JOBS Act Fallout: Do New Rules Mean Don’t Talk Money on Demo Day?
What started off as the usual demo day for the Entrepreneurs Roundtable Accelerator in New York quickly showed how the JOBS Act’s new rules on fundraising have clamped down the way startups pitch—or have they?
Over and over, the audience at last month’s ERA demo day was told the companies on stage were not seeking funding, which was taken by many as a response to JOBS Act provisos that went into effect on Sept. 23 regarding general solicitation.
Thanks to some fuzzy language in the law, opinions vary greatly among demo day organizers across country such as the TechLaunch accelerator in Clifton, NJ and the Aggie Angel Network in College Station, TX on what triggers the rules.
Though there has been no regulatory crackdown yet, some publicly conducted demo days may walk the line of general solicitation for funding. Some say the rules apply if a startup pitches before any audience, others believe the law applies only if startups mention their funding aspirations.
General solicitation requires startups to make certain filings with the Securities and Exchange Commission. That can be a prohibitive drain on time and resources for startups that are just emerging—though the penalties can be even worse. If startups engage in general solicitation but do not comply with the filing rules, they may be banned from raising funds for one year.
On one hand, the federal law loosens the collar for startups to discuss with accredited investors their plans to raise funding. But differing interpretations on what constitutes a general solicitation have spurred changes at some demo days.
For the ERA team, that meant nixing public talk of funding. Meanwhile, some programs have limited attendance to their demo days to accredited investors only or barred reporters from writing about the presenting startups, and yet other demo days have made no changes at all.
In the past, TechLaunch CEO Mario Casabona says, startups freely presented their technology, financial projections, and funding needs at demo days. That changed in September when the general solicitation rules went into effect.
“We don’t know, as the promoters of demo days, where the boundaries are,” he says. “If you take the JOBS Act literally, we can’t even talk about projections or raising money.”
He believes demo days will not come to a halt, but predicts the focus will shift to technology descriptions rather than pitches that talk dollars and cents for investors. “Whoever is putting together demo days will have to be careful,” Casabona says.
There seems to be a bit of disconnect, he says, between what the rules imply and the reality of how deals get done. Even if offerings were made to startups after demo days, Casabona says, the nitty-gritty details such as negotiating the terms of the deals all happen privately rather than publicly.
TechLaunch had its most recent demo day, with investor pitches, on Sept. 19, days before the rules went into effect. But Casabona believes that will change for everyone in the future.
“We’re going to see more and more of the demo day format that ERA put together,” he says.
For now, though, there are different views on how the regulations should be handled, he says. “One interpretation is to continue doing business as you have been,” Casabona says. “I’ve heard others say you can’t even have demo day.”
With so many grey areas yet to be defined, he plans to keep a close eye on what develops. “I’m looking at the next six months to see how this shakes out,” Casabona says.
Getting the federal government, once the shutdown is over, to step in again to clarify how the rules apply to demo days might not be the best solution by his reckoning. “Whenever we get the government involved in telling entrepreneurs how to do business, I’m always a little reluctant on how successful that’s going to be,” Casabona says.
Organizations such as the Angel Capital Association, he says, are lobbying to make sure that rulings under the JOBS Act will not be too harsh and that where will be some flexibility on determining public versus private offerings.
Keeping regulators from becoming even more hands-on with startups, he says, may be crucial to the health of the nation’s innovation ecosystem. One of the advantages the U.S. possesses over other countries, he says, is letting entrepreneurs build their companies without bureaucratic hindrances.
“I’m concerned that things like the JOBS Act can put some roadblocks in the way of entrepreneurs’ ability to launch their startups,” he says.
In some cases, the potential effects of the new general solicitation rules on demo days have caught folks completely off guard. Phelan Riessen, co-founder of SD Tech Scene and app development firm Digithrive in San Diego, has been planning a demo for Nov. 7 and is now sorting out the differences between demos that show off products and pitches for investors. “I need to consider how we’re doing our pitch event,” he says.
The objectives for his forthcoming demo day, he says, are to give entrepreneurs some practice pitching and to show the community the type of startups San Diego is home to. Now, Riessen is in a bit of quandary. “I don’t know how we can do a pitch event without talking about financials,” he says.
Excising talk of money from the proverbial elevator pitch may be a challenge, but Riessen says he wants to keep the event intact and comply with the rules. He believes that startups looking for funding will have to separately meet with potential investors to vet them as accredited.
“It needs to be thought out to make sure we fall under the guidelines,” he says.
As planning for the event proceeds, Riessen says he is reaching out to legal experts for advice on how to proceed. For now, he continues searching for answers. “What is the breaking point?” he asks. “Where do we stop and say we can only do ‘this’ or we can only do ‘that’?”
Defining what constitutes a demo needs to be sorted out as well, says Omar Hakim, managing director with the Aggie Angel Network. “Some people might refer to a startup company’s pitch to an established angel group like ours as a demo day,” he says. “We don’t think of that as a demo day.”
Hakim says his network makes sure all attendees of such pitches are accredited investors. That way the startups can say they have not violated SEC rules. “We think going forward that element is unchanged,” he says.
The lack of consensus on demo day formats may contribute to the confusion on how the rules apply. Hakim says other organizations conduct their events far differently from his.
“They’re going to elevator pitch competitions, they’re going to ‘Shark Tank’-like public events where they pitch their companies,” he says. The concern is, he says, that the companies who pitch in such venues may be tripping up on general solicitation rules—with a one-year ban serving as a very stiff punishment for young companies.
“That’s like saying you’re barred from oxygen for a year,” he says.
This new risk factor has led Aggie Angel to closely scrutinize startups to find out who else the entrepreneurs have talked to and what other forums they have presented in.
“If we think they’ve been on a tear talking to lots of different groups and trying to raise money incorrectly doing general solicitation, this may put off our investment,” Hakim says.
Companies that spread too much information about their plans over the Internet might also draw unwanted attention from the SEC. “If we put money in there, it may go into a lockbox if the company gets barred from raising money for a while,” he says. “That puts our investment in jeopardy.”
Startups that simultaneously seek conventional investments and money from crowdfunding also raise concerns, Hakim says. “How do we know their crowdfunding activities haven’t triggered these problems?” he asks.
That may drive away angel investors who fear the penalty may kick in, he says. “Since we don’t yet have the full rules on crowdfunding this remains an unknown,” Hakim says. So far the available rules, he says, have added a layer of complexity to raising funds that startups had not considered before.
With the new regulations less than one month old, he says Aggie Angel is in wait-and-see mode.
“We’re going to look for more guidance from the SEC on how they’re going to interpret this,” he says. The Angel Capital Association, he says, also plans to bring the concerns of its members to regulators. “There’s some hope there maybe some course corrections,” Hakim says, “but this is now the law of the land.”
The breadth of what the new rules may cover could lead to a bit of overzealous self-policing, he says, that negatively affects the startup-investor ecosystem.
“The bottom line is I think there is going to be less investing occurring,” Hakim says. “That’s the opposite of what I think the JOBS Act is all about.”