Last week, we reported about an important event for startups: Title II of the Jumpstart Our Business Startups Act or JOBS Act took effect last Monday and it lifted the ban on general solicitation, allowing startups to publicly advertise that they are seeking investments. General solicitation means “to publicly advertise the opening of an investment round in a private company by utilizing mass communication.” As reported by Forbes magazine, “under Title II of the JOBS Act, entrepreneurs will be permitted to publicly advertise that they are fundraising for their businesses, something that was previously illegal for the past 80 years under Rule 506 of Regulation D and Rule 144A of the Securities Act of 1933.” As promised, this week, we will discuss several important steps startups must take to comply with the regulations of Title II if and when they choose to generally solicit their fundraising efforts.
Under Regulation D Rule 506(c), the rule allowing for general solicitation, the first thing you must do if you are a startup choosing to engage in public fundraising or general solicitation is ensure that only accredited investors are permitted to enter the funding round. This requirement differs from private fundraising, which is regulated by Regulation D Rule 506(b), and which allows you to have in your funding round up to 35 non-accredited investors with whom you have had a pre-existing relationship.
So what is an “accredited investor?” According to Regulation D Rule 506(c), an “accredited investor” is one generally having earned $200,000 for the past two years, or $300,000 if married, or having a net worth of $1 million not including a personal residence. Of course, it is not as easy as simply asking a potential investor if they meet this threshold. The JOBS Act requires startups to verify the status of investors and provide official documentation to confirm that each investor meets the “accredited investor” threshold. Because some investors may not feel comfortable providing such personal information (including tax returns, relevant bank statements, brokerage account statements, credit reports etc.) directly to startups, the SEC has allowed third-party services to undertake this necessary due diligence. This service protects a potential investor’s proprietary information and also relieves the startup of the burden of verification. A third-party service can be a registered investment advisor, a broker-dealer, an attorney, or a certified public accountant.
Finally, in order to generally solicit an investment opportunity, a startup must file a Form D with the SEC. This form alerts the SEC that you are raising money using an exemption. As of today, you must file a Form D within 15 days of receiving your first investment. But, this may change. At present, the SEC has also suggested further proposed rules, which will go into effect 60 days after a public-comment period. Under the proposed rules, startups will need to file a Form D three times: (1) 15 days before beginning to generally solicit; (2) within 15 days of receiving the first investment; and, (3) 30 days following the termination of an offering, i.e., once fundraising has closed. For now, startups need only file a Form D within 15 days of receiving the first investment.