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Startups can talk about fundraising. Flickr photo via Sam Oster.

The world changes for startups on September 23.

How?

On that date, thanks to the JOBS Act, it will become legal for startups to “generally solicit” and “generally advertise” their securities offerings. Startups haven’t been able to actively promote their private fundraising efforts, well, since before we were all born.

This is big deal.

What do these terms actually mean.

The SEC doesn’t define the terms but gives the following 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.

For eighty years, companies have not been able to advertise that they were raising money.

Is the lack of venture capital funding a problem for the Seattle startup ecosystem?

They couldn’t run ads on TV. Put up billboards on the side of the road. Respond to a GeekWire inquiry: “Are you raising money?” Or, even worse, mention that they were raising money on Internet.

In other words, when raising money startups had to work relationship to relationship.

While VCs or other funding sources could announce to the world that they had money to invest, companies had to be quiet, and not say anything in the media. I called this the “Rule Against Entrepreneurs.” 

Startups had to work their networks, sticking to “pre-existing substantive relationships,” as the SEC puts it.

Now, on September 23rd, a startup will be able to put on its web site that it is raising money. It will be able to respond to reporter inquiries that, yes, it is raising money. It will be able to stand up at trade shows or other industry events and say, yes, it is raising money. All without fear that it is blowing itself up for violating the securities laws.

The Drawbacks?

If a startup generally advertises or generally solicits its offering, then:

1. The startup 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 non-generally soliciting offerings isn’t really very helpful in any event.) “Accredited investor” means someone with income 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 primary residence.

2. The startup will have to take additional steps to verify the accredited investor status of its investors, and keep records that it did so. This means reviewing Forms W-2, 1099s, etc. This is potentially a touchy issue for your angels. Angel investors may balk at giving this information to startups in a garage somewhere, regardless of the fact that so many great companies have begun there.

3. The startup will have to make a note on its Form D that it generally solicited. The Form D is the form startups have to file with the SEC and state securities regulators announcing that they have raised money.

Should You Rush In?

Joe Wallin
Joe Wallin

Never rush when it comes to a securities offering. Be careful. The drawbacks are real. If you can raise money without generally soliciting, it will be easier because you won’t have to review investor W-2s, or other investor financial data. So, if you can raise money without generally soliciting you should. (See my earlier post: Weekend Read: Time to Advertise Your Private Offering? Not So Fast.”

But, Congress did us a big favor in the JOBS Act, and you just might want to take advantage of it.

What else should you do?

Comment to the SEC on its proposed rules. You may or not be aware, but the SEC’s proposed rules on general solicitation are really bad. An all-star cast of none other than Brad Feld, Naval Ravikant, Fred Wilson and Steve Blank — who Tweeted recently that the “SEC screws the JOBS Act by not understanding startups”— have come out heavily against them. You can read all of the comments submitted to the SEC here.

You have until September 23rd to comment. I encourage you to do so!

Conclusion: Have fun, but be careful out there.

Joe Wallin is an attorney at Davis Wright Tremaine. He’s the editor of the Startup Law Blog. Related posts: Crowdfunding: Current Legalities & Proposals… The President Favors Crowdfunding, But Is It Good Enough?The Troubles With The New Crowdfunding Law


Comments

  • http://startuplawblog.com/joewallin Joe Wallin

    For another resource on the proposed SEC rules, see saveregd.org.

  • http://ohheyworld.com/ Drew Meyers

    I actually didn’t know it was against the law to answer those questions from a reporter. Glad I know, and just in time for it to not matter anymore it sounds like :)

    • http://startuplawblog.com/joewallin Joe Wallin

      Well, you still might want to raise money the old fashioned way. Without generally soliciting. So you don’t have to ask your angels for their financial statements etc.

  • Vroo (Bruce Leban)

    The new rules have a poison pill in them. If you violate the rules, then you are banned from fundraising for a year. Considering the rules aren’t even final you could violate them before they’re written and still get in trouble. And just the amendments to the rules are 186 pages! http://www.sec.gov/rules/proposed/2013/33-9416.pdf

    • http://startuplawblog.com/joewallin Joe Wallin

      It is the proposed rules that have that penalty. We will see if they become final in the form proposed. Submit your comments to the SEC.

  • Jean Peters

    Here’s a Catch 22? On Oct. 1, a startup is ready to close a $500k deal. Said startup pitched her deal at a statewide venture forum in August, and attracted several investors. If startup checks box 506c on Form D, she is acknowledging that she generally solicited before it was legal. If she checks box 506b, she is saying there was no general solicitation….but, it it is deemed that there was, then can’t use 506b, and is now “locked out” from any exempt offering for a year. And, has to offer rescission to all investors. In either case, game over. As they say, October is the cruelest month…..

    • http://startuplawblog.com/joewallin Joe Wallin

      Jean, we don’t know when the proposed rules will become final, and what they will look like in final form. But it is the proposed rules that contain that 1 year penalty–not the rules that go final on Sept 23.

      But you are right–you can’t generally solicit in any event before Sept 23.

      • Jean Peters

        Okay. So it’s “just” rescission. But my question still stands. Which box does the issuer check? 506b, for ” no general solicitation?” Or, 506c, for general solicitation (but only when it was illegal to do so)? Door number 1, or 2? (Tiger behind both?)

        • http://startuplawblog.com/joewallin Joe Wallin

          If you generally solicit, you have to check the 506(c) box. But don’t generally solicit before 9/23! And don’t do it at all if you can avoid it.

          • Jean Peters

            You are missing my point. The startup participated in a statewide venture forum (or other open event) in AUGUST, as hundreds of startups have done. Now, it is October 1, and they need to file a Form D because they are closing the deal.
            This isn’t hypothetical. Hundreds of startups that have participated in events designed to attract investors prior to Sept. 23 and will be closing a transaction shortly after the new Rules take effect, are going to face this conundrum.
            What box do they check?

          • http://startuplawblog.com/joewallin Joe Wallin

            Right. So, the answer is–don’t generally solicit prior to 9/23!

          • Jean Peters

            So…. the August “pitch event” wasn’t general solicitation? Is that what you are saying?

          • http://startuplawblog.com/joewallin Joe Wallin

            Jean, I have no idea because I don’t know all of the facts surrounding that event. But my point is–it has been illegal to generally solicit for as long as we can all remember. That has been the rule forever.

            If that event is open to the public, and people are pitching their securities at that event, then see the above quoted rue: “Any seminar or meeting whose attendees have been invited by any general solicitation or general advertising.” That has been the law forever. I don’t know what to say other than, people need to abide by the law, and consult counsel. But, the law does change for the better on 9/23. And that is a good thing.

  • http://startupexecutives.tumblr.com/ John M Sutton

    After discussions with several connections across the investment community, I agree that established VCs are by default accredited investors and most likely will not participate by General Solicitation. Advertisement may raise their
    awareness of previously unheard of deals, however professional VCs already work established communication channels (“deal flow”) and preexisting relationships.

    If you believe that premise, here are some potential outcomes:

    1. Until some spectacular JOBS Act enabled “WINS!” occur, prototypical Venture Firms and established Seed Investors will continue to invest in “Tier 1” deals through historic channels.

    2. More marginalized startups, those that may not meet baseline requirements for more orthodox venture firms, will generate runway through general solicitation.

    3. More diverse value propositions and business models will secure needed capital. Established investors generally look at a finite type of startup; business (social), model (SaaS), leadership team (proven) and market opportunity (scalable). Now smaller, more niche or “localized” startups will generate runway and marketplace buzz. This may be a true renaissance in sheer awareness and
    growth of “unorthodox” businesses serving previously untapped market
    needs.

    4. No longer “the only game in town”, deal terms may improve as those requiring capital will possess a realistic alternative. As liquidity improves from new sources, founders seeking capital will need to consider the true value of what an established VC firms brings to the table in terms of growth enablement.

    5. Unqualified investors, potentially those without startup and even business experience, may clamor for a turn at the wheel. These folks will want their voices to be heard, and will need to be kept informed. This requirement may evolve within startups as more akin to the Investor Relations function within publicly traded companies.

    Of course, the true consequences are unknown at this time. The ability to leverage “General Solicitation” and generally advertise your securities offering pre-existed our birth dates. This story has yet to be written. It is an exciting time.

    • http://startuplawblog.com/joewallin Joe Wallin

      I agree John! Great comment.

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