO and CFO mentality, which is you can talk about your business, you can talk about your prospects, but you can’t talk about an IPO. And I think that’s now true for pre-funding companies as well. Talk about your company, talk about your prospects, but you’re not going to talk about your financial needs or your financing in a public forum.
So, you know, begs the question, what’s public. If you get invited to an angel dinner or an angel pitch event, is that a public forum? Probably not if it’s not open to the public and the angel group is pre-screening people in the anticipation that they want them to invest and they’re inviting them. You almost, by association, have a pre-existing relationship with those folks. But standing up on stage at pitch events and saying, “I’m here to raise $300,000 dollars” is probably technically a general solicitation that you want to avoid.
Social media, by definition, I can’t see any way around it. You might argue that Facebook, because they had to be your friends and every one on there, supposedly, you have a pre-existing relationship with by liking them and following them in the beginning. Maybe you could send out a Facebook wall post that just goes to the people that you’re friends with and get away with the argument that that’s not a general solicitation.
For me, personally, I think that’s probably a stretch, inviting people to take a look at your business plan. Then again, doesn’t mention that you’re raising money. It may mention that you’re going to need money in order to execute your plan, without asking for money is probably going to be okay. And then having people reach out to you or you reach out to people on a more one-to-one basis is going to be the safe way to go ahead and do those kind of things.
But the rule of thumb is if you don’t talk publicly about a financing, you’re very unlikely to run a foul over general solicitation requirement that would disqualify you even from 506(b).
LINGAM: Would you have any concern where nobody talks about their financing on stage but it’s pretty clear that everybody there is raising money? Sort of an implicit, ‘why else would you be pitching’ type of question, which I think some have raised.
FULTON: You know, I’m not overly concerned about that. If it’s designed as an event for companies to pitch and people go there voluntarily, and the ask only comes in a one-on-one that’s a follow-up on that, I think that regulators would have a really hard time demonstrating where the general solicitation was. If state regulators really do get aggressive on this and send people to attend some of these public pitch events and they hear people making their pitch, and then decide they’re going to scrutinize all the companies that showed up and then start sending them letters after they file their necessary state and federal securities law filings, it’ll be interesting to see if anybody goes that far.
I would have to believe that that’s pretty much a stretch. And my own political views aside, it would seem to me that given this environment where jobs are so paramount, that folks who are complying with the letter of the law and not sort of sleuthing a solicitation and creating jobs, it’s going to be really politically untenable for the state regulators to go try to ferret those companies out as bad boys.
LINGAM: I just wanted to get any final thoughts on other practical steps you may have. To me, I definitely think proceed with caution. Definitely, before you do anything, you need to do a pretty thorough analysis on if 506(c) is appropriate to you. I think a safe course may be to start with a 506(b) offering, see how it goes, and it seems from the law that you can always later switch over to 506(c). You can’t go the opposite way but you can start with a (b) and go to a (c), so that may be something that people may want to think about.
Again, before you go out and start doing any general solicitation, before you go to a demo day or a pitch event, just think about what your pitch is. Make sure you’re not saying anything that can be construed as a general solicitation, unless you are in a 506(c) mode.
FULTON: For me, the number one thing is planning. Plan ahead. Don’t start down the path of fundraising before you fully ironed out your securities law exemption and what your options and opportunities are. As I’ve indicated, there’s a lot of flexibility for offerings below $750,000 dollars. But in order to take care of that flexibility, you really do need to plan before you’ve even whispered “I want to raise money” to a potential investor.
There’s a lot of good help out there. You know, Kiran’s a recovering practicing lawyer at a law firm, I’m sort of an addict and I’ll continue to do it as long as they let me. But there’s plenty of good practitioners out there and I would encourage all of you to take advantage of their largess. Most of them will consult with you in an introductory meeting before they start charging you, but the money’s worth it if it’s going to potentially allow you to raise money as opposed to being locked out due to a footfault that keeps you out of 506 period for a better part of the year.
LINGAM: Yeah, I think we’re out of time. If you guys have further questions, feel free to send either of us a tweet and we’ll try to answer publicly so everybody can see as well. But otherwise, thanks for everybody for attending.
FULTON: And thanks to General Assembly for this great space. You guys can’t see it from out there but the facility here is quite well-suited for this kind of webinar. So have a good afternoon.
This post was written by James Han on August 20, 2013