(Updated to reflect comment from Roger Royse)
Today is an historic day: Title II of the JOBS Act has finally gone into effect, and with it the new rules for general solicitation that the Securities and Exchange Commission adopted back in July.
A brief overview: for decades (80 years), as a way to reduce the risk of fraud, the 1993 Securities Act prohibited venture capital firms, private equity funds and hedge funds from marketing their investments to a wide audience by advertising them. Back then, as you can imagine, it was very hard for investors (particularly non-sophisticated ones) from getting information about companies.
That began to change last year, with the passage of the Jumpstart Our Business Startups (JOBS) Act on April 4, 2012, which was meant to ease restrictions on small businesses, in order to allow them to raise more money from more investors more easily.
Now, with the new rules having gone into effect these funds will be able to publicly discuss and advertise investment opportunities.
What has changed?
Starting Monday, investors are now able to solicit and advertise for potential investors. That means posting Tweets or updates on their Facebook, LinkedIn or Vator profiles is OK. Even taking out a newspaper ad or having a commercial on TV or radio is acceptable.
Companies that choose to generally solicit will be labeled as Rule 506(c) offerings, as opposed to the 506(b) offerings that do not solicit. To become a Rule 506(c), the SEC has added a few additional requirements.
The downside to General Solicitation
1) No non-accredited investors in the offering
While there is no restriction on who an issuer can solicit, there are restrictions on who can buy. Issuers are not allowed to sell securities to any investor who is not accredited. An accredited investor is one whose net worth is $1 million or more, or one who make more than $200,000 a year (or $300,000 joint income if they have a spouse). Under the Rule 506 (b), a company can raise money from 35 un-accredited investors. But under 506(c), no non-accredited investors are allowed.
2) Constant filing
The new rule also states that fundraisers will have to file a Form D with the SEC at least 15 days before they begin general solicitation, and they will also be required to file an amended Form D within 30 days after the offering is finished.
3) Higher cost to confirm accredited investors
Companies who want to solicit have to take more responsibility for determining who is accredited. Part of the reason that these general solicitation restrictions existed in the first place was to combat fraud; the old rules basically made it so that the fundraisers were not able to sell securities to those were are not qualified to participate in the offerings. Previously, investors could just "check a box" saying that they were accredited, and that was it.
With these new rules, the issuer will need documentation, such as a receipt of tax returns or bank account statements for verification, in order to verify that the investor is accredited. The burden has shifted to them to make sure that they know whom they were selling to.
"The real difficulty is going through that verification process," Roger Royse, founder of the Royse Law, told me in an interview. "Before, investors could reasonably rely on their own ability to assess the situation. Now, with these more onoruous restrictions, it introduces uncertainty."
Now these companies have to ask themselves in they want to be in a position where they have to go through this process.
"They have to hope that the benefit will outweigh the burden," he said. "It would be a real drag if you didn’t raise any more money, and all you did was just create a bigger administrative hassle."
4) Stiff penalties
So what happens is these companies do wind up selling to unaccredited investors? If the fundraiser does not follow the rules, the SEC has the right to ban them from subsequent securities issuance for at least a year.
The next step for the SEC is to finalize rulings for Title III of the JOBS Act, under which it "will address ways that non-accredited investors may begin investing in companies," according to Crowdfund.com.
These are the "classic crowdfunding rules that were set up in the JOBS Act, said Royce, and they are unlikely to pass as they are right now.
"The SEC is hostile to Title III", he said. "And it is difficult to implement with current technology."
At the moment, though, there is another potentially big problem for these companies: it is unclear if demo days count as general solicitation.
As Joe Wallin of StartupLawBlog pointed out, this could become a major issue. For example, if someone pitches at a demo day and describes how they would make money, and how much they are looking to raise, is this a violation of the rules?
"Is this general solicitation? If so, this woman probably has not filed her “Advance Form D.” Has she just blown it?" asked Wallin.
The SEC was apparently asked to clarify this recently, and did not give a satisfactory answer. So startups presenting at demo days, and similar events, have to be careful, for the time being, of not accidentally tripping up.
Companies already taking advantage
Right now, companies who solicit are taking on more risk and responsibility if they chose to broadcast if they are looking for funds. But some companies are already taking advantage of the new rules.
Peoples Venture Capital (Peoples VC) announced at midnight last night, exactly when the law went into effect, that it is seeking to raise up to $4,750,000 through the sale of PeoplesVC's Series A Preferred Stock.
I think it is safe to say that we will see many, many more announcements of this kind in the days and weeks ahead.
(Image source: http://www.dividendsandpreferences.com)