Matching supply and demand in the capital-formation process has been, and always will be, one of the great challenges in the startup ecosystem.
In July, the Securities and Exchange Commission adopted final rules eliminating the prohibition of general solicitation and advertising for certain offerings. This move has the potential to make the matchmaking process between private companies and investors more efficient.
Prior to the lifting of the advertising ban, startups and other companies looking to raise capital were prohibited from publicly releasing information about an offering, unless it was registered with the SEC. This registration process is time-consuming, expensive and generally impractical for most startups. As such, most companies rely on Regulation D, a private-offering exemption. With the new SEC rules, they will be able to advertise some of these Regulation D offerings. For example, a startup will be able to promote the offering online.
Unsurprisingly, the SEC has included some fine print.
First, these rules will not go into effect until September. Thus, this is the time for preparing an offering, not for publicly launching one.
Next, these advertised offerings are limited to “accredited investors.” In the SEC’s eyes, accredited investors have sufficient means and sophistication to fend for themselves — meaning they have income in excess of $200,000 ($300,000 jointly with their spouse) or more than $1 million in assets, among other established financial metrics.
Companies must take reasonable steps to verify that their sale of securities is made solely to accredited investors, which can include the review of the investor’s tax forms or bank statements, or other third-party verifications. In any startup financing, investors have always self-certified to the same effect; the new rules take this process one step further.
Now, if a business publicly advertises the offering, the investor likely will need to share some highly personal financial information. We already are seeing some feedback that this level of information sharing could have a chilling effect, particularly for angel rounds involving high net-worth individuals.
So what does all of this mean for Boulder startups and investors? The new SEC rules will allow startups to seek funding in new ways and reach a much broader audience and, without the cloak of secrecy, many investors will have access to greater deal flow. Other market participants, such as funding platforms and broker-dealers, will be able to match supply and demand for startup opportunities in new ways.
It is important to note, however, that these rules do not change the fundamental principles of startup investing, nor do they change the antifraud protections contained in the securities laws. Just because a startup can advertise an offering does not mean success is any more or less likely. We expect that many startups and investors will continue to operate under the “old” rules of networking, hustling and face-to-face meetings. Once a startup has launched an advertising campaign, it will be very difficult to unring that bell — meaning they will have committed to selling to only accredited investors and the verification requirements imposed by the SEC.
Finally, on the same day the SEC eliminated the general solicitation ban, it also proposed some additional rules regarding these offerings. These proposed rules would make general solicitations even more onerous, requiring that companies supply the SEC with information about the offering in advance, among other things. If these rules are adopted, the appeal of general solicitations will be even more limited.
The Boulder startup community is one of the most innovative in the country, and we expect to see creative approaches to these new rules in the near future.
Matt Stamski is a corporate attorney at Faegre Baker Daniels LLP who focuses on emerging companies, venture capital and mergers and acquisitions. He devotes a significant amount of time to emerging companies and is an active participant in the Boulder startup community.