Raising Money is critical for Entrepreneurs and small business owners who are starting and growing their companies.
If you are raising money for your business in a Private Placement (such as the issuance of Capital Stock or Debt to third-party Investors), then you probably have considered announcing the offering on your company’s website or using social media to contact potential Investors.
Under the current Federal Securities Laws, raising money for your company with General Solicitation or general advertising is not allowed, but change is coming . . .
As required under the Jumpstart Our Business Startups Act (or the JOBS Act), on August 29, 2012 the Securities and Exchange Commission (SEC) proposed amendments to Rule 506 of Regulation D under the Federal Securities Laws, which allows your company to offer and sell an unlimited amount of Securities to an unlimited number of Accredited Investors without SEC registration. The proposed amendments would make a significant change to Rule 506, by allowing General Solicitation and general advertising in these private placement offerings.
It is important to remember that the proposed amendments to Rule 506 have not been finalized (and therefore are not yet the law of the land), but below are three key issues that you should understand regarding the upcoming changes to Rule 506 and how they will affect your ability to raise seed, working and growth capital for your company:
1. “Reasonable Steps” to Verify Accredited Investor Status
Your company would be able to use General Solicitation and general advertising (e.g., publicly available websites, social media postings, seminars, newspaper ads, television and radio broadcasts) to offer Securities to Investors, so long as your company takes “reasonable steps” to verify that all purchasers of the Securities in the offering are Accredited Investors.
2. “Reasonable Belief” Standard Still in Place
Under the proposed rules, the “reasonable belief” standard would continue to apply in determining whether or not a proposed Investor is an Accredited Investor. In practical terms, all purchasers of Securities in your company’s offering would need to be Accredited Investors either because (i) they fit squarely within one of the specific definitions of Accredited Investor under Rule 506 or (ii) your company reasonably believes that they are Accredited Investors.
3. Investor Verification Tailored to Your Offering
Despite some speculation about onerous verification requirements on the horizon, the SEC’s proposed amendments do not outline specific verification procedures. The “reasonable steps” to verify Accredited Investor status would depend on the particular facts and circumstances of your company’s offering and the related Investors involved in the offering. While the SEC did not propose specific verification procedures, it did provide some guidance as to how your company might verify Accredited Investor status for a particular offering:
- What is the nature of the proposed Investor and what type of Accredited Investor does the Investor claim to be? The verification steps will depend on the types of Investors involved in your securities offering. For example, if your company’s offering will involve many individual Investors, then you will need to use verification procedures that request additional information and documentation to verify their financial status (i.e., net worth or income level) and Accredited Investor status. You also may rely (but only reasonably) on third-party verification services that will have additional procedures to assist with the Accredited Investor verification process.
- How much information and what type of information does your company have about the proposed Investor? Your company could rely on various types of information verifying Accredited Investor status, including publicly available information filed by potential Investors with governmental regulatory agencies (e.g., tax returns or stock purchase/sale filings) or third-party information such as a Form W-2 or brokerage statement.
- What is the nature of your company’s Securities offering and how is your company soliciting potential Investors to participate in the offering? The SEC has explained that, if your company solicits potential investors more generally (e.g., from a website or through social media), then you likely would need to take more detailed steps to verify Accredited Investor status. For example, in a broadly solicited offering, it likely would not be enough for a potential Investor to simply complete an Accredited Investor Questionnaire or check a box indicating Accredited Investor status when there is no other information available to support Accredited Investor status. Also, if your company’s offering requires a minimum investment amount that is sufficiently high, then this requirement may serve as a helpful screen (or additional verification step) to limit the proposed investment opportunity only to Accredited Investors.
Overall, your company will need to review the particular factors relating to its particular Securities offering, in order to determine what reasonable verification steps need to be taken. It also will be very important to create and maintain detailed records that outline the steps that your company has taken during the offering and Investor verification process.
Old and the New. The proposed amendments would not affect the Rule 506 offerings that presently are allowed (i.e., without general solicitation or general advertising), in which case your company could offer and sell Securities to up to 35 non-Accredited Investors and would not have to take reasonable steps to verify whether purchasers are Accredited Investors. In either case, your company still would have to file a Form D with the SEC for this type of Rule 506 offering, except the amendments would add a separate checkbox on Form D to indicate whether your company is using General Solicitation in its offering.
The Impacts of Rule 506 offerings with General Solicitation
The ability to use Rule 506 offerings with General Solicitation has the potential to change significantly how Privately-Held Companies handle and close Financing transactions. The pool of potential Investors will be expanded greatly for many companies, even though the proposed amendments to Rule 506 would impose the additional requirement to take reasonable steps to verify Accredited Investor status.
Comments on the proposed amendments are due within 30 days after they are published in the Federal Register, so final amendments soon will be in place. These are exciting times for Privately-Held Companies that soon will have new ways to access capital.
It would be great to hear how these proposed amendments and Equity Crowdfunding will help your company and its Financing plans.