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The SEC’s New Final Rule Relating to Angel Investors Could Hurt, Instead of Help, Start-Ups Across the Country

1412644_75137726.jpgAccording to a recent report issued by the research firm CB Insights, Northern California remains the most active region for startups. In fact, between Silicon Valley and San Francisco combined, start-ups raised over $2 billion in the first three months of 2013. While a number of cities and areas around the country have tried to duplicate the success of the Bay Area start-up scene, none have been able to do so. Now, a new final rule issued by the Securities and Exchange Commission (“SEC”) meant to make it easier for start-ups to attract investors may be doing just the opposite. The move by the SEC, which came about as a result of the Jumpstart Our Business Startups Act (“JOBS Act”), was aimed at loosening restrictions for businesses attempting to raise capital. Prior to the adoption of the rule amending Rule 506, issuers relying on Rule 506 were prohibited from using any form of general solicitation or general advertisement.

The rule, approved on July 10, 2013, permits startups to openly solicit funding from investors, action that was previously prohibited by the SEC. With the passage of the new rule, businesses will now be able to more widely solicit and advertise for potential investors, including on the Internet and through social media. However, this new freedom does not come without a price. Businesses will have to take reasonable steps to ensure that only accredited investors actually purchase securities, which is one reason that investors may not be fully on board with the new rule.

In order to determine whether a potential investor is “accredited” the businesses issuing the securities will have to consider various facts and circumstances, including: (1) the nature of the purchaser and the type of accredit investor the purchaser claims to be; (2) the amount and type of information that the issuer has about the purchase; and (3) the nature of the offering, such as the manner in which the purchaser was solicited to participate and the terms of the offering.

Notably, for a business to undertake the analysis required, it will need a significant amount of paperwork from the potential investors. In the final rule, the SEC provides a non-exclusive list of methods that issuers can use to satisfy the verification requirement. Some of the methods include:

• A copy of the investor’s tax returns to be kept on file by the company.

• A letter stating that the angel has a “reasonable expectation” of reaching a prescribed income level in the current year.

• Documents proving that all of the investor’s personal assess and liabilities are being disclosed.

• A letter from either a third-party lawyer, accountant, or broker affirming the investor is accredited under SEC rules every 3 months.

The rule amendment becomes effective on September 23, 2013. While the effect of the new rule will remain to be seen, the Law Offices of James G. Schwartz will continue to keep you apprised of any updates. The Law Offices of James G. Schwartz provides practical advice for starting and operating commercial enterprises in California. If you have any questions or need advice about starting up your own business, contact a Northern California business law attorney today at 925-463-1073.

Sources:

Silicon Valley’s still No. 1, by Crowmwell Schubarth, Silicon Valley Business Journal

SEC loosens rules on raising venture capital and hedge fund advertising, by Marcy Gordon, San Jose Mercury News

Eliminating the Prohibition on General Solicitation and General Advertising in Certain Offerings, U.S. Securities and Exchange Commission