For some time now, we’ve been rhapsodizing about how general solicitation is going to open up the capital markets and facilitate the fundraising endeavors of entrepreneurs. Lo and behold, on September 23, companies will be able to publicly announce that they’re raising capital through all forms of media — Twitter, Facebook, newspapers, blogs, email communications, you name it. Investors will have increased access to deal flow and entrepreneurs will have additional marketing power at their disposal to reach a broader network of previously inaccessible investors.
For all the increased flexibility and reach this new rule grants to startups, it doesn’t come without caveats. Startup founders should be cognizant of regulatory requirements before deciding whether to pursue this route. Any new method of raising money requires proper knowledge and prudence, and we encourage all companies to consult counsel before and during the process.
3 Things to Know About General Solicitation
Before you start crafting elaborate marketing plans for your offerings, we advise you to keep these key considerations in mind. It’ll help you evaluate whether general solicitation offerings are appropriate for your company as well as save you valuable time if you end up using traditional private placements instead. Listed below are the requirements for general solicitation which goes into effect on September 23rd:
- Only accredited investors can participate in the offering.
- Issuers need to take reasonable steps to verify the accredited status of their investors.
- Within 15 days of the first sale of securities, issuers must indicate on Form D that they generally solicited.
Of the three, verification of accredited status is the most troublesome requirement because the definition of “reasonable steps” is murky at best. Fortunately for entrepreneurs and intermediaries like Return on Change, the SEC has provided a list of non-exclusive safe harbors that issuers can rely upon as adequate verification methods:
- Income: Review copies of IRS forms that report the investor’s income for the two most recent years and obtain the investor’s written confirmation that he or she has the reasonable expectation of reaching the income level necessary to qualify as an accredited investor.
- Net Worth: Review documentation dated within the prior three months that show the investor’s assets and liabilities and obtain a written confirmation from the investor that all liabilities necessary to make a determination of net worth have been disclosed.
- Third-Party Verification: Obtain written confirmation from a registered broker-dealer, an SEC-registered investment adviser, a licensed attorney, or a certified public accountant that such person has taken reasonable steps to verify that the purchaser is an accredited investor within the prior three months
- Grandfathering: For an investor who has invested in an issuer’s Rule 506 offering as an accredited investor prior to the Rule 506(c) effective date and remains an investor of the issuer, the issuer only needs to obtain a confirmation from the investor that he or she remains qualified as an accredited investor.
What to Expect in the Future
Additionally, the SEC has proposed new rules that, IF adopted, might make it more difficult for startups to rely on general solicitation. The SEC will review public comments and determine whether to adopt the proposed rules.
- Form D: Issuers are required to file a Form D with the SEC at least 15 days before they engage in general solicitation. Form D would also have additional disclosure requirements.
- Legend requirements: All general solicitation materials would be required to include cautionary legends and disclosures.
- Submission of general solicitation materials: All general solicitations materials would have to be submitted to the SEC on a temporary (2-year) basis.
Any startup founder will have realized by now that these amendments will make the capital raising process a lot more cumbersome. We feel the same. So what can startups do on the 23rd? The SEC has yet to adopt these amendments, so issuers are neither expected nor required to abide by them until they’re finalized. The ban on general solicitation will be lifted this upcoming Monday and we hope (depending on what the final rules end up looking like) that it will be a great windfall for entrepreneurs who are struggling with inefficient capital raising methods currently in place. Still, entrepreneurs are advised to exercise caution and consult legal counsel in this radically new and changing environment. The SEC is sure to be monitoring general solicitation offerings, and the heightened disclosure and diligence standards are things to keep in mind should you decide to rely on this new rule.