Today, the U.S. Securities Exchange Commission’s final rules allowing general solicitation went into effect. In the fundraising context, general solicitation means publicly advertising the fact that you’re raising money. Previously, this was a big no-no.
The Way it Was
The most important securities regulations for startups is Regulation D, or Reg D. In a nutshell, Reg D provides exemptions from the general rule that all securities have to be registered with the SEC. Registration is a complex and expensive process that would in itself sink many small companies, so Reg D is a big deal. Blowing Reg D exemptions keeps securities lawyers up at night.
The most useful of the exemptions Reg D provides is Rule 506, which doesn’t have a dollar-amount cap. However, Rule 506 has two catches. First, companies can only raise funds from an unlimited number of accredited investors plus up to 35 non-accredited investors. For individuals, an accredited investor is someone with a net worth over a million dollars, or who makes $200K per year (or $300K with a spouse). The second catch was that companies couldn’t advertise the fact that they were raising money. The practical effect of these two catches was that (1) startups could only raise money from rich people, and (2) networks of investors were really important.
What Changes Today
As of today, the ban on advertising the fact that you’re fundraising goes away, but this, too, comes with a few catches. Under the new rules, if you advertise your offering, you have a heightened duty to make sure you only take money from accredited investors. Companies already had to be careful about this under the old rules, but the new rules are more stringent and the SEC’s staff has promised more vigilance.
Does this mean attendees will have to bring their tax returns to get in to demo days? Hopefully not, but we’ll see. At a recent public meeting, the SEC staff didn’t have great answers.
Points Of Uncertainty
As AngelList CEO and COO Naval Ravikant and Kevin Laws pointed out here this weekend, the SEC’s new rules use lawyers’ favorite weasel word: “reasonable.” Specifically, companies raising money have to take “reasonable steps” to make sure they don’t take money from unaccredited investors. A new part of Rule 506, subsection (c)(2)(ii) gives a few specific examples of what the SEC would consider reasonable, including looking at the potential investor’s tax filings or getting a verification letter from the investor’s lawyer, accountant, or SEC-registered broker-dealer or investment adviser.
There has been a lot of griping over these verification requirements. Yes, this will impose some costs on the process, but it’s not the end of the world. AngelList is taking an interesting step and turning this into opportunity by providing verification services. The SEC describes its approach to verification as “principles-based,” so these are not the only possible reasonable verification steps. Other angel investor groups could get into verification, as well, to help their members.
You Can Still Do It The Old Way
General solicitation is optional. If you’ve raised money under the old rules and are comfortable with them, you can stick to what you know and play it safe. If you do, the heightened verification rules don’t apply. I expect many entrepreneurs will play it safe and sit out general solicitation, at least for now, and let someone else take the first SEC enforcement bullet.