On September 23, 2013, the world changed.
For longer than most of us have been alive, if you wanted to raise capital – which usually means offering securities – the basic rule was simple, but frustrating: If you wanted to advertise your offering, you had to register with the SEC, which was very expensive and time-consuming. If you wanted to avoid SEC registration, you could not advertise your offering or conduct any other “general solicitation” (broadly defined). And that, of course, begged the question of how can you find investors if you can’t advertise or go out soliciting them.
The Jumpstart Our Business Startups Act (JOBS Act) mandated the repeal of that restriction on so-called “private placements” or nonpublic offerings, which are exempt from SEC registration. On September 23, 2013, that repeal took effect through amendments to SEC Regulation D. Companies can now advertise and conduct general solicitations to raise capital without registering with the SEC. In other words, now you can actually go out looking for buyers, and the crowdfunding floodgates have opened!
But of course, it’s never all that simple.
If you want to operate in this new world, you can advertise to anyone BUT you can only sell to “accredited investors,” as defined by the SEC. The full definition of “accredited investor” is longer than this whole article, but the principal part of the definition is: (1) a person who had annual income of at least $200,000 in each of the last two years, or $300,000 if you include a spouse’s income, and who reasonably expects to reach that income level in the current year; or (2) a person whose net worth exceeds $1 million, excluding his or her primary residence.
Even before the new rules, “accredited investor” was an important concept, and many companies limited their offerings to accredited investors to avoid the special disclosure rules that applied to sales to non-accredited investors. But back then, companies just needed to reasonably believe that an investor was accredited. It became routine to use a check-the-box instruction on the subscription agreement for investors to claim accredited status, and companies tended to rely on that checked box to show their reasonable belief, without asking investors for confidential financial or tax information to prove their status.
Under the new rules, check-the-box is not enough. Companies must be proactive in getting specific information about an investor that reasonably demonstrates accreditation. The most reliable information will probably be the hardest to get, namely tax returns, W-2 forms, or personal financial statements. Of course, if your investor is Warren Buffett or Carl Icahn, you can just rely on his identity to conclude that he is accredited. But the less actual knowledge you have about a particular investor, the heavier the burden will be on you to obtain sufficient and reliable information that demonstrates the investor’s high income, high net worth, or other accredited status. And you will need to retain adequate records that support your conclusion. You can well imagine that some potential investors might resist.
What if you can’t get this information, or what if you get it and it shows you that your investor is not accredited?
Well, the old rules for private placements still coexist with the new rules. Under the old rules, if you do not advertise or conduct general solicitation, then you can sell to a limited number of non-accredited investors and you will also be held to a lesser standard in ascertaining accredited status.
But not so fast…. When you advertised your offering in reliance on the new rules, or hopped on a crowdfunding platform, you lost your eligibility to rely on the old rules, which do not allow this activity.
So what all of this comes down to is that if you rush into your offering, without proper legal advice about how to structure it and about all the decisions you will have to make have going forward, you might wind up in a worst-case scenario – not qualifying under the new rules and disqualifying yourself under the old rules. Ouch!
And, by the way, the antifraud provisions of the securities laws have not changed. No matter how you advertise your offering, the legal consequences of failing to disclose material information, or making material misstatements or omissions, are severe.
If you plan to raise capital without experienced securities law counsel, plan again. If you plan to launch your offering and then retain securities law counsel at a later stage, plan again. If you plan to do anything other than proceed cautiously with expert advice right from the get-go, plan again. If I can be of assistance to you, it sounds like a plan.