For almost 100 years, companies seeking investors have had to be very careful not to “advertise” an offering – or else risk attracting the ire of federal regulators. To be specific, federal law requires all sales of securities to be either registered with the SEC (aka, “publicly traded” like Apple or Facebook) or else qualify for an exemption from registration. The exemption most commonly invoked by young companies is Rule 506 under Regulation D, which allows a company to raise an unlimited amount of money from high net-worth individuals, so long as the company refrains from engaging in “general solicitation.”
What is a high net-worth individual?
A high net-worth individual – also known as an “angel” or “accredited” investor – makes at least $200,000 in annual income or has at least $1 million in net worth (not including primary residence). Basically, these folks range in the top 3-5% of the American public, and (until very recently) they have been the only class of investor eligible to invest in young companies. However, because of the ban on general solicitation, an entrepreneur essentially had to have a pre-existing network of rich uncles in order to make an offering of securities under Rule 506 because of tight restrictions around what could be said to the public about a securities offering.
What is general solicitation?
The type of activity covered by “general solicitation” – and therefore forbidden by companies relying on Rule 506 – includes the following:
• Any advertisement, article, notice or other communication published in any newspaper, magazine, or similar media or broadcast over television or radio; and
• Any seminar or meeting whose attendees have been invited by any general solicitation or general advertising.
In short, because young companies have not been permitted to broadcast news of a securities offering (even to “high net-worth individuals”), the safe course until very recently was to limit a young company’s investor base to friends and family, or to those with whom the entrepreneur has a pre-existing relationship.
How Did Companies Pitch Without Violating the Ban on General Solicitation?
Although entrepreneurs (and angel groups) have not always followed the letter of the law, the safest route for a pitch event involving members of the general public was a “demo day” – or a product focused presentation that omits any reference to a capital raise, funding need, investment opportunity, etc. This means no business plans, financial projections, growth rates, etc.
The only time an investor could truly pitch an investment opportunity was in a room of exclusively accredited investors that were previously known to the entrepreneur or event organizer.
If you are interested in more detail related to your specific situation it is best to speak with an attorney. Schedule a consultation with a Founders Legal Intellectual Property attorney
