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Pitfalls of The Proposed Regulation D Rules

PITFALLS REGULATION D RULESThere is an argument going around that the proposed Reg D rules are not that bad because they affect only companies that are going to generally solicit their Reg D securities offerings.

This is simply not true.

The SEC’s proposed rules will adversely affect companies that are not going to generally solicit their offerings as well.

How?

Even companies that don’t generally solicit their offerings are going to be subject to the potential one year penalty box if they miss their Form D filing deadlines. Sure, companies not generally soliciting won’t have to file “Advance Forms D,” but they will still have to timely file Forms D. The 15 day deadline, under the proposed rules, is going to become very real and very painful for companies that miss it.

Companies that are not generally soliciting will also have to complete the same Form D as companies generally soliciting. Under the proposed rules, the Forms D are going to require a lot more disclosure, and take a lot more time and expense to complete. This is another facet of the proposed rules that is not great.

Finally, companies that are not generally soliciting will also have to file terminating amendments to their Forms D, just like companies generally soliciting.

Fulfilling Requirements

What bad part of the proposed rules will companies not generally soliciting escape? They will escape the following three requirements, which will apply only to companies generally soliciting:

  • The requirement to file an Advance Form D at least 15 days before generally soliciting
  • The requirement to prominently include lengthy legends on all written general solicitation materials, and
  • The requirement to submit all written general solicitation material to the SEC prior to use.

Everyone in the startup ecosystem should care about the proposed rules, regardless of whether they intend to generally solicit or not. This is even more true because of the nebulous nature of what constitutes “general solicitation.” Many, many companies that don’t intend to generally solicit may trip inadvertently and fall into the rules governing companies that generally solicit.

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Section 1045: Let’s Fix It

Amend Section 1045If Congress is on the hunt for ideas to make life better for startups and emerging growth companies, here is another:

“Amend Section 1045 of the Internal Revenue Code to extend the 60 day rollover period to 6 months.”

First Off, What Is Section 1045?

Section 1045 is a tax code section that allows non-corporate taxpayers to rollover their gain on qualified small business stock, into other nonqualified small business stock. I’ve quoted the first part of Section 1045 below.

Why is Section 1045 important? Section 1045 is to startups what Section 1031 is to real estate. It encourages investments into startups. A noble objective!

Here is the operative provision I am recommending be amended:

    (a) Nonrecognition of gain
In the case of any sale of qualified small business stock held by a taxpayer other than a corporation for more than 6 months and with respect to which such taxpayer elects the application of this section, gain from such sale shall be recognized only to the extent that the amount realized on such sale exceeds—
(1) the cost of any qualified small business stock purchased by the taxpayer during the 60-day period beginning on the date of such sale, reduced by;
(2) any portion of such cost previously taken into account under this section.
    This section shall not apply to any gain which is treated as ordinary income for purposes of this title

Why Amend It?

60 days is a very short window in which to find a replacement investment. If you have ever done angel investing, you will know. To find and close an investment in 60 days is not an easy task. Usually investors hunt for months before they find an investment that they like. Then the paperwork to effectuate the investment can sometimes take weeks as well, if there is back and forth on various business points as the deal is negotiated.

In short, the Section 1045 statute exposes a lack of understanding on the part of the drafter as to how these transactions work. You can’t just call your broker and place an order. Most angel investments are not effectuated through a broker-dealer (which is one of the flaws of the crowdfunding bill–forcing companies who want to crowdfund to work through a broker-dealer).

Conclusion

We need is a Congressional representative to introduce a bill extending the 60 day window to 6 months. Very simple. Could someone please do this?

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Double Down: Deal of a Lifetime

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