Mitch Kapor's letter to the SECBy http://profile.typepad.com/1237764140s22740 // September 5, 2013 in Angels, General Solicitation, JOBS Act, Reg D
The subject is the proposal that the SEC has made to change Reg D and Form D, the rule set by which most startups raise money from angel investors.
Kapor is not the first prominent investor to pick up on the notion that the proposed rules will, if enacted as proposed, undercut, if not entirely moot, new Rule 506(c), which is a final rule (to go into effect later this month) and which implements the Congressional mandate and intent to make it easier for small businesses to raise private capital from angel investors.
Kapor distills many of the points already made by other prominent investors, namely Fred Wilson, Brad Feld and Naval Ravikant. And Kapor echoes a point frequently made by Angel Capital Association leaders such as Jean Peters, who in testimony to Congress spoke of how angel investing remains remarkably free of fraud and abuse.
But Kapor's letter is especially cogent on an aspect of this regulatory transition that is hard to talk about. If I try to identify what that aspect is, today I might say it has to do with how we aren't really going to be able to put the general solicitation toothpaste back into the tube.
But let's focus on the better way Kapor puts it in his comment letter. He's speaking here of how the information requirements proposed for 506(c) specifically, and the penalties for missing filing requirements under Rule 506 generally, will end up making general solicitation a booby-trap:
"Practices that have worked well without incident for decades could suddenly become unintentional minefields for honest startups and sophisticated investors alike. Demo days, where startups present to investors and press, will most certainly be called 'general solicitation' by the law firms advising startups (and likely by SEC enforcement as well). This means that some of the most high profile ways new startups raise money transparently may now cause those same startups to go out of business if the penalties are enforced."
I think Kapor is absolutely right about how lawyers are going to behave. They are going to tend to default toward telling clients to comply with 506(c), rather than rely on 506(b), if there's even a close call as to whether general solicitation might be afoot.
Why aren't lawyers, by and large, warning their clients away from demo days and pitch events today? I don't really know, but I share a sense with many of my lawyer friends that this passivity, or tacit acceptance, has settled into a de facto industry practice over the course of some years. New Rule 506(c) is in this sense a wake up call.
But the introduction of general solicitation needn't be a crisis.
We should stay focused on the fact that the SEC has, indeed, delivered general solicitation as Congress intended it. This fulfilled promise takes the form of the final rule which will go into effect on September 23. Come that day, new Rule 506(c) will be in effect - SEC Chair Mary Jo White has confirmed as much - and the new rule contains no pre-filing requirement, no information filing requirements, no draconian penalties for messing up filing requirements.
The only thing 506(c) demands from issuers, as the quid pro quo for permitting general solicitation, is that they verify the accredited investor status of each of the purchasers in a 506(c) deal. This, too, is not as big a deal as many people think (and to the extent you do think this is a big deal, your problem is with Congress and Title II of the JOBS Act, which mandated verification). There are ways verify under the new rule that don't require looking at W-2's or running credit checks on investors. See for example this excellent guidance from the ACA (disclosure: I was part of the team that helped ACA leadership develop the guidance).
Photo: Michael Lynch / Flickr.