SEC LIFTS BAN ON GENERAL SOLICITATION; IMPACT ON STARTUPS’ FUNDRAISING

By Michael S.

The Securities and Exchange Commission (the “SEC”) took a major step last month in their ongoing interpretation of the different segments of the Jumpstart Our Business Startups (JOBS) Act. By adopting Rule 506(c), the SEC permitted general solicitation and general advertising in private securities offerings (direct solicitation of accredited investors). Effectively, this now allows startups to market to investors in the open market as long as the startups abide by certain new rules.

Companies privately placing securities in offerings conducted pursuant to Rule 506 and Rule 144A under the Securities Act of 1933 have historically been prohibited from using general solicitation or general advertising to market their securities in offerings conducted under those rules. These changes are a welcome step forward for the SEC regarding the JOBS Act. Rule 506(c) will become effective on September 23, 2013.

We at AlumVest are very excited to see this rule implemented as it shows that the SEC is finally making progress with the rulemaking under the JOBS Act. We also, however, remain cautious that the new rules may place overly burdensome requirements on startups, especially if the proposed related changes to Form D (as discussed below) are adopted.

While startups may get a great urge to shout from rooftops or advertise on TV or radio or place advertisings directly on their products to announce that they are fundraising, the general advertising approach may not work for all startups in light of the limited pool of accredited investors that maybe the recipient of such calls to fund.

Of importance is the new requirement that the startups raising the funds are responsible for taking reasonable steps to verify that all investors are accredited investors. The determination of the reasonableness of the steps taken to verify an accredited investor is an objective assessment by a startup. It was great to see the SEC respond to many commenters’ requests by providing a non-exclusive list of methods that startups may use to satisfy the verification requirement for individual investors, such as:

• Reviewing copies of any IRS form that reports the income of the investor and obtaining a written representation that the investor will likely continue to earn the necessary income in the current year.
• Receiving a written confirmation from a registered broker-dealer, licensed attorney, or CPA that such entity or person has taken reasonable steps to verify the investor’s accredited status.

What may serve as the ultimate determining factor on the practical use of the new general solicitation rules are the SEC’s related proposed changes to Regulation D and Form D. So what do these proposed changes actually require? In particular, the startups:

• Will need to file an “advanced” Form D with the SEC more than 15 days prior to engaging in general solicitation. Using a real world example, a startup that wants to participate in a public investor presentation or a an accelerator demo day in March, will need to start working with its advisers in February to be sure to make the deadline;
• Will be required to submit to the SEC all written general solicitation materials before their use;
• Will be required to add considerably more information to the Form D than previously included; and
• Will need to file a closing Form D no later than 30 days after

Failure to comply with these proposed rules will impose a draconian penalty by disallowing a startup from making a Rule 506 offering of any sort for 1 year after the date of the infraction.

We at AlumVest are very excited by these developments as it seems that the SEC is finally making progress with the rulemaking under the JOBS Act. We continue to eagerly await for the eventual release of rules to Title III of the JOBS Act, allowing the democratization of equity-based crowdfunding to anyone who wants to invest in a startup of their choice.