Dan Rosen is chairman of Alliance of Angels.
On June 10, the Securities and Exchange Commission released rules allowing entrepreneurs to publicly advertise their investment opportunities, finalizing a portion of the JOBS Act of 2012. These included a final rule lifting the ban on general solicitation and provided guidance on how issuing entrepreneurs could “reasonably” verify their investors are accredited; a final rule disqualifying “bad actors” from investing in private offerings; and a proposed rule requiring entrepreneurs to submit multiple reports and information for solicited offerings. The Angel Capital Association (ACA) has taken a strong stance on these rules, stating that these rules could greatly reduce entrepreneur access to angel investment, as they require investors to provide their private wealth or income information to issuers or third parties, and also may require entrepreneurs to submit considerable information to the SEC with harsh penalties for missing filing dates.
I am being asked, why is the SEC proposed ruling such a big issue?
Unless you read the entire ruling, it won’t be clear why it poses such a threat.
Simply put, the proposed SEC ruling is (a) trying to fix a problem that doesn’t exist; (b) will increase risk in our early-stage deals by adding a dimension of regulatory risk that isn’t there now; (c) will increase the cost and time for getting deals done; and (d) violates the Congressional intent of the JOBS Act, which recognized that using angel investment to create more jobs in startup companies was good for the U.S..
Their proposed ruling is setting new policy by bureaucrats in an area where the policy should be set by legislators.
There are several issues here:
1) What constitutes a general solicitation?
One reason I welcomed the JOBS Act provision on general solicitation was that angel groups living in the 21st century would conduct business that might be construed as general solicitation – a boundary that is subjective. My angel group, the Alliance of Angels (AoA), was ultra-conservative. For example, we didn’t give our 2 page startup summary sheets to guests who had not yet given us the accredited investor forms. When a company posts its plan to Gust (as the AoA requires), are we generally soliciting? We live in a connected world, with social media being the norm, so the new rules should take that into account. But the boundaries are murky and, if the proposed rules are adopted, the consequences of a mistake are draconian.
2) Rules make raising capital harder
When the JOBS Act passed, Congressional intent was to ensure more startups could access capital. The new SEC rules not only won’t achieve that intent, but will also make it harder to do so because of the uncertainty about what constitutes general solicitation. I will likely avoid investing in any deal that uses general solicitation. If the startup makes a mistake, I will lose my investment quickly, since they will have spent my money and not be able to return it when the deal is rescinded. Even if the deal is not rescinded, they will be prohibited from raising money under Reg D for one year—a death sentence for a startup.
3) Private financial data required
I most certainly won’t give personal financial records of any type to a startup. Perhaps a third party verification industry of broker/dealers will emerge that will do so on my behalf, but that will add cost and complexity. Furthermore, that will likely require me to fill out additional myriad forms for each investment, attaching my tax returns, bank accounts, etc. each time. Again, I find myself asking “what problem are you trying to solve?” Public market equities don’t require me to jump through any hoops. Seems simpler.
4) Potential severe penalties
If the entrepreneur thinks they are not using general solicitation, but later it is determined that they did (e.g. presented at a public event, did a post on a social network, talked to a reporter, or potentially even told a customer who asked how you could ship your product), the impact is severe: The startup has 30 days to file an amended form D, allow existing investors to rescind, and potentially face a one-year ban on fundraising.
5) More reports and filings
Today you can file a “Form D” after you raise the money (15 days). In the proposed rules if you do use general solicitation (506c), then you must file an Advance Form D 15 days BEFORE the first time you generally solicit. So, that would mean that you will need to file before you speak to your first investor and then file (an amended Form D) when you reach final terms. And the Form D is posted to a web site that can be reviewed by state regulators who can then require a company to jump through myriad state hoops.
6) Complexity and more fees
The SEC is making the Reg D forms much more complex. You can read that to mean that legal fees will be substantially higher. This will make the smaller deals (that we have been advocating) more problematic.
For a more thorough treatment of these issues, see: www.startuplawblog.com/ or www.angelcapitalassociation.org/blog/.
Dan Rosen is a Board member of the Angel Capital Association, the world’s largest organization of accredited investors, and is also chairman of the Alliance of Angels, a Seattle-based angel investment group.