Excited About your Company’s but Need the Right Investors?
Do you believe that your business really will take off once you get the right amount of money in the door.
You want to get the word out to as many potential investors as possible because you have heard that other companies have raised money over the Internet and with social media. And why not your company? You never know when and where a potential investor might get interested and invest in your company. If only it were that simple.
You now need to back away from your keyboard and put down your smartphone. Don’t press send on the email blast, don’t publish the blog post and don’t launch the tweet announcing your new stock offering.
Like it or not, your company will need to follow various federal and state legal requirements when raising money in a private placement offering of securities. It is absolutely necessary to do proper planning up front, including an evaluation of the types of financing communications to be used, so that your financing is legal and stays on track. Raising money certainly has its challenges, but your company may not survive an SEC investigation or other regulatory action.
Raising money is complicated and there are a lot of moving parts.
We are focusing here only on one key decision that you will need to make early in the financing process: How broadly will you offer your company’s securities to potential investors?
- Old Way – Your company cannot raise money by offering its securities through general solicitation or general advertising (i.e., no website postings, no social media, no email blasts, no newsletters, no radio or tv spots, etc., regarding the proposed offering); and
- New Way – Your company can use general solicitation and general advertising to seek potential investors, which then will trigger additional legal requirements as you cast a wider net with your financing outreach efforts.
More legal requirements mean more complexity and cost, so it is important to weigh the pros and cons of each alternative given your financing goals, investor contacts, etc.
Accredited Investors Only – Plus Verification
In making this decision, you will need to pay particular attention to the type of investors that legally can participate in the financing. Because of the strong temptation that many founders have to use general solicitation and general advertising when raising money, we will focus on the critical verification requirement when using the “new way” or general solicitation method.
Specifically, with the “new way” or general solicitation method, each purchaser in your company’s offering must be an Accredited Investor, either because such purchaser is a high net worth individual or financially sound legal entity (as outlined in the federal securities laws), or you reasonably believe that such purchaser is an Accredited Investor at the time of investment. More simply, if your company intends to cast a wide net for investors, then it can only sell its securities to high net worth / sophisticated investors.
Also, with the general solicitation method, your company must take “reasonable steps” to verify that each purchaser is an Accredited Investor – not as easy as it sounds. This verification requirement introduces additional complexity and costs in the fundraising process and could push away potential investors given the extra steps and hassle. Even if all of the purchasers are Accredited Investors, your company will not meets its compliance obligations if it does not take reasonable steps to verify that each purchaser is an accredited investor. Your company therefore must verify Accredited Investor status before a purchaser invests money in the financing.
How to Verify
The current rules do not outline specific verification procedures, and what is “reasonable” depends on the particular facts and circumstances of the offering. Three factors to consider are: (i) who the purchaser is and how it claims to be an Accredited Investor; (ii) the specific information that your company has about the purchaser (i.e., easier to verify if information from public sources); and (iii) the offering structure and mechanics (i.e., more verification is required if broad solicitation, less verification if there is a high minimum investment amount).
The rules do mention, however, certain non-exclusive (and non-mandatory) ways to take reasonable steps to verify that a natural person is an Accredited Investor, including:
- If Accredited Investor status is based on income: review any IRS form that reports the person’s income for the two most recent years, plus a written representation that the person reasonably expects to reach the required income level in the current year;
- If Accredited Investor status is based on net worth: for assets – review bank statements, brokerage statements, tax assessments, or other documents detailing the person’ assets, if dated within the past three months; and for liabilities – review one of the national consumer reporting agencies and obtain the person’s written representation that all liabilities necessary to determine net worth have been disclosed; and
- Written confirmation from a certain type of third party, such as a licensed attorney in good standing, a registered CPA in good standing, a registered broker-dealer or investment advisor, indicating that such third party has taken reasonable steps to verify the person’s Accredited Investor status within the past three months and has determined that the person is an Accredited Investor.
You will have the burden of showing that your company has complied with its legal requirements, so you will need to keep good records of the verification procedures that your company has undertaken.
Practical Tips – Important
Once you have gone down the general solicitation path, you can’t pull back and decide midstream that you now want to use the “old way” to offer securities (i.e., with no general solicitation). The general solicitation already has occurred and you cannot retrieve from cyberspace all of the information that you previously disseminated. Similarly, if you start with the “old way” of raising money and take in money from investors, you cannot later switch to the “new way” if you have not verified Accredited Investor reasonably or taken money from unaccredited investors before the switch.
You will need to make sure that you pick the right compliance method at the beginning and make sure that it will work for your company during the entire financing process.
Also, if your company plans to participate in a pitch event that has been (or will be) announced in the media or on the unrestricted Internet, then there is general solicitation environment and your company must comply with the “new way” requirements to offer securities, including the reasonable verification of Accredited Investor status.
The above discussion of reasonable verification of accredited investor status is only one piece in the financing puzzle. You should conduct the proper planning and execution of your financing, with the help of experienced legal and other advisors, so that you raise properly and don’t trip up on the various legal requirements.
Will you use general solicitation to seek potential investors? Are you ready to take reasonable steps to verify Accredited Investor status? How do you expect investors will react to the extra verification required for general solicitation? Let us know your experience raising money with general solicitation.