Startups raising money need to know how to do so in compliance with federal and state securities laws. The trouble is–it is not always easy to know what the rules are.
To make it more difficult, the rules keep changing. Congress passes new laws. The SEC issues new regulations. All of it becomes difficult and hard to keep up with; even for the lawyers who spend substantial portions of their time reading new laws and rules and pronouncements and thinking about them.
The law regarding fundraising has changed quite a bit recently.
- We had the JOBS Act make general solicitation of offerings under certain circumstances and under certain conditions legal — but watch out — you might not want to accept the conditions and limitations.
- We have had the SEC issue a bunch of recent guidance on what constitutes general solicitation and general advertising.
- We have also had the SEC issue the CitizenVC ruling, giving people instruction on how to form online relationships with people who can become your investors without you being considered to have generally solicited and generally advertised your offering.
This is a lot of change.
Here is what you need to know:
- Before you start selling securities; before you start talking to people about your securities offering; before you start doing anything with regard to your securities offering other than talking about it internally, you need to settle on which securities law exemption you are going to use in your offering.
- The various securities law offerings that are available can’t be mixed and matched. You can’t take ingredients from some you like, and discard others.
- You have to pick your exemption path, and then you need to stick with it.
So, if you pick Rule 506(b) as your exemption, then:
- you cannot generally solicit or advertise your offering; and
- you have to be careful, really careful, not to be considered to have generally solicited or generally advertised your offering.
If you pick the Rule 506(c) offering as your exemption, then:
- you can generally solicit your offering, but
- you have to ask your investors for their personal financial statements or persona tax returns to verify that they are accredited (or you can use a qualified third party service to verify).
What if you just met someone? Can you pitch them without being considered to have generally solicited your offering?
It depends. How did you meet them? Did you meet them because you generally solicited or generally advertised your offering? Or did you meet them because a friend introduced you to them? Or did you meet them because you read that they invested in companies and you cold emailed them asking for meeting?
The SEC has said that the existence of a pre-existing, substantive relationship is only one way to show that you did not generally solicit your offering. But that is not the only way to show you did not generally solicit your offering.
In general, if you are working through your friends and contacts, and meeting people who might be able to help you, including as investors, and you pitch those people–this can work and not be general solicitation. But it depends on how you do it. You are not going to want to be posting on LinkedIn that your company is raising money and you are looking for investors. But individual introductions from your contacts should not get you in trouble unless they are spamming their network or something along those lines.
When in doubt whether what you are doing might run afoul of the Rule 506(b) prohibition on general solicitation and general advertising, consult the counsel you have retained to help you make sure you are complying with the rules. They are tricky.
In the most recent SEC guidance, here is what the SEC that is most helpful to answering this question about pitching someone you just met:
Question 256.27
Question: Are there circumstances under which an issuer, or a person acting on the issuer’s behalf, can communicate information about an offering to persons with whom it does not have a pre-existing, substantive relationship without having that information deemed a general solicitation?
Answer: Yes. The staff is aware of long-standing practices where issuers and persons acting on their behalf are introduced to prospective investors who are members of an informal, personal network of individuals with experience investing in private offerings. For example, we acknowledge that groups of experienced, sophisticated investors, such as “angel investors,” share information about offerings through their network and members who have a relationship with a particular issuer may introduce that issuer to other members. Issuers that contact one or more experienced, sophisticated members of the group through this type of referral may be able to rely on those members’ network to establish a reasonable belief that other offerees in the network have the necessary financial experience and sophistication. Whether there has been a general solicitation is a fact-specific determination. In general, the greater the number of persons without financial experience, sophistication or any prior personal or business relationship with the issuer that are contacted by an issuer or persons acting on its behalf through impersonal, non-selective means of communication, the more likely the communications are part of a general solicitation. [August 6, 2015]
Disclaimer: This blog does not constitute legal advice, or the establishment of an attorney-client relationship. This blog is for informational purposes only. Always consult your attorney with your securities law exemption questions.