In order to advertise publicly for financing—whether via the internet, radio or on TV–the federal and state regulatory agencies require that you file a registration statement. In other words, you must first go public, an onerous and costly task when you are just starting your business. Fortunately, the securities laws do not prohibit you from approaching potential investors with whom you already have a pre-existing relationship; registered broker-dealers; or, accredited investors. Thanks to the JOBS Act, in a 506 offering, you can solicit accredited investors as discussed below even if you don’t already have a relationship with the accredited investor.
With respect to advertising to the public, there is an exception to the “general solicitation” prohibition in California under CA Corporations Code 25102(n) which allows a very limited ad on your website for an unlimited amount of funding within California. If you are relying on this exemption, be sure that the ad does not deviate from the precise language allowed under the Corporations Code. Furthermore, 25102(n) requires a comprehensive filing with the California Corporations Commissioner before you publish the ad. Once a prospective investor shows interest in your offering, you must then insure that the investor is a “Qualified Purchaser,” which includes large institutional investors and high net worth individuals. A Qualified Purchaser for purposes of 25102(n) must have a minimum net worth of $250,000 and an annual income of at least $100,000, or, if no annual income, a minimum net worth of $500,000. Also, the amount of investment cannot exceed the individual’s net worth by 10%. While 25102(n) is available to a number of companies, this exemption is not available in roll-up transactions, blind pool funds or to investment companies subject to the Investment Company Act of 1940.
Is there any other way to solicit funding over the internet?
Under Title III of the JOBS Act, a new exemption was created for crowdfunding to raise up to $1 million in a 12-month period as long as individual investments do not exceed certain thresholds and provided other conditions are met. One of those conditions is that the issuer must use a registered broker or a funding portal as an intermediary. A funding portal does not need to register as a broker-dealer with the SEC but the portal does need to be a member of a national securities association and is subject to other SEC requirements. As the issuer, you can accept funds from unaccredited investors provided you have made certain informational and financial disclosures to investors and the SEC depending on the amount of funding sought, and you did not advertise the offering except in the form of a notice to direct potential investors to the broker or portal. In addition, you can only accept the greater of $2,000 or 5% of the annual income or net worth of an investor if that investor’s net worth or annual income is less than $100,000. If an investor’s net worth or annual income is more than $100,000, you can accept up to 10% (but not to exceed $100,000) of the annual income or net worth of the investor. Once the investors buy your shares, investors are also subject to resale restrictions, and you will be required to provide the SEC with annual reports as well as providing investors with the results of operations and financial statements as the SEC determines. Crowdfunding as described above will not be permitted for unaccredited investors until the SEC finalizes all related rulemaking.
An alternative to crowdfunding is the recent revision to Rule 506 offerings. The JOBS Act allows for general solicitation and advertising, if you are relying on a 506 exemption, to accredited investors, defined in Rule 501 of Reg D (i.e. large institutional investors, an individual with net worth over $1 million or annual income of over $200,000 per year, etc.) In July of 2013, the SEC stated, “The amendment to Rule 506 permits an issuer to engage in general solicitation or general advertising in offering and selling securities pursuant to Rule 506, provided that all purchasers of the securities are accredited investors and the issuer takes reasonable steps to verify that such purchasers are accredited investors.” Reasonable steps, according to the SEC, would include reviewing tax returns to verify whether a potential investor satisfied the accredited investor test for sufficient income, or reviewing bank and brokerage statements as well as a credit report to verify whether a potential investor satisfied the accredited investor test for sufficient assets.
While the securities exemptions are complicated and require legal guidance, the intention Title III of the JOBS Act is to loosen the securities restrictions on obtaining capital for startups.