General Solicitation and Why 506(c) Matters to Your Startup
There has been a lot of buzz within the investment community about equity crowdfunding for both accredited investors under 506(c) and for non-accredited investors under Title III of the JOBs Act and recently enacted state law exemptions, including the crowdfunding bill recently passed (but not yet enacted) in Washington.
The main feature of both types of crowdfunding is the company’s ability to spread the news about the investment through the community, by advertisement and public broadcast.
Historically, or rather from the early 1930s until last year, you could not spread the news about such a “private placement” generally, as doing so by default made the offering “public,” triggering onerous securities regulations that can be incredibly expensive to comply with. Instead, investors learned about private placements through existing contacts, and the investment community was made up almost entirely of connected wealthy people and institutions.
So what do you get when you decide to do a 506(c) offering, as opposed to the traditional 506 offering that does not allow “general solicitation?” To understand, it is a good idea to become familiar with what general solicitation means.
General solicitation is:
- 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 of general advertising.
The determination of whether a particular communication constitutes a prohibited general solicitation involves two questions:
Is the communication a general solicitation or general advertisement?
A communication is a general solicitation or general advertisement unless it is directed only to persons with whom the company or its agents have a pre-existing relationship. This relationship must be sufficiently substantive to provide a reasonable basis for determining that the person targeted by the communication is an accredited investor and has the financial experience and sophistication needed to evaluate the risks of the investment.
Is the communication being used to offer or sell securities?
General solicitation and general advertisement are prohibited only if the communications are being made for the purpose of offering or selling the securities that are a part of the private placement. Any communication that could create interest in an issuer’s securities may be deemed to have been made for the purpose of offering or selling securities.
If the answer to either of these questions is “no,” then the communication is generally permitted.
So if you are offering your securities to people you already know and are confident their investment will be enough, a 506(c) offering won’t offer as much upside as it would if you need to reach an investor market broader than your network. But if you are looking to spread the word about investing in your company throughout your community, right now 506(c) is the primary method for generally soliciting your company’s next “private” offering.
If you have questions about private placements, Rule 506, or securities offering generally, please comment below or contact us.