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We’ve heard a lot in the last couple of days about the SEC revising its private offering rules. Yes, a set of rule changes went into effect on Monday. No, these are not the crowdfunding rules! (Not yet, anyway.) Monday’s changes will allow businesses raising capital to advertise their securities offerings, but only to “accredited investors” and only in certain kinds of offerings. It’s also a technical rule, and getting the details right is very important.
First, a little background: The basic rule in federal and state securities law is that, when you sell equity or debt, you must register the sale, or you must find an exemption from the registration requirements. For years, the SEC has had a package of rules called “Regulation D” that creates three exemptions from the federal registration requirements. The exemptions are usually known by their rule numbers: Rule 504, Rule 505, and Rule 506.
For the last 15 or 20 years, most equity capital-raising has been conducted under Rule 506, for two basic reasons. First, you can raise more than $5 million – so if your deal is bigger than that, it’s your only option. Second, it’s a “safe harbor” rule – which means that even if you fail to comply with a small part, you can still argue that you complied with the underlying statute.
For investors soliciting capital, the downside to Rule 506 has been that it prohibits “general solicitation or general advertising.” In other words, it bans businesses from using any form of public communication to contact potential investors: TV and radio advertising, newspaper and magazine ads, cold calling, whatever. To avoid running afoul of this requirement, you have to find investors through a daisy chain of relationships.
In 2012, Congress passed the Jumpstart Our Business Startups (JOBS) Act, a bundle of amendments to the securities laws that were intended to stimulate capital formation for startups. Most of the changes require the SEC to revise its rules or to make new rules, and Monday’s rules changes are the first wave.
But this first wave is pretty limited. It amends Rule 506 to eliminate the prohibition on “general solicitation or general advertising”. It really creates two flavors of Rule 506:
This last part is really important. In Famous Original Rule 506 offerings, you could rely on an investor’s promises in a contract that he, she, or it met the definition of “accredited investor. Under New Improved Rule 506(c), you must collect enough information from the investor to prove that the investor is accredited. For individual accredited investors, that can include two years of tax returns, bank records, and a credit report from a major credit reporting agency.
What does this mean for you? This change may make it easier to reach out to large groups and networks of angel and venture investors, without fear that the communication itself will be considered a violation of the general solicitation prohibition in Rule 506. And if you’re working on raising a lot of money, you can advertise it pretty widely. (On Monday, Silicon Valley startup TechShop started publicly soliciting $60 million from accredited investors.) But this is not crowdfunding, and the revised Rule 506(c) has been not designed to allow you to raise capital in small amounts from a large number of people. Consider your capital needs and your target investors very carefully, and be sure to consult a qualified legal advisor, before you head down this road.