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Business Crowdfunders Face Investor Liability Minefield

If you plan to raise money for your business through crowdfunding, get ready to spend lots of quality time with a good lawyer. If you run afoul the rules, which could be quite easy, you’ll need one to deal with Wall Street cops.

Two weeks ago, entrepreneurs got a different answer to their never-ending question: How can I raise the funds necessary to start/expand/optimize my business?

Issuers of certain private securities will be able to advertise to the general public under a new Securities and Exchange Commision rule.

Typically, it’s very difficult to raise money or even ask investors to be a part of your business without violating securities laws and becoming the next Bernie Madoff.

Thus, the best and only way to raise significant capital from “silent” partners and multiple investors, is to create a private securities offering under the Securities Act, and more specifically Rules 504, 505, and 506 of Regulation D. These rules allow companies to offer and sell their securities without having to register the securities with the SEC. However, the rules are a pain for who you can “talk to,” the time frame in which the funds can be raised, and who may invest in the offering and how much you can ask for.

Until recently, all such offerings were subject to a prohibition on general solicitation and advertising. This means issuers under Regulation D have had to previously rely on private networking and word-of-mouth to market their offerings.

Actually, Congress required these types of changes to be implemented in April 2012, when the federal government enacted the Jumpstart Our Business Startups or “JOBS” Act. That law required the SEC to establish rules eliminating the prohibition on general solicitation and advertising of Regulation D offerings if: sales are limited to accredited investors and the issuer takes reasonable steps to verify that all purchasers are accredited investors.

Fast forward to July, and the SEC approved the final rules on the subject, which will finally take effect in approximately mid-September. 

Under the SEC’s new Rule 506(c), an issuer is permitted to engage in general solicitation or general advertising if:

• The issuer takes reasonable steps to verify that the investors are “accredited investors” and
• All purchasers of the securities in the offering are accredited investors or the issuer reasonably believes that the investors satisfy the accredited investor requirements at the time of the sale of the securities.

This means that for issuers who anticipate taking advantage of the new Rule 506(c), it will be critical to establish appropriate procedures to comply with the requirement to take reasonable steps to verify “accredited investor” status.

The opportunity to generally solicit and advertise Regulation D offerings could be a game-changer for many entrepreneurs looking for a way to take their businesses to the next level. However, as is usually the case when the government makes large-scale changes to a regulatory scheme, a good measure of caution must be prescribed. The new rules are a veritable minefield of potential liabilities. As such, the counsel of a competent securities law attorney is vital to any company seeking to navigate the brave new world of Rule 506(c) offerings.

In summary, make sure to get a consultation regarding the raising of capital and multi-member LLCs when you have “silent partners” or more than five partners. There are certain rules and guidelines other than advertising you need to consider.

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