What Entrepreneurs Need to Know About the Historic Change in General Solicitation Law That Goes Into Effect September 23 The 80-year-old ban on private companies advertising their fundraising efforts lifts on Monday, and the industry is largely cautious, waiting for the SEC to hand down more details on how the change will be regulated.
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An 80-year-old ban that has prevented private companies from publicly advertising their efforts to raise funds will lift on Monday.
If you are an entrepreneur struggling to find investors, that may be very good news. But hold the champagne for now.
What this historic change in general solicitation law really means is that if you are an entrepreneur looking to raise money from investors, you might want to spend some quality time with a lawyer before you go shouting it from the rooftops.
That's because the Securities and Exchange Commission is expected on Monday to release further guidance on how it will regulate the new law – guidance that may determine how much the change will ultimately end up benefiting entrepreneurs.
"The proposed rules are absolutely critical to determining whether this will be successful or not. They have the potential to dramatically reduce the ability of companies to take advantage of this," says Rory Eakin, co-founder of CircleUp, an online portal that connects consumer-product entrepreneurs with accredited investors. If the SEC requires companies to file excessive amounts of paperwork, many entrepreneurs may choose to not take advantage of the rule change, says Eakin.
The lifting of the ban on general solicitation was just one of a handful of measures included in the Jumpstart Our Business Startups Act, or JOBS Act, which was signed into law in April last year. The legislation, best known for its crowdfunding provision, which will allow companies to sell equity in their businesses to unaccredited investors, was designed to boost access to capital for entrepreneurs. The lift on the general solicitation ban is separate from the measure that would make equity crowdfunding legal for unaccredited investors. Negotiations on how to regulate crowdfunding have been heated and are ongoing.
The uncertainty of how exactly the SEC is going to regulate the impending rule change has made both advocates and opponents of the lifted ban a bit jumpy.
"There are the people who just want to keep doing what they are doing, and their concern is that the new regulations will make what has always worked suddenly become legally ambiguous," says Alex Mittal, co-founder and CEO of Funders Club, an online venture capital firm that has been invited to comment on the changes by the White House, the Treasury and several D.C. think tanks. Mittal says that the camp of people who have pushed for the lifting of the ban are concerned it will be 'impractical' to actually practice. "They are all unified by the fact that they feel there is ambiguity here," he says.
Here is a look at what it is already determined will change on Monday and what is still up for negotiation.
1. Public companies can advertise that they are raising money. Where previously, it would be illegal for a private company to even tell a newspaper reporter that it is seeking funding, the new 506(c) general solicitation rule will, as of Monday, allow entrepreneurs to tell anyone they want that they are raising money. They can tweet about it, blog about it, email customers about it, post on Facebook about it and employ any other avenues of public advertising. This change stands to benefit startups, hedge fund managers, broker dealers, angel groups, web platforms, venture capital firms and any other stakeholder with private company stock.
"I think there is a lot of cautious optimism from small businesses and the entrepreneurs we are talking to about the ease of identifying potential investors and utilizing modern communications technology, email and social networking tools to start the conversation with potential investors. Until this change goes into effect, the ability of companies to find investors is severely restricted," says Eakin.
Not only does the law change help entrepreneurs seeking capital, but it will make it easier for investors to find cash-hungry startups. "What we are excited about is this allows for the democratization of information flow. Today, only the top tier venture firms and angel investors have access to many private offerings because there is no information available in the marketplace," Eakin says.
2. Only accredited investors can actually purchase equity in a private company. While the lift of the ban means that entrepreneurs can tell the world that they are raising money, it's still only accredited investors who are able to make investments, explains Jay Kalish, general counsel at the equity crowdfunding platform, OurCrowd, on a conference call with reporters and investors earlier this week.
In the U.S., an accredited investor has to have $200,000 in annual income over the past two years and be able to prove a reasonable expectation that he or she will maintain such an income during the current year, or $1 million in net worth, not including the value of his or her primary home. Also, anyone with a history of fraud or a felon, a so-called "bad actor," will not be able to participate.
3. Your mom, grandma and sister will all start to see more advertisements from startups, even if they aren't accredited investors. While only accredited investors will be able to purchase private company stock, everyone is going to see more advertisements. "For the non-accredited investor, the regular consumer, you can't stop what is being publicly put in your face, right? Just by virtue of being a consumer of media and just a consumer, period, you will be messaged, too, and that is different than before. It used to be that the SEC prevented you from seeing these sorts of things," says Mittal. "There is a whole new type of messaging that regular people will be exposed to."
4. Accredited investors need a third party to verify their wealth. Before Sept. 23, investors are able to self-attest their own financial worth, thus validating their status as accredited investors. But after Sept. 23, self-accreditation is no longer sufficient, says Kalish. Instead, an investor who wants to buy private company stock will be required to verify their accredited investor status with certification from a third-party broker dealer, accountant, or lawyer, for example.
5. The amount of paperwork to be required by an entrepreneur that opts to generally solicit is still undecided. Separate regulations will determine when and how often a private company needs to file a Regulation D form surrounding a general solicitation. The current proposal, which is not yet finalized, is for an entrepreneur to have to file a Regulation D form at least 15 days prior to generally soliciting an offering and another after the solicitation is ended. A public comment period on these regulations ends Sept. 23 and then the SEC will hand down final rules. The expectation is that the regulations will be final by the end of the year, says Kalish.
Also, the industry is waiting to learn whether the SEC requires that private companies put a "legend," or warning label, on their marketing materials warning potential investors of the risks associated with investing in private companies.
Until the final regulatory details are established by the SEC, much of the community will be on pins and needles. "You don't see us jumping with a megaphone touting the benefits" of general solicitation, says Mittal. "We are being very cautious interpreting the regulations as well as waiting for the final rulings before making our own determination as to if this is ultimately going to be a good thing or a bad thing for people."
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