Crowdfunding Obstacles

Crowdfunding obstaclesIf you are still digesting the 585 pages of rule changes on crowdfunding the SEC dropped last week, don’t worry, you are not alone. Folks are still processing all of the rules the SEC issued in July, which means if you’ve been scratching your head all summer, keep scratching.

The other day I received this question from the CEO of a company that has already gone through several rounds of funding. The question was–what if I generally solicit my next round? What do I have to do then?

I gave the standard spiel:

  • Additional administrative burden.
  • Have to collect information from the investors showing that they are accredited.
  • Forms W-2.
  • Forms 1099.
  • Personal financial statements.
  • No non-accredited investors can participate.
  • Have to check the box on the Form D indicating that you generally solicited.
    “What if they say no? What if they refuse to provide their Forms W-2, etc.,”he asked
    “Well, then you can’t take their money,” I said. “Just like in the old days, if an investor didn’t check the right ‘accredited investor box’ on their investor certification form, you couldn’t take their money or had to return it.”
    “What about my existing investors,” he asked. “What if I generally solicit, and out of the 100 people who call me, only 10 are willing to provide the information, and the rest drop out, and I have to go back to my existing investor to fill the round, how do I treat them?”

And that leads us to this week’s Q&A question:

Q: If I generally solicit my next round, so that I have to take reasonable steps to verify my new investors are accredited, what about my existing investors who wish to participate in the round? Am I going to have to ask them for Forms W-2, 1099, personal financial statements, etc.?

A: Under the rules, there is a carve-out for existing investors. The rule says this, exactly:

    “The issuer shall be deemed to take reasonable steps to verify if the issuer uses, at its option, one of the following non-exclusive and non-mandatory methods of verifying that a natural person who purchases securities in such offering is an accredited investor; provided, however, that the issuer does not have knowledge that such person is not an accredited investor:
    In regard to any person who purchased securities in an issuer’s Rule 506(b) offering as an accredited investor prior to September 23, 2013 and continues to hold such securities, for the same issuer’s Rule 506(c) offering, obtaining a certification by such person at the time of sale that he or she qualifies as an accredited investor.”

In the commentary to the final rules, the SEC said this:

    “We are including the fourth method in our non-exclusive list of methods that are deemed to satisfy the verification requirement in Rule 506(c) because we acknowledge that existing accredited investors who purchased securities in an issuer’s Rule 506(b) offering prior to the effective date of Rule 506(c) would presumably participate in any subsequent offering by the same issuer conducted pursuant to Rule 506(c) based on their pre-existing relationships with the issuer. Accordingly, for these existing investors who were accredited investors in a Rule 506(b) offering prior to the effective date of Rule 506(c), a self-certification at the time of sale that he or she is an accredited investor will be deemed to satisfy the verification requirement in Rule 506(c). This provision does not extend to existing investors in an issuer who were not accredited investors in a Rule 506(b) offering that was conducted prior to the effective date of Rule 506(c).”

Conclusion

Generally solicited Rule 506(c) offerings involve difficulties not present in non-generally solicited Rule 506(b) offerings. Meaning, if you want to make life easy (administratively speaking) the non-generally solicited route is the way to go.

About Joe Wallin

Joe Wallin focuses on emerging, high growth, and startup companies. Joe frequently represents companies in angel and venture financings, mergers and acquisitions, and other significant business transactions. Joe also represents investors in U.S. businesses, and provides general counsel services for companies from startup to post-public.
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