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Recent Developments in Legislative Attempts to Make Raising Capital Easier

Jul 17

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7/17/2013 8:50 AM  RssIcon

RECENT DEVELOPMENTS IN LEGISLATIVE ATTEMPTS TO MAKE RAISING CAPITAL EASIER

In the past two years, there have been a number of legislative efforts to make raising capital easier.  For example, you might recall that in April 2012 a new law (the “JOBS Act”) was adopted that most people have heard about mostly for its “crowdfunding” provisions.  Last week there was a major development in that area, and I will take this opportunity to provide a status report on a few fronts.

As many of you who have attempted to raise capital in the past know, two key characteristics of the legal landscape have been that under most scenarios (1) you can’t cast your net too widely when soliciting investors, lest you be accused of engaging in a prohibited “advertising or public solicitation”, and (2) things are a lot easier if you limit your investors to so-called “accredited investors” (basically business entities and people with a minimum level of income or net worth).  The recent legislative efforts seek to ease up on these cornerstone restrictions.

Changes to Regulation D – You Can Use Advertising/Public Solicitation if you are Careful to Sell Only to Accredited Investors

The JOBS Act required the Securities and Exchange Commission to modify Rule 506 of Regulation D under the Securities Act to eliminate the prohibition on “general solicitation and general advertising,” so long as all purchasers in the offering are accredited investors.  Last week, the Securities and Exchange Commission released these amendments to Regulation D. 

Regulation D is being amended to permit public solicitation in a Rule 506 offering if (1) “reasonable steps” are taken to verify that all purchasers are indeed “accredited investors” (heads up, this might be a pain) and (2) neither the issuer nor any defined “covered person” affiliated with the issuer has been subject to a “disqualifying event” (generally, a regulatory body’s sanction for relevant misbehavior).  You can still raise capital under Rule 506 the old-fashioned way, except that the new “bad boy” disqualifications will apply.  This is just a new option.

But Simon didn’t say “advertise” yet!  The new rules become effective 60 days after publication in the Federal Register. 

“Crowdfunding” – Federal Exemption

“Crowdfunding” is the raising of capital by allowing large numbers of typically small investors to make small investments. The ability to do this has historically been greatly limited by securities laws that restrict both how widely you can cast your net in soliciting investors and the characteristics of the investors you may solicit. 

The JOBS Act included provisions intended to facilitate crowdfunding.  Ever since then, I have grown very tired of people wanting to raise capital saying to me “Why don’t we use crowdfunding?  What  about that new crowdfunding law?” - like it lets you just post an announcement on Facebook and Twitter, automatically resulting in hordes of people throwing money into your bank account, and my ignorance was making the whole money-raising process unnecessarily tedious.

Here’s the thing.  In order for those laws to be used, the Securities and Exchange Commission must adopt rules implementing the laws.  Well, the Securities and Exchange Commission has not yet adopted rules implementing the crowdfunding exemption.  Given that the Regulation D amendments were to be adopted in 90 days and it took about 15 months, and a timeframe of 270 days was specified for the crowdfunding rules, there is no telling when we might see crowdfunding rules.  Some insiders hint that the rules will be released by October 1, 2013, but there is no guarantee. In the meantime, the anticipation of these new rules has prompted the establishment of funding portals like SterlingFunder that are facilitating some capital-raising transactions using exemptions from securities registration that are available in some narrow circumstances now (but for which it is not required to use a portal or intermediary). 

When the rules are enacted, what will they look like?  The “good” news is that this exemption will allow raises up to $1,000,000 in a rolling 12-month period from sales to a lot of small investors.  Part of the “bad” news is that unless the SEC really surprises with its regulations then there will be a lot of requirements for doing so that will frequently make it just not worth it.  I don’t want to lose your attention by going into a lot of detail, but do at least note that you will have to use a registered broker or “funding portal” as an intermediary and you will have to collect and provide a lot of information to the funding portal, the Securities and Exchange Commission and your investors both before and after your offering.

 “Crowdfunding” – The “Invest Georgia Exemption”

Georgia is actually one of the leading states in the area of legislation enabling crowdfunding, and our new “Invest Georgia Exemption” can permit some degree of crowdfunding for financings up to $1,000,000 when the company and each and every one of the investors are located within the State of Georgia.  (Before you even ask, no you cannot split an offering into one offering that is “within Georgia” and a second offering that is “not within Georgia”.)  If you have a situation that meets the Invest Georgia Exemption criteria, it can be a really good way to go.  It is in fact my guess that the additional benefit of the federal exemption will only be incremental because of all of the burdens associated with it, and that with the Invest Georgia Exemption we already have most of the practical crowdfunding capability we are going to have.  One funding portal, SterlingFunder, is already in operation utilizing this exemption.

What do I think of this crowdfunding business?  Well, I guess it is nice that new alternatives are being created.  But overall, I am afraid that I am not a big fan.  First, utilizing these new exemptions will be a lot more involved than just posting some stuff on Facebook and Twitter, and I think most people are greatly overestimating investor response.  Second, in my opinion having a lot of owners you don’t know well – particularly if they are not sophisticated, experienced investors - is just a bad idea and likely to result in a lot of referrals by me to my litigator friends.  I think anyone who takes on investors they don’t know should be very careful to put in place a good system of shareholder controls.

I would say that I will issue another alert when the rules become effective, but I am loathe to risk pelting people with more e-mails than they want to receive.  If you want to be alerted when the rules become effective, why don’t you send me an e-mail letting me know and I will alert you privately.

Many thanks to my friend David Lilenfeld, Founder and CEO of SterlingFunder - the portal mentioned in this advisory - for looking over it and sharing his thoughts with me.

What would any written material coming from a lawyer be without a disclaimer?  Here it comes: This advisory contains general information only.  It is not intended to be and should not be relied upon as legal advice for any specific situation.  Your mileage may vary.  Offer void where prohibited.

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