By Guest Contributor, John Warner | CEO, InnoVenture.com
I’m surprised. In 2012 Congress passed the JOBS Act, which provides entrepreneurs powerful new tools to raise capital. Last September, the Securities and Exchange Commission (SEC) issued enabling regulations.
One Greenville company, Serrus Capital Partners, has successfully jumped all over this to raise capital. Despite lots of calls to securities attorneys and entrepreneurs, I haven’t found another company in South Carolina that has.
To understand why the JOBS Act is such a big deal, let’s step back and review how most entrepreneurs raise capital today. Before we do, understand that securities laws are complicated and the penalties for violating them can be severe. Don’t act on what you read here; get advice from a really good securities attorney.
The default rule of securities law is that if you raise capital, you have to file a registration statement with the SEC. The first time this is done it’s called an initial public offering (IPO). This is a difficult, expensive and highly regulated process most entrepreneurs don’t want to go anywhere near.
So entrepreneurs need to find an exception from the requirement to file a registration statement. The most common exception is contained in Rule 506(b) of Regulation D, which requires that the company cannot use “general solicitation” or advertising to market the securities. The entrepreneur has to have “pre-existing relationships” with investors they already know.
That doesn’t sound so bad until you layer on another rule. The company can sell its securities to an unlimited number of “accredited investors” and up to 35 non-accredited investors, all of whom must be sophisticated in financial and business matters. There is a long definition of what an “accredited investor” is, but most real people, as opposed to investors like venture capital firms or trusts, who are accredited have a net worth of $1 million other than their home, or income exceeding $200,000, or joint income of $300,000 with their spouse.
Summarizing all this, to qualify for this exception, you basically can only raise capital from millionaires you already know. For people who hang in those circles that’s OK, but for many entrepreneurs that’s a problem because they don’t know that many millionaires.
The Internet has brought innovations to fundraising like just about everything else. On the most popular “crowdfunding” sites, like Kickstarter or Indiegogo, presenters aren’t selling securities, but they are raising funds by pre-selling products to be developed or soliciting charitable contributions.
The JOBS Act allows “equity crowdfunding,” which is a whole other animal. Theoretically, the SEC will issue regulations that allow private companies to use equity crowdfunding to raise capital from large numbers of non-accredited individuals without the need for the formal IPO process.
This scares the socks off of regulators at the SEC, who have visions of debacles like Carolina Investors, where lots of small investors lose their life savings. The SEC will issue regulations for running “equity crowdfunding portal” websites, but when they do they’ll be so onerous that almost no one will operate one. A cynic would say that’s the point.
What’s developing, though – and this is the really big deal – is that there is a new exception to having to file a registration statement, Rule 506(c) of Regulation D. Now a private company can raise capital publicly, which is what Serrus is doing. In exchange for the flexibility of being public, the SEC requires that the company now “validate” that an investor is accredited. A company can no longer just take the investor’s word that he or she is accredited; the company needs to see documents, like tax returns, or it needs to get a letter from a knowledgeable professional like a CPA, an attorney, or an investment advisor.
In the 1990s, I ran a venture capital firm called Capital Insights. I identified about 500 accredited individuals with whom I had a pre-existing relationship. I raised and invested $15 million from 150 accredited investors for investment in a dozen companies.
The challenge when I started an offering was which of the 500 prospects would be interested in the company for which I was raising capital. I’d schedule several investor meetings and send invitations to all 500 prospects. Those interested would self-identify by showing up.
There are around 70,000 millionaires in South Carolina. Had I been able to advertise publicly to reach thousands of prospects instead of only a few hundred, it would have supercharged what I was able to accomplish. What I think we’ll begin to see are websites on which companies can promote their offerings publicly, helping them attract accredited investor prospects they would otherwise never reach.
We’re at the beginning of a powerful new way for entrepreneurs to raise capital, which is particularly crucial for a capital-poor state like South Carolina.
