Editor’s Note: This post was originally published on Seattle 2.0, and imported to GeekWire as part of our acquisition of Seattle 2.0 and its archival content. For more background, see this post.
By William Carleton & Joe Wallin
This is a guest post by WilliamCarleton, corporate attorney at McNaulEbel Nawrot & Helgren PLLC, and Joe Wallin, corporateattorney at Davis Wright Tremaine LLP. Theyare both concerned about the unintended consequences of draft law beingcirculated in the Senate that could have adverse impact for startups seekingangel investors.
Earlier this month, Senator Dodd posted a discussion draft of the Restoring American Financial Stability Act of 2009. At over 1,000 pages, it is not a light read.
Buried on page 686-687 of the draft is a proposed repeal of the federal pre-emption of state laws regulating accredited investor securities offerings under Regulation D. Reg D offerings make it possible for companies raising small amounts of capital to do so safely, quickly and efficiently. This aids in job creation. America’s next great companies are being funded right now with very small amounts of capital. It’s feasible to raise capital in such small amounts, while still protecting investors who need protecting, because of Reg D.
There is no clearer example of how well this system works than here in our state. We see this in our practices particularly for web and software startups that may be raising tens of thousands, or hundreds of thousands (as opposed to millions) of dollars: the ability to raise small amounts of capital in an efficient way makes a critical difference for the viability of the venture. And because investors in such financings must be accredited, no harm comes to unsophisticated investors for whom the risks of early stage technology companies are not appropriate.
It hasn’t always been this way. Previously, states were able to impose their own merit review of securities offerings to residents in their states, and the vast majority of states did this. This posed significant uncertainty for companies raising capital, and significant cost. Perhaps the greatest frustration was a lack of uniformity: states imposed varying degrees of merit review, different disclosure requirements, different notice and filings requirement, different comment systems, varying length of review and comment periods, different suitability standards, different securities legending requirements, and more. In effect, the state-by-state system discouraged entrepreneurs from crossing state lines when raising capital. And when the amounts needed were small, it was often not feasible to go through the process at all, in state or out of state, because of the costs.
The state-by-state system all changed with passage of the National Securities Market Improvements Act (NSMIA), which brought with it federal preemption of state regulation of accredited investor offerings. NSMIA made the process simple you file a Form D with the SEC and you file copies of the Form D with states in which your investors reside. You have to pay state filing fees, too, in most cases. But, because of federal preemption, states could not impose merit or substantive review of your offerings. It was a masterstroke of rationality and good public policy, friendly to entrepreneurs, and wholly protective of unsophisticated investors. Keith Baldwin, a securities attorney at Davis Wright, puts it this way: “In my view, other than Reg D itself, NSMIA was the best thing to happen tocapital formation for small business in my 30+ years of practicing securitieslaw.”
By proposing to end federal preemption, Senator Dodd is proposing that we go back in time to the days of state merit and substantive review of securities offerings. In Baldwin’s view, “Although some state securities regulators may choose to keep existing practicesin place, other states will likely revert to the widely variant schemes ofexemptions that preceded NSMIA.” We think this would be especially harmful to the smallest companies that are raising angel capital in fairly small offerings. Today it is possible for small companies to raise as little as $250,000 in angel financings and not expend too great of a portion of that capital raise on lawyer fees. Imagine, though, that those angel investors are in three or four states, and your lawyers tell you it will cost you twenty percent of what you raise to comply with the various securities laws!
A group of entrepreneurs, investors and attorneys have joined in a letter to Washington State’s two Senators, Patty Murray and Maria Cantwell, urging that Dodd’s proposal not become law. This group includes: Keith Baldwin, Attorney; Bill Bromfield, Attorney; Bill Bryant, Investor; Marcelo Calbucci, Entrepreneur; John Clyman, Entrepreneur; Stuart DePina, Entrepreneur; Geoff Entress, Investor; Sonya Erickson, Attorney; Jim Ewel, Entrepreneur; Daniel Fine, Entrepreneur; Jeremy Freeland, Attorney; Joe Harb, Entrepreneur; Matt Heaton, Entrepreneur; Mark Hoffman, Attorney; Brian Myers, Attorney; Joe Snell, Entrepreneur; Mark Spangler, Investor; Matt Springer, Entrepreneur; Jason Thane, Entrepreneur; Tandy Trower, Entrepreneur; Jon Washburn, Entrepreneur; and Joe Whitford, Attorney. We particularly thank Marcelo Calbucci for supporting us in this effort and for inviting us to guest post here at Seattle 2.0.
The text of our letter is below. The issue is not just confined to Washington State. We hope readers of this post, throughout the country, will urge their representatives in Congress to not turn back the clock to a time when it was much more difficult for small companies to safely raise needed capital. Our entrepreneurs are getting smarter about doing more with less; let’s not make it unfeasible to raise seed funds.
November 23, 2009
Via U.S. Mail, Fax and Email
U.S. Senator Patty Murray, 173 Russell Senate Office Building, Washington, D.C. 20510
U.S. Senator Maria Cantwell, 511 Dirksen Senate Office Building, Washington, DC 20510
Re: Protecting the Way Technology Startups Safely Raise Seed Financing
Dear Senator Murray and Senator Cantwell:
We are writing to bring to your attention language in Senator Dodd’s Restoring American Financial Stability Act of 2009 that would be harmful to technology innovation in Washington State. If Senator Dodd’s draft legislation, as currently drafted, were to become law, it would be harder for entrepreneurs in our State and indeed, throughout the nation to launch startup companies.
Section 928 of Senator Dodd’s draft legislation would repeal the existing federal preemption of state regulation over “accredited investor” securities offerings. This would end the uniform, national set of rules for financing that currently makes capital raising for technology startups so safe and so efficient. By gutting something that is working, Senator Dodd’s draft legislation would expose technology startups to a potentially Byzantine system of patchwork, state-by-state regulation, resulting in higher costs, greater legal risks and pervasive uncertainty. Nothing would be gained from this change: no additional protection would be provided to the types of investors who truly need protecting, and there would be no benefit to the national financial system or to the economy.
The startup ecosystem in Washington State, comprised of entrepreneurs and the angel\ investors and professionals who support them, is one of the \spawning pools from which tomorrow’s great American companies are born. In our State, as well as in other regions of innovation in our country, technology startups are funded by (a) the entrepreneurs who start them, (b) the friends, networks and family of those entrepreneurs, and (c) experienced angel investors who have a taste for startups and a passion about supporting entrepreneurs. This community depends upon the uniformity, clarity and certainty of federal exemptions, which substantially ease the costs and legal risks of raising critically needed seed capital.
The persons signing this letter are entrepreneurs, angel investors and lawyers who found, fund and work with technology startup companies in Washington State. We ask you to look into this matter and to take action to protect the technology startup ecosystem, for the sake of the entrepreneurs and startups of Washington State and for the sake of innovation throughout our country.
