Everyone who is fundraising is selling. They are selling their company, their product, themselves. And if that weren’t hard enough, you also need to be mindful of the limitations on fundraising. Read on for some dos and don’ts when it comes to contacting potential investors.
Our federal government (and fair enough) has had some concerns about potential investors being duped into making investments. This concern is particularly acute when it comes to private investments, about which there is much more limited, and much less market-tested, information. Have I mentioned that I spent ten years of my legal career as part of the team sorting out the Madoff Ponzi scheme? So yes, deception does happen and with some regularity.
So great. There should be some rules, right? Yes. Now, what are those rules? Really good question and one to which there is a technical answer that is, at the same time, wholly unhelpful. Putting the policy aside, the real problem here is that the rules aren’t very clear. Who can you talk to? What can you say? What is a “preexisting relationship”? What is “solicitation” (no, not that kind of solicitation)?
The Basic Standard. If you are raising money in a private offering (as opposed to through an IPO or other public market offering), you are likely doing so under an exemption for private placements that allows you to avoid a bunch of regulatory hoops related to “registered” securities. These exemptions are contained in the SEC’s Regulation D (“Reg D”), the most common of which are 506(b) and 506(c).
Here’s the critical rule: if you raise money under 506(b), you are prohibited from engaging in “general solicitation.” We’ll get into what that means below, but I wanted to highlight that there is another option here that does allow for general solicitation: 506(c). This underutilized provision gives you much greater freedom to market. The tradeoff is that the SEC adds in an extra layer of protection to balance that freedom. You must verify that all your investors are accredited–investors cannot self-verify and you cannot take money from any non-accredited investors. You can do this through an independent service so you aren’t personally reviewing your investors’ tax information, but not all investors (particularly VCs) are interested in going through this process. I can feel this is starting to get really, really dull for any non-lawyers, so we will move on!
Here’s the standard for the 506(b)’ers out there: “neither the issuer nor any person acting on its behalf shall offer or sell the securities by any form of general solicitation or general advertising.” § 502(c). Was that clear to you? Me neither. Let’s break it down.
Are you offering or selling? The first question is, is what you’re saying an offer or sale of securities? What if you are on a podcast just talking about how awesome your product is . . . while you are fundraising? Is that an offer or sale? What if you just mention that you’re in the middle of fundraising but no terms of the raise? Does that breach the threshold? The answer: unclear. The most frustrating thing about this area is the lack of guidance, particularly practical, contemporary guidance, on what this means.
The SEC has explained that “factual business information that does not condition the public mind or arouse public interest in a securities offering is not an offer.” Oh, thanks. We are yet to see any guidance about the practical use of social media or targeted email campaigns. One would think a mention that you are fundraising, along with a disclaimer that only accredited investors could participate, would be enough. But no guarantees.
What is helpful here is this: if you aren’t launching your fundraising anytime soon, then you can’t be “offering” anything. In other words, develop your relationships early. This is just good business practice. The chance of a cold email leading to an investment is minimal anyway.
Substantive Relationships. One thing that is clear (if not particularly helpful), is that you can have conversations with people you already know. Super. The SEC has also acknowledged that it is common for someone in a preexisting relationship to refer a company that is raising to other investors in her network, and that such actions may be acceptable. So referrals are just probably okay. Come on!
Pitch Days. There is a carveout (with a number of very particular requirements) for discussing your offering at a “pitch day” or “demo day.” As long as these events are organized for a targeted group of individuals who are sophisticated investors with whom the organizers have pre-existing relationships, it’s probably fine. Presumably anyone that is organizing one of these events is familiar with the rules and does what needs to be done to ensure it’s compliant.
What’s Really Going On. Some of you might now be thinking back to all the LinkedIn messages you’ve gotten from companies who are fundraising. I mention that as one example of this very true reality: people violate these “rules” all the time. Why? Because the rules aren’t clear, they are impractical, and businesses who need funds to survive may not be all that concerned regardless. I recently read an article about the use of the internet in soliciting that referred back to SEC releases from the 90s. The 90s!
The Final Takeaways. What did we all learn here? Primarily we learned that it is very difficult to know with any certainty whether a communication will be considered an improper general solicitation. That means we go back to the principles underlying these rules. The SEC doesn’t want unsophisticated investors tricked into purchasing securities they don’t understand. So don’t do that, don’t even give a hint that you’re doing that. Instead, focus on: building relationships with sophisticated investors (or at least people who you are confident are accredited investors).
I hope this wasn’t as frustrating to read as it was to write. SEC–get your act together! We’re moving at a glacier's pace here. Also, so many of these rules exist in part to make it easier for rich people to get richer. Let’s have some clearer, more egalitarian, and practical guidance. Please please, pretty please.