The Securities and Exchange Commission today lifted an 80-year ban on general solicitation, allowing businesses to now publicly advertise their need for funding — a potential boon for firms in need of capital.
The ban was initially enacted during the Great Depression to prevent fraudulent securities from moving across state lines and to protect naïve investors from financial ruin. Now, what is known as Title II crowdfunding (i.e., mass-funding by accredited investors), which was authorized last year by the JOBS Act and later approved by the SEC to take effect on Sept. 23, allows entrepreneurs to start advertising their capital needs as they see fit.
However, they must follow current financing rules and adapt to some new regulations that will come into effect later this year.
What follows is a brief outline of the situation that Title II will create for entrepreneurs seeking funding.
What businesses can accomplish under Title II:
As stated above, businesses will have the ability to publicly advertise their need for funding on and after September 23rd. Businesses will not be limited to any specific form of advertisement, so anything from ads on bus stop benches to television commercials will be considered viable. It’s very likely, however, that due to the ubiquitous nature of the Internet, many of these advertisements will be seen online.
Some businesses, for example, may consider posting offerings on Internet-based crowdfunding platforms. Others may wish to seek alternative means of crowdfunding, but with the implementation of Title II, and eventually Title III of the JOBS Act (allowing crowdfunding by non-accredited investors), online crowdfunding platforms will likely become the simplest and most effective means for firms to raise capital.
Details of current Title II regulations for businesses:
Title II imposes restrictions as to who can actually invest in a business soliciting capital. In the past, self-accreditation was all that was required of an investor and a business was allowed an unlimited number of such investors and up to 35 non-accredited investors.
Now, general solicitation rules require that all investors must be accredited and that businesses must take reasonable steps to verify the accreditation status of their investors. A business can verify the accreditation status of a business by doing the following:
• Obtain any IRS form that reports an investor’s income for the past two years. Such forms include, but or not limited to Form W-2 (“Wage and Tax Statement), Form 1099 (report of various types of income), or a copy of Form 1040 (“U.S. Individual Income Tax Return”).
An investor must also include a written representation that states he or she has a reasonable expectation of reaching the income level necessary to qualify as an accredited investor during the current year. The individual investor must make $200,000 in annual income or $300,000 if his or her spouse is included to be considered accredited.
• Review documentation for assets and liabilities that is dated within the prior three months, and a written representation from the investor stating that all liabilities required to make a determination of net worth have been disclosed. Documentation for assets can include bank statements, brokerage and other statements of securities holdings, certificates of deposit, and tax assessments or appraisal reports issued by an independent third party.
For liabilities, a credit report from at least one of the nationwide consumer reporting agencies and the abovementioned written representation stating an investor’s liabilities is considered an adequate form of documentation.
• Obtain a written confirmation from a registered broker-dealer, an SEC-registered investment advisor, a licensed attorney, or a certified public accountant that the business advertising for funding has taken appropriate measures to assure that an investor is accredited.
• Provide certification of accredited investors involved with the business prior to the effective date of Title II stating that the investor’s accreditation is compliant with the new regulations.
Details of looming Title II regulations for businesses
There are also proposed rules associated with Title II that, at the earliest, will not be adopted until October of this year. These rules are subject to change or may be abandoned completely and this disparity has been a point of confusion in the discussion surrounding the agency’s announcements.
The unpredictability of the SEC’s decision to enact these rules yields some gray area for businesses when it comes to the documentation of general solicitation materials.
Under these rules as they are currently proposed, a business is required to file appropriate documentation of the general solicitation of investors before and after the advertisement has been publically announced. Failure to do so could subject a company to penalties that have yet to be determined or could ban the firm from general solicitation for a year.
So, a business that wants to advertise its need for funding is best served by being compliant with these rules as they are currently proposed.
What lies ahead?
The implementation of Title II is only one more step for the JOBS Act to become completely functional in the marketplace, but it marks a change of how business may be conducted for years to come. Title II will present investors with many more investment opportunities than what current policies allow and will enable startups and small businesses of all types unprecedented access to funding.
Entrepreneurs who have greater access to funding will be able to focus more on new ideas that will foster a more spirited and democratized marketplace. Crowdfunding platforms that are compliant with Title II rules and are precisely designed to link entrepreneurs with investors will more than likely be at the forefront of a boom in our nation’s economy.
Judd Hollas is the founder and chief executive of investment platform EquityNet, which has facilitated more than $200 million in investment transactions for entrepreneurs, and he holds multiple patents for Web-based capital marketplace systems.
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