Over time, capital formation has dramatically changed for small companies. Even though Title III federal crowdfunding is not yet legal, the JOBS Act has significantly altered the landscape of small securities offerings, which are now being powered by the use of technology (websites as funding platforms) that use general solicitation to attract investors to a wide array of alternative investments.
General solicitation is not defined in statute, but it is generally construed to mean advertising through public channels including newspaper, television, radio, seminars, social media and the internet. While historically prohibited, the use of general solicitation allows for the first time the broad advertisement of private securities offerings.
Historically, investors could not be contacted concerning investing in a private placement of securities. The only exception was if there was already a substantive, pre-existing relationship with a broker-dealer or issuer. Congress allowed general solicitation specifically in order to ease the ability of entrepreneurs and startups to raise capital. The thinking was essentially, we can permit it because these sales are limited to accredited investors who theoretically can bear the risk of loss of their entire investment. And with Reg A+, which permits general solicitation and investment by non-accredited investors (people who are not considered to be wealthy), the SEC appears to have concluded that the added protections afforded by audited financials (tier 2), or state review (tier 1), and continuing periodic reporting requirements are sufficient safeguards to allow general solicitation.
Included with general solicitation in Title II of the JOBs Act was an exemption so funding platforms did not need to register to be a broker-dealer, so long as precise conditions were met, that was specifically designed to lower the costs and ease the ability of entrepreneurs and startups to raise funds. In contrast, the earlier ban on general solicitation effectively required broker-dealers to be involved in any private placement securities offering for it to be successful, as this was the only permitted mechanism for legally communicating: first prescreening prospects with no discussion of any deal and then, after a cooling off period, selling to prospective investors. This frequently eliminated the prospects of startups to obtain funding as many were too small to generate sufficient commissions to persuade the broker-dealer community to assist them to raise capital.
So the sea change is general solicitation combined with technology, which opens the door for entrepreneurs and startups to offer their securities directly to investors. This together with the reluctance of traditional market intermediaries to participate where startups are too small or unknown to generate sufficient commissions, and the entrance into the arena of fintech, pliable firms offering marketing, back office and compliance solutions, leads further to a reduced use of traditional market intermediaries.
While the law is grey in many areas, lessons are already becoming clear. On the legal side: do not operate your funding platform like a broker-dealer unless you are registered to be one. The SEC has traditionally viewed “solicitation” as a component of a securities transaction that had required broker-dealer registration, but general solicitation now by funding platforms is permissible. But funding platforms must make certain they are not crossing the line and acting as a broker-dealer (such as by negotiating securities transactions, or having possession of customer funds or securities in connection with the purchase or sale of the securities) when they are not registered to be one. Remember also to make sure you are registered or exempt from registration in the states where you sell securities (or use a selling agent who is registered). And consistently ensure that your advertising is fair and balanced and that all material facts are disclosed to prospective investors. On the practical side: the challenge remains how to not only get traffic to your website, but actually succeed in having investors invest in your offering there. Fintech firms are offering solutions such as aggregating offerings on websites, thus providing one stop shopping where similar offerings can be evaluated, weighed and selected, and by reducing friction for investors by utilizing investor friendly tools such as FundAmerica’s “invest now” button, which can be cut and pasted on to any website and which opens a gateway to its back-office and compliance services. Broker-dealer firms can also be tapped to help drive investor interest and investment to your securities offering.
We are now observing widespread Internet based general solicitation of securities to accredited and non-accredited investors directly by entrepreneurs and startups. This new method of raising capital cannot be successful unless it is done ethically and in a manner consistent with investor protection. The need for low costs that startups can afford, and high ethics necessary to protect investors and make the industry successful, is already resulting in the creation of new, financial intermediaries that are more pliable and cost effective in offering marketing, back office and compliance solutions. With time and experience the industry will develop best practices, not so much from expensive and unworkable (for startups) market intermediary solutions of the past, but from more fintech, pliable, and cost effective solutions offered by a new age of financial intermediaries.
The information and materials in this article are provided for general informational purposes only and are not intended to be legal advice. The issues discussed include complicated areas of law and legal advice should be obtained from a securities attorney about your specific circumstances.