SEC Finally Proposes Rules to Allow Crowdfunding

Joseph R. Soraghan

By Joseph R. Soraghan

Not quite ten months late, the Securities and Exchange Commission (SEC) on October 23, 2013 proposed rules to allow entrepreneurs and other small businesses to advertise investments in their companies on the Internet and in other general venues, and to allow persons other than wealthy investors to purchase those investments. Congress, in the JOBS Act signed by President Obama on April 5, 2013, had told the SEC to propose such rules by December 31, 2012. (In fairness, the SEC was faced with great pressures from numerous quarters, including the legislators themselves, concerning the content of the rules, which made that deadline impossible to meet.)

This type of investing, called “investment crowdfunding,” was illegal, and will remain illegal until the process of review, amendment and adoption of final rules is complete. The SEC has asked the public for comment on the proposed rules within 90 days. At least a few months of further processing after that 90 day period will be required before the rules are final. Continue reading »

Crowdfunding is Not the Best Thing in the Jobs Act for Entrepreneurs

Joseph R. Soraghan

By Joseph R. Soraghan

The JOBS (Jumpstart Our Business Startups) Act (the “Act”), was signed into law by the President on April 5, 2012.

The Benefits to Entrepreneurs

Probably, to entrepreneurs, the most important change in the “Act” is the elimination of the ban on “general solicitation”. This elimination in effect allows advertising of small (heretofore “private”) offerings of investments in their businesses. For companies seeking pre-seed, seed and angel investment, this step creates or implements essentially two new types of offerings: 

  1. Accredited investor offerings, in which the investments may be sold only to accredited investors (those who meet significant net worth or income requirements), which offerings are not new, but in which now the issuing company may  advertise the offering in mass settings, such as newspapers, broadcast, and most importantly, on the Internet and in social media; and
  2. “Crowdfunding” offerings, also generally solicited, in which non-accredited investors may purchase the investments, but only (a) up to the lesser of $10,000 and 10% of their annual income; (b) with the assistance to the company of “intermediaries” who must meet certain requirements; and (c) with maximum sales in each offering limited to $1 million in any 12 month period (hereinafter called “crowdfunding”). 

It is my belief that perhaps the most beneficial of the above two “new” offerings will be the first, that which simply removes the prohibition on advertising on offerings to accredited purchasers only.  The removal of that prohibition will allow an issuer to reach many more possibly interested persons, and therefore many more accredited investors. And although those offerings will not require the use of registered brokers dealers or unregistered intermediaries, the entrepreneur offering companies will now be able to use “intermediaries” (or “portals”) who no longer must be fully registered as broker-dealers, to assist in finding and working with accredited investors. This will be a huge advantage to entrepreneurs seeking capital. And this type offering will place no restrictions on the dollar amount which the purchasers may acquire or the amount which the entrepreneurial business may raise.  

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There are Fewer Accredited Investors Now: “Dodd-Frank Act”

Joseph R. Soraghan

By Joseph R. Soraghan

Wednesday, July 21, 2010, the number of investors available to entrepreneurs dropped significantly. On that date, President Obama signed the Dodd-Frank Wall Street Reform and Consumer and Consumer Protection Act (the “Dodd-Frank Act”) into law.

As we pointed out in the February 2010 Enterprise (Missouri Venture Forum), the legal requirements for raising capital from investors requires that either the offering of the investments be registered with the Securities and Exchange Commission, or that an exemption be available for the offering. The exemption which has become far and away the most used, and the most useful, to entrepreneurs is that for “accredited” investors under Regulation D.

Regulation D allows an investor to be “accredited” by having a net worth of only $1,000,000, or have an individual annual income exceeding $200,000 or $300,000 if investing with one’s spouse. Most users of this exemption qualified for it simply by assuring that all investors met the net worth requirement of $1,000,000.

And in calculating that net worth, until last Wednesday, essentially all of the investor’s assets could be included, including the investor’s primary residence. This is important because many, if not most, such investors’ $1,000,000 net worth consisted primarily of his or her primary residence.

But the Dodd-Frank Act excludes the value of an investor=s primary residence from the calculation of net worth for determining the accredited investors status (Section 412(a)).

Some persons in the entrepreneurial community predict that this will significantly reduce the number of persons who can qualify as “accredited.” (Other proposals were made in the legislative process leading to the Act which arguably would have effectively eliminated the usefulness of the exemption completely, but they were not adopted.)

Entrepreneurs seeking to raise capital, or in the process of doing so, must now use the new standard in determining compliance with the accredited investor status.

The changes emanating from the Act will eventually likely not be restricted to this one adjustment. The Act authorizes the Securities and Exchange Commission within one year to review and promulgate rules amending the definition of “accredited investor” (which amendment will likely require some showing of experience in “angel” investing). Within three years, the Government Accountability Office is required to submit a report to Congress regarding income, net worth and other criteria for accredited investor status, and within four years the SEC must review the accredited investor exemption in its entirety.

Joe Soraghan is a past president of the Missouri Venture Forum.

Released by permission of the Missouri Venture Forum newsletter ENTERPRISE (August 2010).

A Primer — Legal Considerations When Raising Capital From Individuals

Joseph R. Soraghan

By Joseph R. Soraghan

On occasion, entrepreneurs seek to raise capital from individual investors. But whenever an entrepreneur sells an interest in his company, whether it is common stock (equity/ownership) or notes (debt) or any other investment, that interest is a security, and the securities laws apply, even if he is offering only to FF & F (family, friends and fools).

Federal law and the law of all but two or three states, separately, include securities laws which must be complied with when making requests for investments. However, all those laws, as a class, have some common general principles.

First, every offering of a security must either be registered under both federal and state law, and an exemption from federal law, and the law of every state where any investor resides, must be available and provable by the entrepreneur. To prove that an entrepreneur is liable, an investor only needs to show that he was sold investments in the company, and that the company did not register the sale with both the federal government and with the state where he resides. And registration is almost always impossible for entrepreneurs. Therefore, the entrepreneur must prove he has exemptions under federal and all the relevant state laws.

General Principles for an Offering to be Exempt: Both federal and almost all state laws have their own securities exemption requirements. They usually fall into common categories. For an offering to be exempt, the federal law and/or laws of almost all states:

  1. Require smallness! The company must place limits on the number:
    a. of persons who purchase shares;
    b. sometimes, of persons contacted.
  2. Require the company to have reasonable grounds to believe, before it contacts a prospect, that the prospect is wealthy and investment-sophisticated (“suitability”).
  3. Forbid “general solicitation,” i.e., advertising, mass mailings, large group meetings, telephone campaigns, etc.

In addition to these restrictions, both the federal government and almost every state have additional requirements and filings which are unique to them.

Is a Private Placement Memorandum (“PPM”) Required? To meet the requirements for an exemption, if raising less than $1,000,000 in a twelve month period, a PPM is generally not required to meet exemption requirements. However, if the entrepreneur seeks to raise more money and to do so from any unaccredited investors (this usually means persons with less than $1,000,000 net worth) a PPM is required and it must meet specific, sometimes expensive, requirements.

However, even if a PPM is not required to qualify for an exemption, the offering entrepreneur must be able to show that he has told the investor everything which the investor reasonably needs to know in making his investment (in order to meet the “anti-fraud” securities law requirements. Therefore, it is best to have a disclosure document for all offerings in order to establish that the company has informed all offerees of all material risks. Frequently this need not be a long, involved document, and may consist largely of materials which already exist, such as financial statements, descriptions of the company, etc.