New SEC Guidance on Advertising a Fundraise
-- by Jessie Gabriel
The more private investing becomes mainstream, the more people learn that there are significant hurdles to investing in those companies—or for those companies to raise capital. The SEC regulates who you can raise money from, what information you need to provide them, and what information you need to provide the SEC. These rules evolve, let’s just say, slowly. But recently the SEC issued some guidance that makes things just a bit easier. Don’t get too excited.
When a company raises money in exchange for ownership, they are issuing “securities.” The SEC (U.S. Securities and Exchange Commission) is the one who sets the rules for how you can do this. To put it in context, the job of the SEC in this realm has often been a paternal one. If you’re taking someone’s money in exchange for a piece of paper (e.g., a stock certificate) as opposed to a tricycle you can see in front of you, the opportunity for fraud is much greater. This is not just a historical problem. Think Vice President Selina Meyer’s ex-husband, Andrew, always with a prospectus in his briefcase: “I know two million sounds like a lot, sweetie. It's not. It's a small price to pay to save the Brazilian rain forest.” Funny, but not.
The SEC uses three different levers to address this. The first is they require disclosure to the SEC by way of something called a registration statement. This document provides a ton of detail and is uploaded to the SEC’s public filing system, EDGAR. Now, registration statements are time-intensive and expensive to prepare, and they are invasive. This is something you want to avoid unless you are a very big company raising a very large amount of money. How do you avoid this requirement? By meeting an exemption. If you’ve ever heard someone talk about 506(b) or 506(c), this is what they’re talking about—ways to avoid having everyone and the government all up in your business (a uniquely scary prospect at the moment).
Alright, so how do you qualify for an exemption? This brings in the SEC’s second lever—only raising from people who have money to lose. That’s a cheekier way of describing the “accredited investor” requirement, which provides an assets threshold for your investors. If your investor doesn’t meet the assets threshold, they can’t invest (there are some exceptions here too, which we’re not getting into). In short, the rich get richer. Yada yada. We know this story and, unfortunately, this one isn’t changing anytime soon.
The third lever covers how you advertise to these investors. If you don’t advertise at all—meaning you just discuss your fundraise with people already in your network who you think are accredited investors, you’re all set. This is the 506(b) exemption. You can see how it all comes back to the SEC’s goal of protecting people from getting screwed out of their life savings. People who know you are less likely to be suckered into making a bad investment without any information (and I’d like to think that you are less likely to defraud people you know, but I guess we can’t always rely on that one).
Now, what if you want to cast a broader net? That is an option, but now you need to work a little harder to make sure everyone you bring in is accredited. You can’t just take their word for it. You need to take “reasonable steps” to verify that they are accredited. This is the 506(c) exemption. That doesn’t sound that hard, right? Why doesn’t everyone just go with 506(c)? The problem is the SEC hasn’t been the clearest on what constitutes “reasonable steps.” As a result, issuers have had to make their investors jump through serious hoops. Many companies raising under 506(c) insulate themselves by hiring an outside firm to take these reasonable steps. These firms request things that many investors do not feel comfortable passing around (like tax returns). This can also get particularly onerous if your investors are entities.
That's great, Jessie, but are you ever going to tell us about this great thing that just happened that makes this all easier? Yes, I’m getting there. But I think the background is helpful because if you’re reading this, you’re probably not an attorney. You’re probably a fund manager or founder and when people talk about 506(b) and 506(c), you probably turn to your team and put the finger gun to your head.
So, what happened? Last month the SEC issued some guidance about what it means to take “reasonable steps.” If you are raising at least $200,000 from an individual or $1,000,000 from an entity, you can take the investor’s word for it that they are accredited and are investing their own money (as long as you don’t have actual knowledge that they’re lying). Yeah, that’s it. Not exactly groundbreaking since it’s a safe bet that anyone who is investing $200,000 meets the accredited investor standard (annual income of at least $200,000 or a net worth of $1,000,000).
How it’s helpful: If you’re only bringing in big checks, it’s going to be easier for you to advertise your offering. You can put some materials together and shop it around.
