Image from a FundersClub introductory video.

Every day I engage with at least one person about how startup investing will change because of the JOBS Act.

Crowdfunders want to know when they can set up platforms and list deals. Angels want to know if new verification rules will mean no more investing in startups unless they turn over tax returns and personal financial statements. And entrepreneurs want to know if it’s okay to start tweeting about the $100,000 still available in an open Series A round.

In most of these discussions, the answer usually involves a caution: wait on SEC rulemaking.

One startup in California, FundersClub, appears to be moving on all fronts above at once, not waiting on anything.

I haven’t spoken with the founders of FundersClub. My reaction is provoked by what I read on the FundersClub site and in TechCrunch and VentureBeat.

TechCrunch is enamored: “Don’t call it Kickstarter, because on FundersClub you get real equity for your investments in hot startups.” The reporter for VentureBeat at least mentions key legal concepts that, should you chase them down, explain why others are more circumspect about pitching startup deals in such an open fashion.

William Carleton

From what I can tell, no one has yet publicly called out that FundersClub is playing with fire.

I worry about first-time entrepreneurs, those who haven’t raised private money before, who may not have the judgment to weigh the allure of FundersClub’s promise of low-hanging “dumb money” (the phrase was in TechCrunch) against the radioactive risk of violating securities laws.

What’s at stake in getting it wrong? Because Rule 506 is going to include a bad actor disqualification, a great deal is at stake, potentially. Startups and entrepreneurs that associate with a rogue operation for financing are potentially compromising their ability to raise angel money. Betting their future financeability, you might say, on FundersClub’s arbitrage of the shifting regulatory landscape.

It’s possible FundersClub or their attorneys have found something in SEC interpretive releases and no-action letters that the rest of us have missed. If so, more power to them. More to the point: FundersClub should publish any legal opinions they’ve commissioned. That would help other entrepreneurs assess the risks.

There is an FAQ on the FundersClub site, but it’s conclusory rather than explanatory, too thin for something involving public solicitation of other people’s money.

Here are the questions to which I’d want satisfactory answers before I’d list my startup with them:

(1) What permits you to generally solicit for investors before Rule 506 of Reg D has been changed to permit general solicitation and general advertising? If your position is that you don’t engage in general solicitation, then:

  • are you making new members wait 30 days before having access to deals;
  • what are you doing to clamp down on reports in the tech press disclosing publicly which startups are listed on the site; and
  • are you betting that your screening process will satisfy the accredited investor “verification” rules, whatever those may be when published?

(2) You say you’re putting investors into “special purpose vehicles” more like VC or angel sidecar funds, tried-and-true vehicles that aren’t legally suspect. But at the same time you promise investors access to startup founders, and warn that startups may occasionally veto an investor’s participation — indications of a more direct company-to-shareholder relationship. How do you assess the risk that regulators won’t look past the form to the substance of the offering(s)?

(3) Are you relying on the federal broker-dealer safe harbor for online platforms promoting deals restricted to accredited investors, set out in Section 201(c) of the JOBS Act? If so, can you confirm that you do not take possession of investor funds and don’t hold securities?

Bottom line: If this passes muster, great. But tell the world why. For better or for worse, money raising is an industry where mastery of the legal issues has got to be a core competence.

[Editor’s Note: GeekWire contacted the founders of FundersClub via email today prior to publication and invited them to answer the questions raised by this piece. We’ll follow up with an update if we hear back.]

Attorney William Carleton is a member of McNaul Ebel Nawrot & Helgren PLLC, a Seattle law firm. He works with startups and emerging tech companies, their founders and investors. He posts regularly about tech-related legal issues on his blog.

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  • Bryan Starbuck

    I’m 99.9% sure that FoundersClub is only for accredited investors. For that reason, they are safe — in the same way that Angel List is operating right now legally.

    They qualify people that they are fully accredited when they sign up. They appear to block people who aren’t accredited. Maybe I have it wrong, but that would make them safe.

    • William Carleton

      I know I’m sounding like a wet blanket, but there is a rule against “general solicitation” and “general advertising” that applies to offerings relying on either Rule 505 or Rule 506 under Regulation D.

      Many people seem to think that the JOBS Act removed the restriction on general solicitation and general advertising, so that offerings relying on Rule 506 can now be openly advertised, as long as 100% of the purchasers are accredited. But that is only half true. The SEC still has to write rules to implement this provision of the JOBS Act. Also, Congress has told the SEC that it must come up with new rules for “verification” of accredited investor status, the thinking being, if angel deals are going to be broadcast widely, then tougher standards need to be followed to ensure that investors really/truly are accredited (today, that process is essentially an honor system). So here’s the quandry: how do you generally solicit before it is okay to generally solicit; and how do you “verify” accredited investor status in a deal using general solicitation, when you can’t even know yet what the verification rules are (that’s because the verification rules haven’t even been proposed yet).

      It gets even more complex when you get into the SEC no-action letters about brokers using online portals with customers, and nuances of the “pre-existing relationship” concept and cooling off periods. But the easiest concepts to grasp are those having to do with the transition that is underway on the general solicitation and verification rules.

    • adamslieb

      Bryan you are 100% right FundersClub is only for accredited investors. They screen both companies and individuals before letting them into their private (meaning non-public) portal. This currently has NOTHING to do with the crowdsourced funding acts. This would have been just as legal 2 years ago is it is now. FundersClub is just setting up an online portal for accredited investors to meet startups.

  • Jonathan Chizick

    William – do you think the latest SEC ruling clarifies the questions you raise?

    To answer a question raised in prior comments – yes, FundersClub is only for accredited investors. You are screened prior to even being able to view the names of the companies they are raising funds for.

    However, there’s possibly a question that still needs to be answered…does advertising for FundersClub constitute ‘general solicitation’ for the unnamed companies they’re investing in?

    • William Carleton

      Jonathan, I’m only just now seeing your comment. Apologies for not answering sooner.

      What @joewallin is talking about in the blog post you link to is an SEC release with *proposed* rules to implement the lifting of the ban on general solicitation. The key qualifier here is “proposed.” The rules are not final. Unfortunately, unlike other provisions of the JOBS Act, the lifting of the ban on general solicitation did not become effective once the President signed the JOBS Act. Instead, the law said that the SEC must first write rules to implement the change, and the change won’t go into effect until the SEC promulgates final rules (unless, of course, Congress passes the legislation again, this time not requiring rulemaking, but I don’t know anyone who thinks this is likely).

      adamslieb is correct above when he says the lifting of the ban on general solicitation in Reg D Rule 506 offerings where all purchasers are limited to accredited investors has nothing to do with the equity crowdfunding provisions of the JOBS Act. They are completely separate pieces of legislation. However, both the lifting of the ban on general solicitation in offerings to accredited investors only, and the equity crowdfunding provisions in the separate part of the JOBS Act (Title II and Title III, respectively, if it helps to have shorthand references), do have at least this in common: neither is effective, until the SEC has finalized rules to implement the new laws.

      And speaking of the proposed rules on general solicitation (for offerings limited to accredited investors, not Title III): those have proved to be controversial. Many of us think the SEC will go back to the drawing board and try again. The upshot is, the lifting of the ban on general solicitation will far longer than any of us thought when the JOBS Act passed. (As for Title III, no proposed rules have been published, and in fact aren’t even due yet under the legislation.)

      I think your last question is very apt. It is one that a startup should ask and get independent advice on.

      • Jonathan Chizick

        Thanks William. Certainly an exciting time for startups.

        • William Carleton

          Indeed. Lots of changes in the landscape and on the horizon.

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