If you are or have ever been through the process of raising private capital for an emerging company, you are well aware of the regulatory framework that seems to have been created to test your commitment. When you raise money for your venture you are almost undoubtedly selling a "security." The offering and sale of securities are regulated by both the federal government and each state which has jurisdiction. What this means: when you raise money, the securities you are offering are either: (1) registered; (2) exempt; or (3) illegal. Almost every new and growth stage company will rely on an exemption from registration which is an expensive process and offering illegal securities is not a solid business plan. (Before you ask, there is no "friends and family" exemption.)
The most common exemptions are known as "Regulation D" exemptions, with the most common Regulation D exemption being Rule 506(b). The benefits of this federal exemption are:
1) you can raise an unlimited amount of capital;
2) it preempts state securities laws (meaning you will not need to find a separate state exemption for each state involved, although you probably will have to make a notice filing);
3) it allows you to sale the securities to an unlimited number of "accredited investors" - the topic of this post.
Accredited investors are individuals or companies who meet certain defined income or net worth requirements. The government has decided that these individuals are deemed sophisticated in investments by the nature of their wealth, and therefore not in need of government protection from risky investments as much as the general populace. Companies seeking funding flock to this group of investors for a multitude of reasons, including the relaxed oversight, their expected level of experience and sophistication and, of course, their deeper pockets.
On February 1, the US House of Representatives overwhelmingly approved a bill that would expand the categories of individuals that would qualify as accredited investors. The new legislation would include those who have a securities license or who have professional knowledge in relation to a specific security being offered. This seems to fit within the purpose of the regulatory framework: protect the inexperienced and less sophisticated, but allow those with experience and expertise to fend for themselves without regulatory burdens dampening the transactions.
Young companies and entrepreneurs should take note: this may be opening up an extremely important class of investors in the near future. To the extent a company raising money can be selective, the investors should provide some peripheral value beyond money. Introductions, peer support, and an extra set of interested eyes reviewing product and strategy are all things that can benefit a growing company and, as a result, its investors. I am not suggesting the bill passed in the House is perfect and the underlying regulations will be straightforward (how will the government or any oversight authority determine whether an individual has the requisite expertise?), but it is a welcome discussion to be having.
ABOUT THE AUTHOR – BRIAN CASSERLY
Brian Casserly is an attorney at Gutwein Law. Prior to receiving his J.D. from Indiana University, he earned his MBA from Ball State University and his BA in Finance from University of Southern Indiana. He focuses primarily on business law.