Help Save Our Innovation Economy from the SEC’s Rewrite of Reg D
Over the past 30 years, the United States has developed an infrastructure to nurture, grow, and fund early stage companies that is the envy of the world. There are more than 250,000 active angel investors in this country, and nearly one out of every five of the startup investments they make are in California. At the Tech Coast Angels, California’s most-active group of individual investors, we believe the current system serves our innovation economy very well. But it may effectively be shut down if revisions the Securities and Exchange Commission proposed in July for Regulation D of Rule 506 are allowed to stand.
If you ask entrepreneurs how they secured their investors or vice versa, the answer 90 percent of the time would be “networking.” That’s particularly the case in San Diego, where our innovation community thrives on personal engagement and introductions. The old business adage is true: people buy from people that they know, like, and respect.
But a misguided effort to regulate such networking is one of the things that makes the SEC’s Reg D changes really troubling.
In finalizing a portion of the 2012 JOBS Act, the agency wants to lift a decades-old ban that has prevented hedge funds, private equity firms, and other investment entities from soliciting investors by marketing their offerings to a wide audience.
The proposed rules cover how investors can be solicited, and provide guidance on how issuers could “reasonably” verify that the investors they are soliciting meet SEC criteria as “accredited investors.” There also is a proposed rule disqualifying “bad actors” from investing in private offerings, and another requiring entrepreneurs to submit multiple reports and information for solicited offerings.
At the Tech Coast Angels, we applaud the SEC’s focus on protecting the public from fraudsters. But we are concerned these rules will prove too onerous for angels in San Diego and elsewhere in California who invest an average of $25,000 apiece in startup companies—and we fear our entrepreneurs will suffer as a result.
Until now, individual investors were free to self-accredit; the amounts they invest are miniscule compared to the tens of millions that hedge funds typically invest in a deal. So requiring angel investors to obtain what is in effect a current and independently audited financial statement would be costly for the entrepreneur and unreasonable and impractical for the investor.
If these rules are finalized on September 23, those of us who would have continued to invest in start-ups will seek alternate investment opportunities that are much less troublesome. The net result will be that fewer of us will invest in early stage companies effectively choking off most or all of the $23 billion that angels invest in start-ups annually. It would strangle a sizeable job creation engine—exactly the opposite of what Congress intended.
A provision in the new regulations could also curtail the standard practices most early-stage companies currently use to gain exposure to angel investors, including pitch days, demo days, open office hours, angel group screenings and meetings, and pitch contests. Such events could all be construed to fall under general solicitation. A company that violates the revised solicitation rules, or fails to meet the verification standard, or the array of filing and pre-filing deadlines, would be subject to penalties that prohibit the company or fund from raising new capital for one year. This makes 501(b) investments highly problematic since the penalties would, in effect, shut down the company.
Calmer heads must prevail here for the sake of our economy. If small businesses and innovation are to continue thriving and serve as the backbone of growth for our nation, Reg D must acknowledge the great value that reputable organizations like the Tech Coast Angels and others groups play in helping new companies get started. If not, angel investments may be curtailed—to the detriment of our regional and national fortunes, as well as those who are courageous enough to start companies.