July 11, 2013
Federal regulators recently announced the first of what could be many sweeping changes to the accessibility to capital by the business community. For 80 years, a general solicitation ban has been in place limiting the ways in which hedge funds, venture capitalists and startups could raise money, relying on word-of-mouth and private communication to generate interest in their investment opportunities. The changes set forth in rules adopted by the Securities and Exchange Commission (SEC) on July 10 will effectively allow companies to cast a much wider net to solicit investors by permitting public advertising of private placement opportunities.
Specifically, the SEC voted 4-1 in favor of implementing Section 201(a) of the Jumpstart Our Businesses (JOBS) Act, enacted in 2012. One of the six key tenets of the JOBS Act was to lift the 80-year ban on general solicitation for all private fundraising, which the SEC has now accomplished by making the following changes:
These amendments will become effective in mid-September, and fundraisers will be able to engage in a general solicitation for a Rule 506 private placement commencing 15 days after the new Form D has been filed with the SEC. Upon finishing their solicitation, companies will then have 30 days to amend their Form D accordingly.
Will lifting the ban on general solicitation mean we’ll suddenly be inundated with ads for hedge fund investments? Not likely. Revised Rule 506 doesn’t thrust Joe the Plumber into an investment feeding frenzy. In an effort to reduce risk to unsophisticated investors, the SEC kept certain other provisions of Rule 506 in place, such as the requirement that all purchasers of securities pursuant to the new rule are accredited investors.
Not everyone, however – including one of the five commissioners overseeing the SEC – believes that the safeguards implemented by the SEC will provide adequate protections to investors. Many believe that the requirement for investors to be accredited is a far cry from ensuring that such investors are sophisticated enough to understand and undertake the risks of investing, making them easy targets for companies looking to take their money. And it’s a lot of money: $900 billion was raised in 2012 for unregistered securities under Rule 506 and Regulation D, according to the Wall Street Journal – significantly more than the $43 billion raised in that year’s IPOs.
Opponents of the new SEC rule revision will likely be even more pessimistic as further provisions of the JOBS Act are debated and implemented by the SEC, including the CROWDFUND provision, which the SEC is currently considering. If the SEC ultimately adopts the rules to implement crowdfunding – where unaccredited individuals (such as Joe the Plumber) can invest directly in hot new startups – we will likely see an even greater influx of capital into the markets. The greatest gains may be in the technology startup ecosystem, which has seen a significant recent resurgence of momentum since the 2001 dotcom crash.
The changes enacted by the JOBS Act and currently being implemented by the SEC have generated an intriguing alternative to an IPO, a capital-raising strategy that many companies are hesitant to undertake for fear of losing control of their company and being hamstrung by stringent reporting requirements. Thanks to the SEC’s relaxation of the ban on general solicitation, we are seeing a bridge between, or hybrid of, the prior private placement model (which, due to the ban, was relatively limited in scope) and the IPO. Companies now have the option to reach a significantly larger pool of investors (akin to an IPO) while still maintaining the governance and reporting benefits of a private placement.
For better or for worse, these new changes mean we can look ahead to increased investor awareness of opportunities, as well as increased questions from companies struggling to ensure compliance with SEC requirements in this burgeoning area of capital funding.
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