An End to the Ban on General Solicitation

The rule of law has long been abandoned – especially when the rule is the Securities and Exchange Commission’s ban general solicitation for private placements. In English (and perhaps the problem is that seldom has there been even an attempt by the SEC and securities lawyers to put this in English), the ban means that a privately held company cannot ask people that don’t already have a “pre-existing business relationship” to invest in their company.

Now, of course, as a percentage of American businesses, the ones that are privately owned (rather than publicly traded) is quite close to 100%. And, frankly, the number of potential investors that these business owners have a pre-existing business relationship is also infinitesimally small. So is it any surprise that there is a complete dearth of investment in these businesses? Almost all of the capital used to grow businesses comes from banks and family members – with a large amount of that capital taking the form of Small Business Administration-backed loans.

However, a host of companies do in fact get investment through private placements with accredited investors – a geeky phrase meaning “raising money from rich people”. Now, of course, in my experience, clients seldom even realize that the ban on general solicitation is strict. They routinely ask friends and family to introduce them to third-parties that may want to invest. Interestingly, these same clients easily understand and internalize that investors must be accredited – put very basically, that the investors have income above $200,000 or assets worth more than $1,000,000.

So why ignore the rule about general solicitation? Because the ban makes no darn sense.

But both Congress and the SEC knew that there was an opportunity to fix a problem that had been created under the old regulatory scheme. The problem? Companies raising money were taking money from non-accredited investors. The “wink-wink” usually included a questionnaire where the investor attested (falsely sometimes) that they were accredited, insulating the company from any claim that the investment was improper.

So, the new rules are this:

1) Companies can “generally solicit” and attempt to raise money from anyone.

2) In exchange, the company really needs to investigate whether or not the investor is accredited. This means looking at tax returns or certifications from accountants and/or lawyers.

The new rule only applies to companies raising money from accredited investors, but it is a pre-cursor to the equity crowdfunded future where even non-accredited investors will be able to get into the action. Maybe now securities lawyers can provide accurate guidance that reflects the real world, where successfully raising money requires meeting new investors and marketing the opportunity to invest in a private company.

Sometimes it takes a few decades, but the law catches up to reality.

 

Jonathan Frutkin
Jonathan Frutkin is CEO of Cricca Funding, LLC. He’s written a new book called “Equity Crowdfunding: Transforming Customers into Loyal Owners” which was published in May, 2013.

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