I had an email exchange with a client this morning.
I started it abruptly.
“Are you going to generally solicit your offering?”
He didn’t know what I was talking about. He had been head down, building stuff, not reading and writing about securities laws every day. In other words, he had a real life. He was building stuff people all over the world would one day use every day.
Here is how I responded:
“Well, ok. In the old days, you couldn’t generally solicit or generally advertise your securities offerings. You had to work pre-existing contact to pre-existing contact. You were not supposed to stand up on a stage at an industry conference and say, ‘We are raising $500,000 in Series A at $1.00 a share. Please see me and I’d love to talk to you about it.’ In fact, this was illegal. It was also illegal to blog or Tweet or use Facebook to try to raise money. Many people broke the rules. Some got in a lot of trouble.”
Here is an example in NY Times.
“Now, under rules effective September 23, 2013, you CAN generally solicit your all-accredited investor offering under Rule 506(c) of Regulation D; but if you do, you have to do the following:
- Only take money from accredited investors. (Accredited investors are, most typically, individuals with a net worth greater than $1M excluding their primary residence (but taking into account debt on that residence in excess of its FMV) or individuals with incomes in excess of $200,000 in the last two years with the expectation of the same in the current year or $300,000 with spouse.)
- Take reasonable steps to verify the accredited investor status of your investors. This means reviewing Forms W-2, or other personal financial statements of investors. You can no longer rely on a check-the-box one-page certification.
- Check a box on your Form D that you generally solicited.
There are definitely pros and cons of generally soliciting. I’ve listed some of the pros and cons below. I am happy to discuss on the phone!”
- The ability to reach a wider audience
- The possibility of closing your round faster.
- Increased recognition of your business and your brand.
- The added burden of taking reasonable steps to verify the accredited investor status of your investors; reviewing Forms W-2 or similar financial information, and keeping records that you did so. Some investors who would have otherwise invested may refuse to invest when you request this information.
- It will take more time to undergo the document review referenced in the first bullet point above than what is required in a non-generally solicited Rule 506(b) offering. If you want to keep your securities offering as simple as possible from a legal point of view, it is easier to accept the one-page certifications from investors in a non-generally solicited offering than it is to undergo the diligence and record keeping steps of taking additional steps to verify the accredited investor status of your investors in a generally solicited offering.
- Giving up a fall back securities law exemption. If you generally solicit, you probably can’t argue in the alternative that your offering was not a public offering under Section 4(a)(2) of the Securities Act of 1933, as amended.
- Federal regulatory uncertainty. The SEC has proposed rules that will make generally soliciting much, much more difficult. It is unclear when those rules will go into effect and what they will ultimately look like, and what the transitional rules will be.
- Potential state regulatory uncertainty. See New York, for example. Is an advance filing required under New York State law?
- Arguably a greater risk of regulatory scrutiny than a non-generally solicited offering.
- Once you go 506(c), you can’t go back, at least with respect to the pending offering.
- The risk that strong investors, who bring more to the company than their cash (i.e., their reputation for picking winners, mentoring skills, industry knowledge, etc.) will be less interested in investing in a start-up that has raised money in a less discriminate fashion through general solicitation.
- The risk of raising questions about your company’s financial position to customers and other third parties.