129 posts categorized "Angels"

SEC official to angel community: go ahead, develop your own verification methods!

Keith Higgins, the relatively new Director of the Division of Corporation Finance, delivered a speech at the closing session of the 2014 Angel Capital Association Summit - and was it a doozy!

A huge issue for angel investors is the "reasonable steps to verify" accredited status that is part of new Rule 506(c), which permits issuers to engage in "general solicitation." The issue was a focus of at least two breakout sessions at the Summit, including one Thursday moderated by ACA policy chair Mike Eckert that I participated in with the gifted lawyers Peter Rosenblum and Rob Rosenblum (not related), and an excellent breakfast briefing Friday from K&L Gates lawyers Gary Kocher and Kevin Gruben.

1842308438_83cb923365_oThe reason for such attention is the anxiety caused by the non-exclusive verification "safe harbors" set out in Rule 506(c). These verification methods contemplate that, going forward, an issuer is going to have to demand personal financial information from investors, or engage third party verification services to do so. To many readers of the new rule, including a majority of securities lawyers, the safe harbors - in spite of the "non-exclusive" label - feel destined to prove de facto requirement.

But Higgins said that needn't be the case.

In his speech (the full text of which you can access on the SEC's website), Higgins emphasized that if any verification standard might be core under Rule 506(c), it is the flexible, "principles-based" approach laid out in the inital release proposing the new rule:

"These [applications of the principles-based method] are all part of a deliberate effort by the Commission to provide issuers with an alternative to the clear but highly prescriptive list of verification methods included in the rule. In fact, it is ironic that this list of verification methods is being viewed by some as the primary way to verify a purchaser’s accredited investor status when, in fact, the Commission originally proposed the principles-based approach as the way issuers would comply with the rule’s verification requirement and added the list of specific verification methods only in response to address the concerns of commenters who wanted more certainty."

As Gary Kocher explained plainly in his breakfast briefing earlier in the day, lawyers are a conservative bunch, and naturally are going to navigate to the safe harbors. But, Gary stated he believed that the staff meant what they said in the rule and in the release, that the principles-based approach was viable. I think Higgins' speech completely validates Gary's view.

All of this portends well for verification methods based on the Angel Capital Association's Established Angel Group guidance, which would not require the turning over of sensitive financial information to issuers or their vendors.

As for seeking express SEC staff blessing of particular applications of the principles-based method of verification? Higgins seemed to say that was both not likely to be forthcoming anytime soon, and also beside the point:

"On that note, we have had recent inquiries asking whether the staff would provide guidance – presumably on a case-by-case basis – confirming that a specified principles-based verification method constitutes 'reasonable steps' for purposes of the rule’s requirement.  The notion of the staff reviewing and approving specific verification methods seems somewhat contrary to the very purpose of a principles-based rule and I am not yet convinced of the need for this type of staff involvement. Rather, this is an area where issuers and other market participants have the flexibility to think about innovative approaches for complying with the verification requirement of the rule and use the methods that best suit their needs. While the staff may not be in a position at this point to provide guidance on what constitutes 'reasonable steps' under particular circumstances, I also believe the staff will not be quick to second guess decisions that issuers and their advisers make in good faith that appear to be reasonable under the circumstances."

I should note that the angels I spoke to at the Summit, and the questions they posed in the breakout sessions, were more precisely focused on the definition of general solicitation and the activities at pitch events and the like that might push a company from 506(b) territory into 506(c) territory. But let's step back a second and look at the problem from just a story or two higher: to the extent that verification under 506(c) becomes more manageable, then the general solicitation issue becomes somewhat less of an existential distinction. (There may yet be reasons to avoid publicly soliciting investors - but that is another topic.)

Success for principles-based verification approaches will not be self-executing. Angels and their entrepreneurs will have to insist on them, and will have to make sure they have enough rigor to acquire respect. In the right circumstances, lawyers for a given deal might, just might, go along.

Drawing: "Principles Mound" by Paul Downey / Flickr.

2014 ACA Summit Coming Up!

Next week, I will be joining more than 700 of my colleagues at the largest gathering of angel investors in the world. I have been invited to present at this conference session: The New SEC Regulations - Practical Interpretation and Guidance for Angel Group Management Activities.

2014 Summit MastheadThe session I'm participating in will be chaired by Mike Eckert, ACA Policy Chair and of the NO/LA Angel Network, and my fellow panelists will be Peter Rosenblum of Foley Hoag, and Robert Rosenblum of K&L Gates.

Here's a description, from the conference agenda, of what Mike, Peter, Rob and I will cover;

'Leaders of angel groups continue to deal with confusion, uncertainty and misunderstanding as related to the recently passed SEC regulations about General Solicitation. The questions ”what should my group be doing or not be doing?”, “which rule is effective and when did it become effective?”, “which is not effective?”, “what kind of guidance should my group be providing to entrepreneurs, startups, accelerators/incubators, colleges and universities about General Solicitation and Reg D/Form D?”, “what is and what is not General Solicitation?”, “has anything really changed?”, and “how do I protect my group, its members and the companies presenting to it?” are pervasive. The objective of this session is to provide further guidance and where possible clarity such that ACA members and member groups can make continued informed decisions about these issues in their day-to-day real-world activities, and be key sources of knowledge about these in their respective markets.'

If you’re not already attending the ACA Summit March 26-28th in Washington DC, I invite you to learn more about it at www.angelcapitalassociation.org/2014summit.

Wisconsin leaders support equality in angel investing

Really pleased to see that the Wisconsin LGBT Chamber of Commerce and the Greater Madison Chamber of Commerce are adocating for equality for same-sex couples in angel investing.

Here's a link to the press release. And here's a link to a letter they have written to a member of Congress from Wisconsin.

CaptureCKudos to Zach Brandon for his work on this. I got to know Zach from serving on a panel with him at the ACA Annual Summit a year or two ago. He is a leader in the angel community and it will be people like Zach, stepping up, that will eventually change consciousness on this issue. Right now, it's a sleeper. Few want to talk about it, but, the perverse reality is, the SEC rules for angel investing treat same-sex couples as second class.

Here's the rule change that the Wisconsin LGBT Chamber of Commerce and the Greater Madison Chamber of Commerce advocate, as does Startupequality.org:

A spouse of a natural person shall mean another person, regardless of gender or sexual orientation, whose relationship with the person specified: (1) may be characterized as such person's (i) husband, (ii) wife, (iii) spouse, (iv) domestic partner, or (v) designated beneficiary under any applicable state law for the purpose of ensuring that each person in a two-person relationship has certain rights or financial protections based upon such designation; or (2) is that of the other party to a civil union with such person.

Weekend Read: WSJ Accelerators Post on Pitch Events and General Solicitation

This weekend please read an article I wrote for The Accelerators blog of the Wall Street Journal, The Trojan Horse of Accredited-Investor Verification.

6960882500_cc7fccd4d4_oThe piece gets into how some angel groups, pitch event promoters, and demo day organizers are dealing with new Rule 506(c). Basically, the days of a de facto industry practice of ignoring the Rule 506 prohibition on general solicitation and general advertising are over.

Now that it is okay to generally solicit, it's also time to come to terms with what came part-and-parcel with such over permission: the need to take reasonable steps to verify the accredited status of all purchasers.

It's going to take some time for the ecosystem to sort things out.

Check out this Pando Daily post that Doug Cornelius quoted from in his weekly roundup post. Do you think the newly conservative steps demo days promoters are taking, as recounted by the Pando Daily reporter, Erin Griffith, cut the mustard?

Please do read the piece for the WSJ Accelerators!

Photo: D Services / Flickr.

Three longer reads for where we are after General Solicitation Day

We are now living in the second day after General Solicitation Day. All trying to take stock of what has happened, and how the landscape is different.

And there is no shortage of media coverage! (Here, from a news angle, is a good overview from the Wall Street Journal: General Solicitation Brings Startups Capital, Risks. I was interviewed for this article and love the quote they got from me: "The government is doubling down on the idea that accredited investors can fend for themselves.")

PhotoBut today I wanted to call out three different, longer-form pieces of writing, each published within the last week. Each, in a different way, lends a deeper perspective on where we in the startup financing ecosystem are now.

Each will be a reference piece in the weeks and months to come.

1. Paul Spinrad's take on where we are, how we got here, and how all the different pieces fit together.

Here is an article that Paul Spinrad published on a PBS website: Online Platforms Give the First Public Look at Private Equity. As I said on Twitter yesterday, Paul's is the best written, broadest article yet on general solicitation and the changes to private financing rules.

Among the delights of Paul's well written survey are: an explanation of how public offerings came to be squeezed into a private exemption framework; the balance or contrast of considerations when approaching policy for accredited and non-accredited crowdfunding; and how private equity platforms are rolling out new features to facilitate the new rule set.

On Monday in GeekWire, I tried, not very effectively, to point out some of the new features on some of the leading online platforms. Paul's take on the same topic is far more accomplished. And that topic is only one facet of his survey.

2. Trent Dykes', Megan Muir's and Kiran Lingam's whitepaper on do's and do not's at demo days and pitch events.

This one, Demo Days, Pitch Events and the New Reg D, is controversial. I've had an earful from several people already on how this whitepaper may get one or another thing wrong.

But I greatly admire the ambition and timeliness of it. The question that the rest of us hem and haw about – am I automatically generally soliciting if I show up at a demo day or pitch event? - they tackle.

Whether or not you agree with the protocols and checklists they lay out, Dykes, Muir and Lingam are calling out the right factors to consider and giving laypeople the means to educate themselves about general solicitation.

3. The Gunderson law firm's comment letter to the SEC on the proposed Reg D rules.

This is a letter published on the SEC's received comments page, signed by a Gunderson partner, Sean Caplice.

There are a ton of comment letters on the proposed rules, none too few from big law firms.

What's remarkable about the Gunderson letter is that it provides answers to all 101 "requests for comment" posed by the SEC in its proposing release.

Most commentators either cherry pick which of the SEC's questions they want to answer, or skip the agency's questions altogether and comment from the perspective of the commentators' own agenda or frames of reference. For tackling all 101 requests for comment, and for that reason alone, I think the Gunderson comment letter is a touchstone. (Kudos to Joe Wallin for pointing the letter out to me.)

Angel Capital Association guidance on accredited investor "verification"

Set aside, for the moment, the proposed rules that would impose pre-offering Form D filing requirements, information filing requirements, and other burdens that would make Rule 506(c) more of a burden than a benefit in the angel financing world.

It does seem likely that, come September 23, 506(c) will - at least for a time - go into effect as Congress intended it.

UntitledStartups and emerging companies will be able to "generally solicit" investors and such offerings will be exempt under Reg D, as long as all purchasers are (a) accredited, and (b) the companies raising the money take reasonable steps to verify that such purchasers are accredited.

Much of the discussion of what constitutes "verification" (this burden was imposed by Congress, not the SEC) defaults to certain non-exclusive, non-mandatory verification methods set out in the final rule establishing Rule 506(c). These methods are expensive, raise privacy problems, and are not practical for startups. The burden of following these methods is exacerbated at the seed stage.

But startups needn't despair.

Have a look at this guidance from the Angel Capital Association. See also this post from ACA Executive Director Marianne Hudson, with context and background.

In essence, the ACA is helping to educate the ecosystem regarding just how much an an issuer knows about a given purchaser, by virtue of that purchaser's membership in an "Established Angel Group." And that term is defined in the guidance.

Why is that important? Because the verification rule involves an assessment of the nature, amount and type of information that an issuer has about a given purchaser. It is a facts and circumstances test. The ACA guidance says, in effect, don't overlook facts that are staring you right in the face. Assuming, of course, that you are dealing with sophisticated angels, as outlined in the Established Angel Group definition.

Does this obviate the "reasonable steps" verification inquiry? Unfortunately, no, but it does give a startup a good start.

For 506(c) to work and amplify the power of angel investing, it's vital that seed stage startups not regard the verification requirement as the dead-end of general solicitation. It's going to take some work, some thought, some educating of lawyers, but the only way around is through.

Disclosure: a colleague and I were part of the team that helped ACA leadership develop the guidance.

Mitch Kapor's letter to the SEC

Great comment letter to the SEC from Mitch Kapor.

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.

5144089486_3a94a82b5c_zKapor 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.

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