The longstanding United States ban on “general solicitation” has been lifted.
Startups can now publicly announce that they are fundraising. It’s an enormous shift in the rules for fundraising that has some entrepreneurs incredibly excited. But how many startups are ready to follow this path — and will they be able to navigate the new maze of regulations?
We talked to six companies (a mix of startups and investors) to find out what the rule changes means for them: RockThePost, WeFunder, AngelList, TechShop, Bessemer Venture Partners, and CircleUp.
One of many responses to the stock market crash of 1929, the ban on general solicitation took hold during The Great Depression in 1933. It regulated the offer and sale of securities, which meant that private companies could not publicly solicit investment. Fundraising had to happen behind closed doors.
For more on the JOBS Act’s new provisions, see:
- How the JOBS Act will kickstart the innovation economy, with TechShop as a case in point
- What the CEO of Crowdfunder thinks: The web will eat financing and investing
President Barack Obama signed the Jumpstart Our Business Startup Act (JOBS Act) in April 2012 in an effort to stimulate small businesses (and the economy) by making it easier to raise capital. The bill has seven main provisions. It doesn’t implement some, like permitting anyone to make equity investments, until next year. (Accredited investors include people whose net worth exceeds $1 million or who have an annual income of $200,000 per year or higher. According to a July report by the Government Accountability Office, there are about 8.5 million people in the U.S. who qualify as accredited investors.) Other provisions, like permitting companies to secretly file the initial paperwork for an initial public offering, are already in effect. Twitter is using this for its IPO.
“Through the new rule 506(c), companies are permitted to use general solicitation to reach investors, essentially reaching out publicly in a private offering, as long as every ultimate investor in the offering is accredited,” said Stephen Graham, a partner at Fenwick & West, who also co-chairs the SEC’s Advisory Committee on Small and Emerging Companies. “This should mean greater access to capital for startups as they are permitted to cast a wider net for investors through general solicitation. It also should mean a greater role in private offerings for online platforms.”
Here is a look at what the general solicitation means for these six companies.
Lifting the ban on general solicitation enables private companies to state that they are fundraising on their homepage or social media accounts and raise money through open online funding portals — and theoretically yell about it all from the rooftops. It also means that investors who are outside the tight circle of Silicon Valley will have greater access to deals.
“In the past three years, only 258,000 investors have made an angel investment out of the 8.7 million accredited investors eligible to invest in the U.S.,” said RockThePost’s CEO Alejandro Cremades to VentureBeat. “The ban lift replaces a reliance on word-of-mouth and networking events, which has been the case for the past 80 years. As a result, the active angel investors could grow thirtyfold. Now, investors will have access to quality startup-investing opportunities regardless of whether they belong to an angel investing group or are an insider in the tight-knit venture capital communities.”
RockThePost is an equity crowdfunding platform that connects accredited investors with startups. Before, the investment opportunities had to be kept behind a firewall that only approved members could access. On Tuesday, RockThePost will hold a digital demo day, and four startups will pitch to investors over a livestream.
WeFunder is a Y Combinator startup that has a platform similar to RockThePost. While the company is not going so far as to host a public event, founder and CEO Nick Tommarello said that WeFunder’s site will look more like Kickstarter, where anyone can browse through the opportunities without signing up.
“If you are a founder fundraising, you want to stop fundraising as soon as possible and go back to work,” he said in an interview with VentureBeat. “In a couple days, you could raise a couple of million dollars. The real value of crowdfunding is that people who like your products and use them can invest, and new angel investors can get their feet wet.”
General solicitation means that it will be easier for startups to attract attention and fundraise from more people. However, with equity investments, more contributors is not necessarily a good thing.
One of the concerns with raising money from a lot of different sources is having a crowded cap table and not taking “smart money” from investors who have domain expertise and connections. WeFunder address this issue by pooling all contributed money into one people so just WeFunder shows up as the investor, an approach also taken by online venture capital startup FundersClub.
Another concern is due diligence. Before angels and venture capitalists make investments, they perform due diligence to make sure that the company is legitimate. This is a time-consuming process that many hobby/amateur investors don’t have the time or knowledge to do.
Online investment portals like the ones mentioned above address this by tightly curating the featured opportunities. WeFunder participated in both Y Combinator and Tech Stars, and primarily draws from these already-vetted pools.
As deal flow opens up and there are more accessible opportunities, the due diligence step of the process will become increasingly important.
Along with lifting the ban, the SEC issued a new, stricter set of requirements to verify that investors are accredited. Before “self-accreditation” was permissible. Now official documentation, such as tax forms and statements from CPAs or attorneys, will be required.
Startups must also notify the SEC 15 days before they publicly discuss raising money, file documents with the SEC every time they update their offering materials, and include legal boilerplates every time they talk about their financing publicly
Many influential people in the tech community have spoken out against these regulations.
AngelList is a social network for startups and investors, where investors can also fund startups for small dollar amounts and create syndicates around specific deals.
AngelList’s founder Naval Ravikant told VentureBeat that AngelList will support startups who avail themselves of general solicitation and those who don’t. However, he said these rules also have the potential to hurt startups who are not aware of the difficult filing requirements and receive a penalty for making a mistake.
AngelList came out with memo to help entrepreneurs understand what all these changes mean:
“The SEC’s proposed rules will defeat their goals in letting startups raise money publicly. Startups may be forbidden from raising money at all if they accidentally break the rules—effectively putting the startup out of business. Or startups will decide that these rules are so difficult to follow that they will raise money privately, lowering their chances of raising money and moving their conversations to forums that can’t be tracked by the SEC. Either outcome defeats the purpose of letting startups raise money publicly. And it will have the unintended consequence of putting large numbers of otherwise promising startups (and most of the job growth in the U.S.) out of business.”
Graham said that the new filing requirements prove be “burdensome and costly,” and create additional uncertainty as issuers try to determine what actually constitutes general solicitation materials. For example, demo days have been a common practice in the startup community for years, despite existing in a legal gray area. If demo days are considered “general solicitation,” Graham said his could have a “chilling effect” on angel investing.
Chief executive Mark Hatch announced this morning that his company is seeking to raise up to $60 million to expand into dozens of new locations.
Hatch was enthusiastic about the lifting of the ban on general solicitation.
“In my mind, the JOBS Act general solicitation rules unravel 80 years of SEC tradition of not allowing entrepreneurs to generally advertise and solicit for investments,” Hatch said. “It’s literally been 80 years since you’ve been able to let people know that you’re raising money in a general way in the U.S. It’s a huge deal.”
Hatch said it takes $2.5 million to $3 million investment to open a new TechShop location. Previously, he was able to open locations in Pittburgh, Detroit, and Austin only with help from local city leaders, followed by a string of face-to-face meetings — “which is stunningly inefficient, particularly in the Internet age,” Hatch said. “You have to show up physically. As a result, it takes an incredible amount of time” to raise the requisite funds. This is going to be so much more efficient.”
Bessemer Venture Partners
Venture capital is very much a relationship-based world. A lot is based on “who you know,” and it is difficult to get meetings without a warm introduction. On the flipside, investors who are not in this inner circle don’t have the same access to high-quality deals or even know what their options are.
Approving general solicitation brings a greater level of transparency to the fundraising process and allows a greater number of people to be included, but traditional venture capital has a different role to play.
“Any good team or business can raise money,” said Byron Deeter, a partner at Bessemer Venture Partners. ”The best teams also often want a value-added partner who can help the business in other ways: strategy, hiring, partnering, financings, exits, et cetera, and this is where the best venture capital firms repeatedly differentiate themselves.”
However, some startups struggle to get the attention of venture capitalists. Companies that are far away from centers such as Silicon Valley or New York City, or who don’t make software, have more to gain from raising equity financing in a more public way, and appealing directly to consumers.
CircleUp connects up-and-coming consumer product businesses with accredited investors. The company was founded to give people developing products like kale chips or hand lotion a channel to raise money. Founder Rory Eakin said that it can be a challenge for startups in this sector to raise money, and the lift on the ban means they have more options with whom they raise money from.
A venture capitalist may not be interested in funding in granola, but a mom from Washington, D.C., might be.
“Right now, if you are an engineer in Silicon Valley, there is an ecosystem available for funding. But outside of tech, that ecosystem doesn’t exist,” Eakin said to VentureBeat. “With the ban on general solicitation in place, individual investors are at a disadvantage relative to well-known angels. It is a biased system where equity capital is difficult to find. General solicitation allows that dispersed market to clear more efficiently.”
Like most things in life and in business, there is not a one-size-fits all option. No one I spoke with is sure of how the ecosystem will actually change. Some people are bubbling over with excitement, while others think this will be a disaster. Most said that the change will be slow to manifest, and the real impact will happen next year when non-accredited investors are allowed to invest.
Until then, I am eagerly searching for a billboard that announces a company is fundraising. Keep a look out, readers.
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