What you should know about startups and the JOBS Act
Today, the rules around raising money for your startup will change due to the JOBS Act: Title II goes into effect today. This is dry material for those outside the space but if you’re curious, here’s a quick breakdown of what used to be and what is now.
In the past (read: before today), startups were banned from announcing publicly that they were fundraising (Twitter, Facebook, newspaper, etc). It was always fine to be wealthy and publicly state you’re looking for investment opportunities but not the other way around. Furthermore, even if the announcement was not ‘public’ per se, you still had to personally know each individual who heard or read the announcement.
This ban on ‘general solicitation’ came from the SEC and had stiff penalties - if not always strictly enforced. The grey area around the law included the popular ‘demo day’ model (where groups of startups go through a accelerator program and then present their ideas for investment to a group of select investors). If you didn’t know every investor in the room (highly unlikely as meeting new investors was the point), it was illegal.
Now however, the JOBS Act has changed all that. You can, starting today, publicly tweet or Facebook post about your company, fundraising status and what you’re seeking to raise - potentially making the entire fundraising process much faster and, for investors, much more competitive. The three biggest points to remember are:
Your investors still must be “accredited investors”. This rule has long existed and is not going away. Accredited for individuals means he or she has a net worth in excess of $1 million not including the value of his or her primary residence or an annual income over $200,000 for the past two years and an expectation of the same for this year. I mention this because many assume the law is legalizing raising money from the general public (‘crowdfunding’). Not yet - that’s to be determined and is a part of the proposed Title III of the JOBS Act.
Because you now have many unaccredited investors who will hear about your fundraising plans if you announce publicly, somehow it has to be made clear who is accredited and who is not. The SEC has decided that if you take the route of general solicitation (aka if you ever mention you are raising money in any public or semi-public forum), you as the startup must “take reasonable steps” to verify their eligibility (that is, verify that they have the assets or wealth that they claim they do).
Don’t start tweeting about your raise just because the law has passed. You must disclose to the SEC that you plan to publicly solicit before you do so and provide addition details on exactly what you are doing within 15 days of doing it.
This second point is where I think the SEC went wrong. Putting the onus for verification on the entrepreneur is both tough (because of the ambiguous language of ‘reasonable steps’) and potentially awkward (ex. asking an investor for bank balances or tax returns). I don’t know enough on the issue to offer a definitive alternative but it seems reasonable to instead have the investor offer a self-signing letter saying they qualify. If they lie, they are liable to the SEC for violating law.
Everyone in the startup space - entrepreneurs, angels, advertisers - will quickly see a lot more self-promotion online and offline. Eventually, this will permeate to the general public as well. It’ll be a real challenge to raise awareness that just because everyone is being solicited to invest does not mean everyone can invest and therein lies huge legal and compliance issues.
Is the huge increase in opportunities worth it for angels (more signal but a lot more noise)? Will the SEC be able to keep up with all the new ‘startups’ and companies that suddenly will want the option to solicit publicly? Will fraud become a problem as inexperienced - but legally accredited - individuals buy into high-risk startup ideas?
Talk back @suprasannam.