5 Ways Raising Capital Is Changing
Today, the Securities and Exchange Commission lifts the ban on general solicitation--a rule that was originally put into place during the Great Depression when unscrupulous businessmen would defraud investors across state lines by going door to door selling fake securities. In response to such a serious threat of hardworking people losing their savings, rules were put into place to ensure that securities were only offered to friends, family, and other known associates who had enough wealth to take the risks. Unfortunately, this law had unintended consequences for small business owners who did not have large networks of millionaires at their disposal.
In answer to the effect these laws had on small business, the JOBS ACT was signed in April 2012, which legalized securities-based crowdfunding in two separate phases. What's called the Title II phase goes into effect today, allowing businesses to advertise their need for capital--as long as they are only accepting accredited investors into the offering and filing the correct form.
While this may seem like the greatest thing since sliced bread to cash-starved entrepreneurs, there are ways to get into trouble--and the SEC is going to be watching.
So, what does this mean for businesses? To ensure small business owners understand this monumental legislation, I tapped some of the leading minds in crowdfunding to address today's rule changes. Here are five ways raising capital is changing:
1. Starting today, businesses are legally allowed to advertise their need for capital as long as they file the regular Form D, specifying a 506(c) capital raise. "Businesses will not be limited to any specific form of advertisement, including billboards, commercials, and digital ads. It is likely that many businesses will turn to the emerging crop of investment platforms designed for securities-based crowdfunding, as that is where investors are being attracted," says Judd Hollas, founder and CEO of crowdfunding platform EquityNet.
2. Businesses building capital through a 506(c) raise will need to verify the accredited status of their investors. An accredited investor is an individual whose income exceeds $200,000 annually, $300,000 if a spouse is included. A person with $1 million or more in net worth also qualifies. "This is a big change in the way things were previously done, where most entrepreneurs relied on investors to simply self-verify their accredited status in a statement on paper. Though some of the other rules are up in the air, this is one we know for sure will go into effect. Technology is advancing and will make this hurdle easier for businesses," says Bob Carbone, founder of CrowdBouncer, a provider of compliance tools for investment platforms.
3. In addition to lifting the general solicitation ban, the SEC proposed some corresponding rules that are not yet in effect--so there's some ambiguity regarding how Title II raises will actually work, at least as far as the official paperwork is concerned. "These proposed rules may change or even be abandoned--no one knows for sure yet. This disparity has been understandably confusing for some," adds Hollas. The industry is encouraging businesses to follow the proposed rules about registering your securities outlined by the SEC until the final ones are known.
4. Some crowdfunding proponents see this development as more than just a positive thing for entrepreneurs--but also for investors seeking more and better deal flow. "I think we're going to see more investors with accredited status become involved in funding early-stage start-ups; mainly because more start-ups are able to go directly to the source and solicit them for investment," says Chris Camillo, an angel investor and author of Laughing at Wall Streetwho regularly advises entrepreneurs.
5. According to equity crowdfunding's fans, non-tech start-ups will now stand a fighting chance in the competitive area of attracting wealthy investors. "Equity crowdfunding has the potential to remove a lot of traditional biases that do exist in the angel investing and venture capital world, especially once technology moves the process online," notes Camillo.
While business owners raising capital may have a new tool in the fight for funding, it is important for them to remember that best practices won't go out the window. "Just because you can solicit investors on Twitter does not mean you should," cautions Joy Schoffler, founder of Leverage PR, a public relations firm specializing in financial services who has raised millions of dollars in capital throughout her career. "No one is going to write you a check because you tweeted to them about your company. The same code of conduct when raising capital still applies. You have to look and feel credible. You have to engage with people, not just spam them about your need for funding," adds Schoffler.
Lastly, it is critical that business owners thinking about doing a 506(c) offering (generally soliciting) remember that they could be under a microscope. Misstating the truth--even just a bit--or omitting critical information is considered fraudulent activity and could result in stiff punishments.
For the full text of the SEC's proposed rules, visit http://www.sec.gov/rules/proposed/2013/33-9416.pdf.