The redacted email below was sent to the Cornell NYC/ Tri-state community – thousands of people.

Conveniently, it’s not *automatically* a securities law violation any more, but this is definitely how to be sure you’ve fallen under the new general solicitation rules, which require a company to take “reasonable steps” to verify that each investor is in fact accredited — that means that a representation from the investor is no longer sufficient.

I am a graduate of Arts ’82, currently starting a technology venture. I don’t want to post details here, but you can get a hint at [startup website URL was here]  (it’s just a landing page, not much info, but it suggests what I’m up to.)  I am seeking Angel funding.  If you are an angel funder, or can steer me to someone who is, please contact me at [founder email]  

Thanks in advance for all replies.  [Founder name].

What should this founder have done? How do you let people know without triggering a general solicitation?

The technique I pass on to my startup clients is to simply tell people what you’re doing. Those who are already investors know what trigger words indicate that you’re probably looking for money. If they have an interest, they know how to follow up.

Revised:

I am a graduate of Arts ’82, currently starting a technology venture. I’ve created a landing page with some basic info here. I’m looking to expand and grow to the next level. Please take a look, and if have thoughts on how I might grow, you can reach me at founder@startup.com.

Nearly the same email, but you’re not directly asking for investors to take a look. It’s oblique — those to whom your message is really directed know what you’re talking about. And, they can self-select based on industry and stage of growth if you give them some basic information, like:

I’m Joe Founder. I’ve developed patent-pending intellectual property to help match your socks to your shoes. I’ve got three employees and we are three months into our private beta.

This sample language isn’t about investment — it’s about the business. “Sell the sizzle, not the steak.”


Some might argue that you’re going to *surely* use only accredited investors, but that’s probably not true if you’re the founder of an early stage startup and are sending out your own fundraising emails. My response: don’t create obligations and requirements — and in this case, securities law liabilities — that you don’t have to.

For this approach to make sense, you’d have to believe that your best chance at finding an investor is finding someone who doesn’t already know how to read between the lines and figure out that you might be looking for money. Every startup is looking for money: it’s axiomatic. There’s always expansion to be done. Almost no one is bringing in so much money that they don’t need any more (probably craigslist.org, though).

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As part of the crowdfunding regulations, the SEC created heightened standards for determining whether an investor was accredited, requiring issuers (that means the startup company) to take “reasonable steps” to determine whether each investor who is part of a general solicitation offering under 506(c) is in fact accredited.

Here’s my firm’s recent overview of these rules, explained by Angelina Bruno-Metzger: 

Another lawyer at my firm (Aaron Messing, @amess) recently pointed me to this TechCrunch article about this AngelList offering: their “Accreditation Report.” 

Here’s part of the main text

Meets SEC standards for both privately and publicly fundraising companies. 

And here’s the related statement from their FAQ:

Does an Accreditation Report constitute “reasonable steps to verify” accredited status?
 
We have worked very hard to match the evidence we collect to the standards contained in the SEC’s regulations, but we do not make any guarantees.
 
Ask your lawyer.

So, what should *you* do?

506(c) is vague on what “reasonable steps” means, but that’s supposed to give you flexibility. The core issue is that self-verification is no longer sufficient. The next logical step seems to be some objective evidence, or a good proxy for objective evidence. If you don’t see the documents yourself, you have to rely on someone else to have seen them.

This model is what AngelList has implemented; here’s the part you’re supposed to rely on in an investor’s accreditation report:

A letter from our attorney, or your designated third party advisor, stating that you have presented documents that indicate either income or assets above the required SEC accreditation threshold

This means that the investor can include a letter from a lawyer or accountant as stated, or that AngelList will have their lawyer look at the documents and make the same statement.

Does that work? Well, it’s certainly close. Here’s what the SEC says does work:

a written confirmation from a registered broker-dealer, an SEC-registered investment adviser, a licensed attorney or a certified public accountant stating that such person or entity has taken reasonable steps to verify that the purchaser is an accredited investor within the last three months and has determined that such purchaser is an accredited investor 

What’s missing from the AngelList letter (sample here) is a definitive declarative statement. The party giving the letter doesn’t say that reasonable steps have been taken, stating judgment was exercised: the sample letters says only that documents were seen, leaving you to make the [desired] inference that the steps were reasonable. The letter doesn’t even address the issue of reliance.

So what?

You’re right — so what? If the SEC later determines that you didn’t take reasonable steps with an investor, the implication is that the entire offering exemption is lost. No one knows for sure, and everyone other than the SEC will argue that the loss of exemption should apply only to the specific investor, who in turn should be the only one with a recission right.

If the whole exemption is lost, companies will eventually require AngelList or other third-party verification services to be more explicit in their confirmations. There’s not much harm to the verification companies in doing so, since they’re not liable for mistakes, especially where the issuer hasn’t contracted for any liability. Good faith mistakes will keep most away from negligence liability.

Look back at the exemption requirements: not only do all the purchasers have to be accredited investors but the reasonable steps have to have been taken to verify for each purchaser. I read this as a clear signal by the SEC that there will be no “no harm, no foul” defense here.

Given that the requirement isn’t onerous in the first place, in this third-party model, making the letter more robust seems like a wise modification to keep everyone headed in the right direction.

 

 

 

 

 

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Startup-NY is over-complicated and will under-deliver

19 February 2014

A friend recently asked me about Startup-NY, New York’s new program ostensibly designed to help foster startups. As you might expect, the bark is better than the bite. Fundamentally, there are a bunch of complicated rules, exceptions, and requirements, and some conveniently unstated limits. Now, since I think the prerequisites will gut most of the […]

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Does your startup suffer from premature launch syndrome?

14 January 2014

So here is a message I recently received, unsolicited, from someone I don’t know, through a major Q&A site (URL redacted to protect the guilty): I’m a startup founder starting a company in the legal space. It’s called [abcdef.com], and it connects people with lawyers online. Sorta serves as a law firm to both lawyers […]

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You’re using the form wrong if….

2 December 2013

Here’s an excerpt from a website terms of service I just read: [Please confirm whether users can submit content such as comments, blog posts, etc.] In order to make our Services more dynamic and useful, we may allow you to post comments or reviews or other Submissions to the Services and our forums. The bracketed […]

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Don’t accept passive-aggressive drafting

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I recently came across this language (unaltered) in a contract: The Parties understand and agree that all Confidential Information (i) is to be preserved and protected; (ii) is not to be disclosed or made available, directly or indirectly, to anyone other than Authorized Employees, including, without limitation, third parties or unauthorized employees for purposes unrelated […]

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Simple cap table for VC round calculations

23 October 2013

Over the years I’ve had many occasions to figure out the price of an offering of preferred stock for a typical venture funded startup. This is different from, and definitely not to be confused with, the valuation of the company on a pre-money basis. That’s a topic for a later post.  In its most simple […]

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You know my practice better than LinkedIn

8 October 2013

This article on how to correct and even improve LinkedIn endorsements (not the recommendations, which are far and few between, making them almost certainly more valuable, IMHO) caught my attention this morning. A commenter bemoaned that LinkedIn kept trying to have folks endorse him for “commodity,” which didn’t work while “commodities” might have.  I assume […]

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A path to better drafting

11 September 2013

This post by Ken Adams on improvements to the Series Seed documents (Github versions) triggered a lengthy response from me. It’s no secret that I’ve been fond of the project since its earliest days (see this post on the “simple Series A” and this one on “check the box forms,” my idea from around 2001 […]

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No Chairman under Delaware law

12 August 2013

I have seen a number of articles recently talking about splitting the CEO and chairman roles. Here’s one about JPMorgan.  Everyone *still* seems so up in arms about this issue. I would have thought someone would have done a little digging. Here’s my take: 1. All directors have equal power and equal responsibilities. There is […]

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