The bright future for yesterday's angel investing rules

The SEC release staging the unleashing of Rule 506(c) - permitting general solicitation in angel offerings where their accredited status is verified - takes pains to reassure private investors and seasoned entrepreneurs that old Rule 506 remains in place, in parallel.

That's comforting.

Comforting in the way a soon-to-be ex- girlfriend or boyfriend is comforting when she or he says, "it's fine, we can still remain friends."

How is it 506(c) will largely displace the old rule, even though the old rule will remain on the books?

Let me count the ways:

1. You may be operating under 506(c) already, without knowing it.

Old Rule 506, hereinafter 506(b), has been widely abused. The prohibition against general solicitation - a key condition of 506(b) - was honored more in the breach than in the observance. Once 506(c) goes online (sometime in September), you can bet that much of today's 506 behavior will be seen for the 506(c) activity it has probably been all along.

Think public pitch events, demo days with funding prizes, etc.

We've called that 506(b) behavior up to now because, well, there was no other place for it to go; otherwise we would've been admitting that prevalent industry practice is per se illegal.

2. Proposed rules signal that Form D will be remade in the image of the new 506.

Though the general solicitation release is comforting in stating that the old rules will remain, a separate release, issued the same day, proposes new rules that would, if enacted as proposed, overhaul Form D filing requirements for both 506(c) and 506(b). The proposed rules include a "penalty box" for messing up more than once.

The net of all this is that it's going to be easier to screw up and to blow a Rule 506 exemption. This is not good for entrepreneurs. This is not good for angel investors with money stuck in a startup that's dead in the water because it's made a regulatory mistake in the past and is therefore not allowed to use Reg D to raise a next round.

3. The curmudgeon factor.

Angels who simply will not cooperate with any heightened verification requirement of their accredited status (recall, verification is the required tradeoff for general solicitation) still have the option, no doubt, of telling the entrepreneurs who woo them, "Look, I just don't participate in 506(c) deals. I'm not saying there is anything wrong with 506(c). It's just not something I do."

527363676_38142ff17f_zBut that sounds curmudgeonly, doesn't it. Who wants to be a curmudgeon?

4. "You don't bring me flowers. You just send me promoted tweets."

It's prudent to assume, if not also fair to expect, that regulators are going to be pushing pre-filing requirements for Rule 506(c), including at least contemporaneous filing of communications used in connection with generally solicited angel deals.

Hard to say just exactly how this re-shapes the flow of negotiation between founder and investor; but one has to imagine startups will feel pressured to lock in to deal terms earlier in the negotiation cycle, so they can meet pre-filing requirements before they generally solicit.

Unless, of course, angels can get entrepreneurs to cool it with the general solicitation till a lead investor has been identified and validated terms.

How likely is that? Entrepreneurs are going to feel that the law now gives them express permission to talk things up, and many no doubt will.

Photo: Pulseman / Flickr.


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