By Ashley Boncimino
Published Feb. 10, 2014 on GSABusiness.com
For the past 80 years, the rule of thumb for private-placement fundraising was “Keep it behind closed doors.”
But three months ago, the U.S. Securities and Exchange Commission changed the rules to expand fundraising opportunities for businesses and might do so further, raising some concerns about the fraudulent solicitation of investments.
Once only permitted to raise capital from within inner circles, businesses and, particularly, startups are now allowed to publicly advertise that they’re seeking investments, which broadens the pool of potential investors exponentially, according to Serrus Capital Partners co-founder Leighton Cubbage.
His company, a real estate investment and management firm in Greenville, has reaped the benefits of changes, which were adopted by a vote of 4-1 by the SEC in July and took effect in September.
“Imagine if you had to sell cars without being able to advertise that you were selling cars,” said Cubbage, who said Serrus has taken advantage of the rule by advertising primarily online and in newspapers. “Now, we’re able to advertise.”
Public advertising for private placements, known as general solicitation, was banned by the SEC in 1933 as one of many responses to the Great Depression.
This changed under the Jumpstart Our Business Startup Act signed in April 2012 by President Barack Obama. The new measures were intended to make it easier for small businesses to raise capital and thus stimulate the economy overall. Previously, only very large companies could afford the expense of public offerings, leaving startups and smaller businesses with limited options.
Cubbage, who founded Serrus Capital Partners with co-founder Steve Mudge, wouldn’t say how much funding the company has raised. The new rule has limits.
“In the old days, the rules were you can’t contact people you don’t know already or people in your inner circle don’t already know,” said Neil E. Grayson, a partner at Nelson Mullins Riley & Scarborough LLP. “None of that applies for this new rule ... You’re free to reach anyone you want to under this rule; you’re not free to take money from just anyone.”
Companies may only take investments from accredited investors. Being accredited means having more than $1 million in net worth, earning $200,000 in net income in the last year, if you’re an individual, or $300,000 for couples.
Before the ruling, you only had to have a “reasonable belief” that the potential investor was accredited. Now, companies have to take it several steps further, displaying “due diligence” by taking reasonable steps to verify the accredited status of investors.
“What the SEC has said is, ‘We’re going to lift this ban on general solicitation because we know it’s going to make it easier for you to reach more people, but by reaching more people, there’s a greater likelihood that you’ll end up selling to someone who is not an accredited investor,’” said Nelson Mullins Partner Michael F. Johnson, who worked at the SEC Division of Corporate Finance in Washington, D.C., before moving to Greenville.
South Carolina has taken advantage of the new rule with its recently debuted state-exclusive crowdfunding website, SCCrowdfund.com, where businesses and startups in the state can list their ventures for private placement equity for accredited investors or for donation crowdfunding, which is open to anyone.
But lifting the ban on general solicitation for private placement wasn’t the only provision in the Jobs Act aimed at creating a new way for smaller companies to find investors. Another provision — the equity crowdfunding provision — could allow anyone, not just accredited individuals, to invest in a company.
But this could open the door to fraudulent investment solicitations, so the SEC has not created the guidelines to enact this second provision of the Jobs Act.
“There are lots of people out there who know how to rip you off, and this is just another avenue through which they can scam you,” he said.
“A good example is diet products and supplements,” said Johnson. “They’ll say we have a new vitamin that does A, B, C and D ... and all along it’s really nothing.”
The proposed solution is a “gatekeeper” portal where people can evaluate and discuss companies requesting funding.
“The funding portal will act as the intermediary and sort of vet the prospective investor and make sure it’s a suitable investor for them and make sure they’re suitable to invest,” Johnson said.
The commentary period for the proposed equity crowdfunding ruling ended Feb. 3. It suggests the SEC is moving forward, Grayson said.
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