The Honorable Mary Jo White
U.S. Securities Exchange Commission
100 F Street NE
Washington, DC 20549
Dear Chairman White:
I am an angel investor in early-stage companies and member of a group of fellow angel investors. I write because on September 23, I believe the country will begin to suffer a significant reduction in angel investing and therefore the destruction of jobs, as companies go bankrupt or stop growing due to a lack of funding. This is the precise opposite of the intent of Congress in enacting the JOBS Act.
The SEC is understandably acting to regulate the securities industry and the $1.7 trillion annually invested in private companies (compared to $1.2 trillion raised via public markets in 2012). However, the SEC may accidentally grossly damage the vital angel investing industry in the process. Angel investors form the backbone of the startup economy. Each year, the US angel community invests approximately $23 billion in over 67,000 new start-up businesses. Nearly all net new jobs in the United States between 1980 and 2005 came from companies 5 years old or less, according to a Kauffman Foundation Study, (http://www.kauffman.org/research-and-policy/where-will-the-jobs-come-from.aspx) the great majority of which were initially funded by angels. Preserving the capital investment that the angel community makes in start-up companies is key to job growth.
With respect to the new regulation, I am specifically writing to:
1. Request that the Commission withdraw its proposed amendments to Regulation D and Form D.
2. Propose clarification that limited “Friends and Family” participation by non-accredited investors in 506 (c) issues is allowed.
3. Propose clarification of the “facts and circumstances” that can be used by issuers to establish that an investor is accredited under 506 (c).
1. Withdrawal of proposed amendments to Regulation D and Form D
The proposed changes to the Reg D/ Form D requirements for 506(c) issuers are onerous and almost guaranteed to be unintentionally violated by start-up companies. A start-up company is typically a 1 to 5-person entity operating on a very limited budget. Complying with the multiple requirements of the proposed rules will be virtually impossible due to the rules’ complexities, the cost, and the lack of available employee time. The proposed penalties for failure to comply are extreme, especially the loss of the right to use any 506 exemption for 12 months. In the start-up world, not having access to capital for a year will bankrupt many companies, and make the sector even riskier for angel investors.
We are gravely concerned that, if these Reg D requirements become effective, this additional risk level will cause a reduction in the approximate $23 billion in capital that comes annually from the angel community. We urgently request that these rules be withdrawn in their entirety for start-up companies. We suggest defining Start-Up companies for these purposes as companies which are less than 5 years old, have at least two responsible officers, and have raised less than $5 million in equity capital including the current planned issuance. Reg D forms should not be changed beyond the addition of the 506b or 506c election box. Additionally, issuers should not be penalized, in any way, for inadvertent disclosure (possibly construed as general solicitation) based on public Reg D filings, e.g., the common practice of technology publications to write stories about companies based on their Reg D filings.
2. Permission for limited unaccredited “friends and family” participation
Many startups are initially funded by equity infusions or loans from “Friends and Family,” frequently non-accredited investors. These investors are vital to many entrepreneurs who do not have the individual financial wherewithal to make a capital investment in a new venture, or even to quit a paying job elsewhere to spend time in a fledgling enterprise. For third-party investors like us, the commitment of Friend and Family is an initial sign of the commitment and integrity of an entrepreneur. In many cases, these early investors - many non-accredited- will have a security (such as a convertible note) that converts into the same security as that being offered to new purchasers. This is very positive news for an angel, as the people who know the entrepreneurs best are prepared to invest on the same terms as the new angel.
The angel-investing ecosystem needs clarification that the inclusion of these Friend and Family non-accredited investors will not prevent an issuer from using the 506 (c) exemption. A reasonable red line is that a company can have up to 20 unaccredited “Friends and Family” investors who put in a maximum of $50,000 each, for a total of up to $1,000,000 in capital invested.
3. Clarification of “facts and circumstances” establishing an investor is accredited
The “facts and circumstances” that can be used under the principles-based methodology provided in the rule for issuers to establish that an investor is accredited should include verification of the investor’s membership in an established angel group as one of the valid standards. The Angel Capital Association has developed guidance (available at: http://www.angelcapitalassociation.org/data/Documents/Public%20Policy/GuidanceonEAG09_03_13.pdf ) as to what constitutes an “Established Angel Group.”
It is essential to address and clarify this issue, as the overwhelming majority of angel investors will refuse to give highly personal financial information to a startup company or their intermediaries. That kind of invasive process will increase closing costs and complexity, delay financings, lead to the risk of identity theft, and cause many of our members to stop investing going forward. And that means bankruptcy, arrested growth, and destruction of jobs.
Additionally, it should be stated clearly that an issuer can reasonably assume that individuals investing over a threshold amount (we suggest $10,000) can reasonably be assumed to be accredited, based on the assumption that anyone investing such an amount has significant free cash available.
General Solicitation and the Angel Industry
Addressing the three issues outlined above is crucial to prevent a dramatic decline in cash investment into startups after September 23 because we believe most issuers will elect, and most angels will demand, 506 (c) rather than 506 (b) issues. The penalties if an issuer filed under a 506(b) exemption and then is construed to have generally solicited are extremely severe: rescission and potential Blue Sky violations. With the increase in social media, including Twitter and Facebook, many standard start-up industry events like Business Plan competitions, Tech Demo Days, and even some angel group meetings, could eventually be interpreted as general solicitation. The formal press and individual attendees often cover such events on websites, blog posts and via social media channels. Entrepreneurs need these events and their online equivalents to connect with potential clients, employees, service providers, and other business relationships; investors need them to assess potential investments. Without clarification on general solicitation activities, we expect very limited 506 (b) issues.
To prevent the severe reduction of 506 (b) offerings, and to help maintain the existing healthy angel ecosystem, the Commission could provide some further guidance as to what constitutes general solicitation for early stage companies. In particular, clarification that (1) Demo days, pitch events and similar events where attendance is limited to a specific number of attendees, for instance 300 attendees, are not general solicitations, and (2) any event, no matter the number of attendees, at which the issuer does not present information about a securities offering are NOT considered as generally soliciting.
A Group of New York, New Jersey, and Connecticut based angel groups.