Start-ups Can Now Use General Solicitations to Raise Money

In 2012, the JOBS Act directed the SEC to eliminate the prohibition against general solicitation and general advertising in private placements conducted under Rule 506 of Regulation D of the Securities Act of 1933. Historically, this ban on general solicitations, which can include newspaper articles, website announcements, and email campaigns, has made it harder for start-ups to raise money and gave an advantage to angels and brokers with established reputations and networks.  On July 10, 2013, the SEC voted to adopt a rule that will lift the ban on general solicitations.

Under new Rule 506(c), companies will be permitted to engage in all forms of communication to prospective investors. To qualify for this treatment, however, all investors purchasing securities in an offering must either qualify as "accredited investors" or the issuer must reasonably believe that they are accredited investors and the company must take reasonable steps to verify the accredited status of each investor purchasing in the offering.

Whether a company has taken "reasonable steps" to verify the accredited status of each investor will be determined objectively, based on all facts and circumstances. The SEC has, however, indicated that a company will be deemed to have taken reasonable steps if it:

  1. Reviews copies of any IRS form that reports the income of the investor and obtains a written representation that the investor will likely continue to earn the necessary income in the current year
  2. Reviews documentation, such as bank or investment account statements, and obtains a written representation from the investor that all liabilities required to make the net worth determination have been disclosed or
  3. Receives a written confirmation from a registered broker-dealer or investment adviser, licensed attorney, or certified public accountant that such entity or person has taken reasonable steps to verify the investor’s accredited status.

Unless an investor is an existing investor in a company, merely checking a box on a subscription agreement to represent that she is accredited will not be deemed sufficient.

At the same meeting, the SEC also voted to:

  • Prohibit private placements by companies if such companies or their directors, senior managers or 20% or more owners were considered "bad actors" by the SEC
  • Propose for public comment a variety of amendments to Form D related to the new rule. 

Among other things, the proposed amendments would require companies to file an initial Form D 15 days before commencing an offering involving general solicitations and file another final Form D within 30 days after completing an offering. 

Any companies that failed to properly and timely file a required Form D would be disqualified from conducting any further private placements under Reg D for a one-year period. The Form D’s would need to include disclosure of the nature of any general solicitations used, the steps taken to verify accredited investor status and any persons who directly or indirectly control the company. 

Finally, the proposed amendments would also require companies to include certain legends or cautionary statements in any written general solicitation materials and submit any written general solicitation materials to the SEC.

The new rule will not eliminate the existing private placement safe harbor under Rule 506(b), which prohibits general solicitations but permits the issuance of securities to up to 35 non-accredited investors who meet certain "sophistication" requirements and receive certain information about the offering.  

While the elimination of the ban on general solicitations should make it significantly easier for start-ups to find interested investors, there will be many new procedural requirements around Form D filings and accredited investor determinations and much of the offering materials and process will need to be submitted to the SEC. 

In addition, many companies who wish to remain in “stealth” mode or who wish to defer announcement of an offering until after closing will not be eligible to avail themselves of these new provisions since, as proposed, they require filing a Form D in advance of the general solicitation. 

As a result, many start-ups may decide to continue raising money under existing safe harbor despite the ban on general solicitations, particularly while some of the proposed new rules get sorted out.

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