Today is the first day it becomes legally permissible for startups and emerging companies to advertise their offerings.
Or to tweet that they are raising money.
Or to generally solicit for investors at public pitch events.
What’s that you say? Startups have been generally soliciting at pitch events, demo days, conference contests, for some time now?
Maybe, maybe not.
But today, Rule 506(c) of Regulation D becomes effective, which means, it is okay to advertise your offering, and it is manifestly okay to openly, publicly seek investors at pitch events, as long as (1) only accredited investors may invest, (2) you take reasonable steps to verify the accredited status of all of your purchasers, and (3) you otherwise comply with the conditions of the Rule 506 exemption.
Leading online platforms have wasted no time in adapting their sites to facilitate 506(c) deals.
Rory Eakin, founder and COO of CircleUp, told me that his company “will have companies on the landing page for the first time ever.” Until today, you could only see live investment deals if you had first signed up and gone through a process to vet your accredited status. I remarked to Rory, “so the walls are coming down, then.”
He came back with a more astute metaphor: “for some deals, the wall is moving back.” Meaning, you can see the deal first, then verify your accredited status at the time of investment. Other deals will continue to not be public-facing. (In fact, a majority of CircleUp’s offerings will continue to be under Rule 506(b), the old rule, which prohibits general solicitation and general advertising).
As of this writing, AngelList appears to have 1,076 startups openly soliciting for investors on the site, presumably all committed to filing Form D’s within fifteen days of first sale, and to checking a box to say they are relying on the new Rule 506(c). (Don’t make the same mistake some reporters are making! There is no 15 day pre-filing requirement, no information filing requirement, none of those things in a pretty bad rule set proposed by the SEC, which may or may not eventually go into effect as proposed.)
This transition will not be without friction.
Some angel group leaders have been advising companies to not go there. Some angels are taking the position that they will not be investing in any deals that involve general solicitation or general advertising. The reps and warranties are already being written: “Company has not engaged in general solicitation and is not otherwise subject to Rule 506(c) . . . .” Access to many angel group meetings and demo events is being tightened up, in an effort to preserve the availability of the old rule, now known as Rule 506(b), which very much remains a viable option. (Kudos to the SEC for having the foresight to preserve the old rule in parallel with the new.)
Other angels and angel groups are trying hard to make sure 506(c) will be a viable part of the startup financing ecosystem. The Angel Capital Association is the leader in this effort. ACA has issued guidance for startups and their lawyers to consult, when confronting the new verification standard that is the key new feature of Rule 506(c). (Disclosure: I and a colleague at my firm helped in the development of the ACA guidance.)
The key hangup angels have with the new rules?
“Default” verification methods specified in the rule which have troublesome privacy implications.Though expressly “non-exclusive and non-mandatory,” the specified methods of verification involve securing sensitive financial information from angels. As a serial entrepreneur I’ve worked with for 20 years told me last week, “ironically, the higher net worth the investor has, the more of a problem verification is going to be.” His point was that very, very wealthy people and their families, in his experience, tend to be much more guarded about revealing personal financial information.
Whether or not 506(c) is successful may depend on the extent to which the industry develops viable, meaningful best practices to apply the “principles based method” of verification (a kind of “facts and circumstances” test), rather than defaulting to the non-exclusive, non-mandatory methods set out in the rule.
That said, other leaders in the space are setting about to make it less painful to follow the “default” methods of verification.
For example, SecondMarket will facilitate verification efforts with tools on its site that let investors upload financial information, such as W-2s (when verifying accredited status under the income standard). I talked recently with Bill Siegel, a Senior Director of SecondMarket, and he readily acknowledged that asking investors for financial information is a heavy ask. By outsourcing some of the lifting to SecondMarket — “a heavily regulated entity, very well capitalized, with a secure environment for storing the information” — hopefully the ask gets a little easier.
Thinking about this from the perspective of the prospective angel investor, someone who has not participated to date but meets the accredited investor standard and will now, for a time at least it seems, have access to thousands of startup deals, today marks a very exciting change.
But I also admire something SecondMarket’s Siegel told me as we were speaking: “It’s the issuer that stands to lose in all of this, at the end of the day. It’s their offering that can be affected.” Godspeed to all of us in navigating these changes.
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.
