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On September 23, 2013, over one year after President Obama signed the JOBS Act into law to make securities regulations friendlier to small businesses, the ban on General Solicitation is officially gone. General Solicitation is the act of marketing a capital raise publicly (basically advertising) and had been banned since 1933 because the SEC feared hucksters would con people into investing in time machines and Nigerian oil scams. While the ban has prevented the insidious use of advertising to scam funds, it has also handcuffed legitimate companies and ideas from leveraging the efficiency of today’s communication networks to raise capital, such as the 2009 effort by a pair of LA lawyers to raise money to buy venerable beer brand PBR.

So what will change with the removal of the ban? Well, for one, if you are raising $1 million for your small furniture business, you can now advertise this offering on Facebook, in an email to your customers, on your blog, etc. The ban’s removal doesn’t change who can invest in private securities offerings though—this is still limited to accredit investors only. However, there are still a myriad of challenges for companies seeking to actually use General Solicitation and Union Square Ventures founder Fred Wilson does a great job outlining them in his blog (disclosure: USV is an investor in CircleUp). These problems include onerous filing requirements for small, often under resourced companies seeking to raise money and harsh punishments for those that run afoul of the letter of the law.

Problems aside, General Solicitation has the potential to make a profound impact on some  companies and investors. Below is some advice on how entrepreneurs and investors can navigate the opportunities and challenges of General Solicitation.

For Entrepreneurs

  • Not All Companies Will Benefit From Advertising. The most common misconception about the ban’s removal is that all companies will benefit from being able to publicly advertise their fundraising efforts. However, communicating with the masses is only useful if the masses understand your business. If you are raising money for an innovative popcorn company that makes tangible products anyone can try and form an opinion about, then communicating with the masses makes sense. However, if you are a biotech company developing new stem cell technology or a cloud computing company, chances are a tiny fraction of the population will understand your business, and thus advertising to the masses will likely be an inefficient use of time and resources.
  • Only Accredited Investors Can Invest. Even though you can now advertise to everyone, only accredited investors (individuals making more than $200,000 or whose net worth excluding primary residence exceeds $1 million) can invest in your offering, and the onus is on you (or the broker dealer you work with) to take steps to verify that they’re accredited.
  • Work With Intermediaries You Trust. There are a host of complexities and red tape around the use of General Solicitation, so it is critical that entrepreneurs consult lawyers, broker dealers and other advisors who know the rules cold; otherwise, running afoul of them can lead to severe penalties, including a one year ban on raising capital under Rule 506, which exempts private companies from having to register their offerings.

 

For Investors

“Invest in What You Know”. This principle of the great investor Peter Lynch applies to investors considering putting their hard earned cash in private companies. If you aren’t an engineer, or have deep backgrounds understanding the key drivers in a tech company, don’t invest in a company claiming to have a better search algorithm than Google. There are platforms that are today selling secondary stock in large private tech companies like Dropbox or Pinterest.  Lets think about that for a second- you cant see financials, you cant dig into their technology in a meaningful way and you have no access to the management team.  How would anyone in that situation know if the company is worth $2B, $20B or $200B.  If you don’t know why valuation is critical, you shouldn’t be investing into private companies.  With small consumer and retail companies, investors (i.e. those on CircleUp) can understand the product, often look at historical financials and talk with the management.  Peter Lynch’s mantra is one reason why I think consumer and re tail companies will benefit the most from this regulatory change and the resulting advertising.

  • Be Cautious. Investments in private companies are risky. Very risky.  While they can produce staggering returns when successful, these investments are very illiquid and have incredible volatility—you need to be prepared for your investment to be worth nothing. If you are going to invest in private companies, you should decide upfront how much of your portfolio you want to allocate to such investments and then spread this amount over at least 5-7 companies, as diversification is critical when dealing with such volatile return profiles.
  • Work With Intermediaries You Trust. This advice is the same as it is for entrepreneurs. For investors who plan to turn to crowdfunding portals to find deal flow, it is critical to identify the most reputable ones, as these will have the highest quality investors and, in turn, the best companies. Make sure the platform is a registered broker dealer, or partnered with one.  At CircleUp, the equity crowdfunding site where I am CEO, we pride ourselves on having some of the best consumer investors in the world and only accept a small percentage of companies that apply to the platform.

This change marks an incredibly exciting leap forward for small businesses and investors alike. General solicitation, when used right, will offer a new level of transparency and democratization to finance by giving investors more choices and allowing entrepreneurs to raise capital more efficiently so they can get back to their day job of building their business. However, all participants need to be careful on how they use/rely on advertising efforts. There will be hiccups along the way, but I believe the ban’s removal will be a win-win for investors and entrepreneurs.

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