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.

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Questions Over General Solicitation Rules

General Solicitation QuestionsFolks have a lot of questions about the SEC rules regarding general solicitation that go into effect on September 23rd. (Check out the SEC Rules).

On September 23rd, it will become legal for corporations to generally solicit their Reg D Rule 506(c) securities offerings, provided:

  1. They accept only accredited investors.
  2. They take reasonable steps to verify the accredited investor status of their investors.
  3. They check a box on their Form D indicating that they generally solicited.

The fact that the SEC issued proposed rules on the same date that it issued the final rules on general solicitation has caused a lot of confusion. Especially because the proposed rules would put a whole bunch of additional requirements on generally solicited offerings in addition to the three above.

But on September 23rd, the additional requirements contemplated by the proposed rules will not be in effect. The rules that go into effect on September 23rd allow general solicitation provided you meet the above three listed requirements.

I received the following question the other day.

    Q: Do I have to file anything prior to September 23rd if I want to generally solicit on September 23rd?
    The answer is no. There is no requirement in the rules that go into effect on September 23rd to file anything in advance of generally soliciting.  The current rules, which will remain in effect after September, require a Form D to be filed within 15 days of the first sale of securities.

In the final rules on general solicitation, the SEC summarizes the filing requirement as follows:

“Under Rule 503 of Regulation D, an issuer offering or selling securities in reliance on Rule 504, 505 or 506 must file a notice of sales on Form D with the Commission for each new offering of securities no later than 15 calendar days after the first sale of securities in the offering.” (Emphasis mine.)

See here: www.sec.gov/rules/final/2013/33-9415.pdf

It is true that the proposed rules contemplate an Advance Form D filing. But the proposed rules are just that, proposed. The comment period on those rules ends on September 23rd. I encourage you to comment.

So, given that there is no filing in advance required before you generally solicit, is there anything in particular you should do before going ahead?

Yes. I would encourage you to carefully consult with counsel about the pros and cons of generally soliciting.

I wrote about some of the pros and cons on my article, What You Should Do Before Generally Soliciting.

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What should you do before generally soliciting?

Generally SolicitingWhat happens on September 23rd?

You can generally solicit your private company securities offering under Rule 506(c) of Regulation D.

What are the drawbacks?

    1. You can only accept “accredited investors.”
    What is an “accredited investor”? Generally this means a person who has made $200,000 a year for the last two years and expects to make the same in the current year, or with spouse $300,000; or a greater than $1M net worth excluding primary residence.
    2. You have to take reasonable steps to verify the accredited investor status of your investors, and keep records that you did so. You can no longer rely on a simple certification from the investor.
    3. You have to indicate on your Form D that you generally solicited.

Are there are any other catches?

The SEC has proposed rules that will make general solicitation of offerings much more complex. We don’t know when and if those rules will be made final, and what those rules will look like in their final form.

If the rules become final in the form in which they were proposed, the following will be required:

  1. Advance Form D filings 15 days before any general solicitation.
  2. Lengthy legends on all written general solicitation materials.
  3. Filing with the SEC all written general solicitation materials before their first use.
  4. A 1 year penalty if you miss a deadline and don’t cure it within 30 days (you only get one cure per offering). Meaning, you won’t be able to use Reg D Rule 506 for an entire year after the offering in which you miss the deadline.
  5. A lengthier Form D, with a lot more information disclosed.
  6. A terminating amendment to your Form D at the end of your offering.

What should you do before generally soliciting?

Always consult with a lawyer before generally soliciting your private company securities offering under Rule 506 of Regulation D. I know you would expect a lawyer to say this, but there are caution signs all over this road. And lots of dangerous road conditions. This path is not to be taken lightly.

For example, if you generally solicit, you are probably giving up a key legal fall back position (what is referred to as the Section 4(a)(2) exemption). And if you generally solicit and don’t completely and totally comply with the rules, not only may you not have a federal securities law exemption, you won’t be able to rely on the federal rules to preempt state law as well.

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Come Talk To Greg Gottesman of Madrona

Greg Gottesman has graciously agreed to come talk to our breakfast meetup group.

The date of the meetup is September 23rd. The meeting will start at 7:30 a.m. and end at 8:30 a.m., and will be held at our offices 1201 Third Avenue, Suite 2200.

You can sign up at the meetup.com site.

This will be a freewheeling discussion. We’ll ask Greg to expound some at the outset, but otherwise you’ll be able to ask Greg questions freely over breakfast.

Don’t miss this unique opportunity. I look forward to seeing you there!

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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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