All posts in Startup Law

Pros and Cons of General Solicitation

PROS AND CONSI had an email exchange with a client this morning.

I started it abruptly.

“Are you going to generally solicit your offering?”

He didn’t know what I was talking about.  He had been head down, building stuff, not reading and writing about securities laws every day.  In other words, he had a real life.  He was building stuff people all over the world would one day use every day.

Here is how I responded:

“Well, ok.  In the old days, you couldn’t generally solicit or generally advertise your securities offerings.  You had to work pre-existing contact to pre-existing contact.  You were not supposed to stand up on a stage at an industry conference and say, ‘We are raising $500,000 in Series A at $1.00 a share.  Please see me and I’d love to talk to you about it.’  In fact, this was illegal.  It was also illegal to blog or Tweet or use Facebook to try to raise money.  Many people broke the rules.  Some got in a lot of trouble.”

Here is an example in NY Times.

SEC Rules

“Now, under rules effective September 23, 2013, you CAN generally solicit your all-accredited investor offering under Rule 506(c) of Regulation D; but if you do, you have to do the following:

  1. Only take money from accredited investors.  (Accredited investors are, most typically, individuals with a net worth  greater than $1M excluding their primary residence (but taking into account debt on that residence in excess of its FMV) or individuals with incomes in excess of $200,000 in the last two years with the expectation of the same in the current year or $300,000 with spouse.)
  2. Take reasonable steps to verify the accredited investor status of your investors.  This means reviewing Forms W-2, or other personal financial statements of investors. You can no longer rely on a check-the-box one-page certification.
  3. Check a box on your Form D that you generally solicited.

There are definitely pros and cons of generally soliciting.  I’ve listed some of the pros and cons below. I am happy to discuss on the phone!”

Pros

  • The ability to reach a wider audience
  • The possibility of closing your round faster.
  • Increased recognition of your business and your brand.

Cons

  • The added burden of taking reasonable steps to verify the accredited investor status of your investors; reviewing Forms W-2 or similar financial information, and keeping records that you did so. Some investors who would have otherwise invested may refuse to invest when you request this information.
  • It will take more time to undergo the document review referenced in the first bullet point above than what is required in a non-generally solicited Rule 506(b) offering. If you want to keep your securities offering as simple as possible from a legal point of view, it is easier to accept the one-page certifications from investors in a non-generally solicited offering than it is to undergo the diligence and record keeping steps of taking additional steps to verify the accredited investor status of your investors in a generally solicited offering.
  • Giving up a fall back securities law exemption. If you generally solicit, you probably can’t argue in the alternative that your offering was not a public offering under Section 4(a)(2) of the Securities Act of 1933, as amended.
  • Federal regulatory uncertainty. The SEC has proposed rules that will make generally soliciting much, much more difficult. It is unclear when those rules will go into effect and what they will ultimately look like, and what the transitional rules will be.
  • Potential state regulatory uncertainty. See New York, for example. Is an advance filing required under New York State law?
  • Arguably a greater risk of regulatory scrutiny than a non-generally solicited offering.
  • Once you go 506(c), you can’t go back, at least with respect to the pending offering.
  • The risk that strong investors, who bring more to the company than their cash (i.e., their reputation for picking winners, mentoring skills, industry knowledge, etc.) will be less interested in investing in a start-up that has raised money in a less discriminate fashion through general solicitation.
  • The risk of raising questions about your company’s financial position to customers and other third parties.
  • Potential integration of a new 506(c) round with a prior 506(b) offering, requiring you to go back to your investors in your prior 506(b) offering and collect from those investors the additional verification information.
Send to Kindle

Can I Generally Solicit Now?

Question and answerQ: Can I generally solicit or generally advertise my offering before September 23, 2013?

A: No. You can’t generally solicit or generally advertise your offering until September 23, 2013. Until September 23, 2013, general solicitation or general advertising of securities offerings is still illegal.

So please don’t do it. It is not worth it.

If you want to have a sense of how much trouble you can get into, you can review this SEC action:

SEC Press Release

See also: NY Times Article

Send to Kindle

More Questions About General Solicitation

General SolicitationThere is a lot of confusion about the SEC’s new rules that will allow, starting September 23rd, the general solicitation and general advertisement of private company securities offerings under Rule 506(c) of Regulation D.

If you want to read these final rules yourself, you can find them HERE

I received the following question the other day.

Investor Forms W-2

Do I have to review the Forms W-2 of my investors?

The answer to this is–not necessarily.  You only have to review Forms W-2, or other financial statements of your investors, if, after September 23rd, you generally solicit your offering.  You don’t have to generally solicit your offering.  Instead, you can conduct your offering in accordance with old Rule 506, now known as 506(b), which continues to prohibit general solicitation.

The potential trouble with this approach? If you are trying to conduct your offering in accordance with Rule 506(b) and you inadvertently generally solicit your offering (e.g., you tell a reporter when they call that you are raising money, and they report it), then you will have to conduct your offering in accordance with Rule 506(c).

What is General Solicitation?

The SEC doesn’t define the terms “general solicitation” or “general advertising.”  Instead, the SEC provides examples.

  1. Any advertisement, article, notice or other communication published in any newspaper, magazine, or similar media or broadcast over television or radio; and
  2. Any seminar or meeting whose attendees have been invited by any general solicitation or general advertising.

The SEC has interpreted general solicitation to include posting anything on the Internet. (”The placing of the offering materials on the Internet would not be consistent with the prohibition against general solicitation or advertising in Rule 502(c) of Regulation D.”).

The SEC has also said that a general solicitation is not present when there is a “pre-existing, substantive relationship between” a startup and the persons whom it is talking to about selling its shares.

If You Generally Solicit, What You Must Do?

If you generally solicit your offering, you will have to do the following three things:

  1. You will only be able to take money from “accredited investors.”  There is no allowance for up to 35 non-accredited investors (although that allowance in offerings that are not generally solicited isn’t really very helpful in any event).  “Accredited investor” means someone with income of at least $200,000 a year for the last two years, with the expectation of the same in the year of investment, or $300,000 with spouse; or $1 million net worth excluding the investor’s primary residence.
  2. You will have to take additional steps to verify the accredited investor status of the company’s investors, and keep records that it did so.  This means reviewing Forms W-2, 1099s, etc.  This is potentially a touchy issue for angel investors.  Angel investors may balk at giving this information to a startup.
  3. You will have to make a note on its Form D that it generally solicited. The Form D is the form companies have to file with the SEC and state securities regulators announcing that they have raised money.  It is due 15 days after first sale of securities in the offering.

Conclusion

Always exercise caution when you are conducting a securities offering.  Consult with your legal counsel regularly along the way.

Send to Kindle
 
Google