Crowdfunding and Crowding Out

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So private companies can, finally, solicit equity investors from the public, in a process known as "general solicitation." Until now, you either had to register as a public company, or do a "private" solicitation only. In some ways, this is the biggest and first real positive change to private capital raising in almost a century, since the major securities laws were enacted in the 1930s.

My friend Jon Medved, CEO of OurCrowd, wrote a good summary in his OpEd in yesterday's WSJ, although, for reasons unknown, he credits the SEC with changing the rule, rather than Congress with its JOBS Act, which the SEC fought tooth and nail. To be fair, as the CEO of a crowdfunding platform, he has to make nice to the regulators, and a little extra flattery, even if undeserved, probably goes a long way.

The problem is, the SEC's rules in response to the JOBS Act actually made things worse, by adding restrictions that make it far riskier, and represent a step backwards.

Beforehand, there were several key rules that held to do a private solicitation. Note: This is not a comprehensive list or legal advice.

  1. You could only raise company from "accredited investors," generally those with at least $1MM in assets beyond their home, or $200,000 or more of gross income ($300,000 for couples) over each of the last 2 years, and reasonable expectation that it will continue.
  2. Investors had to attest that they were accredited.
  3. You could not solicit from the general public, but only privately with qualified individuals or institutions (like venture capital funds).
  4. You had to register with the SEC within a limited period after the offering.

There are many other limitations, but these are the important ones.

Under the new, "wonderful" and "open" rules, the following has changed:

  1. You still can only raise from accredited investors. The average person cannot buy $1,000 in shares of their neighbour's startup.
  2. The burden is on the startup to verify that the investor is accredited; self-attestation no longer suffices. Undoubtedly, the platforms such as OurCrowd and Angelco will provide services (for a fee) to take care of this administrative step, but if there is an error, it is the startup that will bear the onus of SEC fines and a possible ban.
  3. You can, indeed, solicit from the general public (even if only accredited investors can invest).
  4. You need to register with the SEC 15 days prior to soliciting. Failure to do so will result in a one year ban on any capital raising.

So it turns out that general solicitation is, in many ways, more burdensome and more risky to the startup than private solicitation. Of course, it wasn't Congress who mandated these new rules, but the SEC which, at heart, has never trusted companies that raise capital or the investors who invest in them, that has layered them on.

For this reason, while I think crowdfunding will grow, many companies will continue to raise in private solicitations, whenever they can. Founders with ideas that require confidentiality in the early years and/or those who have access to angels or VC will continue to solicit privately. For those who choose to go the general solicitation route, the minefields to be navigated are treacherous.

Moral of the story: even with crowdfunding platforms, consult your attorney - and make sure s/he really knows the laws and regulations cold - before raising capital.