We've all heard the statistics, that the private market for fundraising is larger than the public market, and that angel investors in the private market are responsible for nearly all seed and early-stage deals. In 2012, for example, angel investors financed 46,921 seed and early-stage deals, VC firms financed 1,927. (Source: Center for Venture Research, UNH, NVCA 2013 Yearbook; PWC MoneyTree).
Angel investors rely heavily on demo days, when presenters get together to showcase their products but not to engage in capital raising activities, and pitch days which are held for the sole purpose of helping companies raise money. These events are often sponsored by angel groups, universities, state or federal business development organizations, universities, non-profits and accelerators.
The status of these events prior to the enactment of Rule 506(c), which allows offers of securities using general solicitation, operated in a gray area, and the situation has gotten even murkier since enactment of the new rule. Previously, although soliciting money from a group of people may have technically constituted general solicitation, the SEC turned a blind eye to it presumably on the theory that the angels in the room where a curated group of invitees, accredited investors with a pre-existing relationship to the sponsor. The new question is, what happens if the presenters at the pitch event are simultaneously engaged in fundraising activities? Could the event be deemed general solicitation? And what if some of the presenters in the group want to offer securities under Rule 506(c) while others want to refrain from using general solicitation and rely on Rule 506(b)?
These queries demonstrate that it's extremely important that events be structured very carefully to avoid accidentally putting the presenters in the situation that they have engaged in general solicitation, triggering the purchaser verification requirements of Rule 506(c) and all the other baggage of the rule.
Closed events, those with a limited invitee list of investors previously known to the sponsor, pose less risk for general solicitation. Open events, where the public is invited, pose real potential issues. The sponsor should determine, through adequate procedures and documentation, whether the presenters want to rely on Rule 506(b) or (c). If 506(b), given the event is" open" with invitations generally distributed or advertised to the public, steps may need to be taken to prevent the discussion of anything related to raising capital or the company's finances or business plan. If 506(c), then the presenters have decided to use general solicitation so fundraising and finances can be discussed, but procedures need to be put in place to ensure that all requirements of 506(c) are complied with (including any necessary Form D filings).
There are particular challenges if the presenters include a mix of companies using both 506(b) and (c). It may be necessary to run separate events, with the 506(b) event not advertised in the 506(c)
materials, and to have the events physically segregated by space and time, and to limit entry to the 506(b) events to a limited list of invitees with a substantial pre-existing relationship to the sponsor who also have completed an accredited investor self-certification questionnaire.
It behooves the SEC to issue an interpretive release or safe harbor related to pitch and demo days, given their essential role in the angel investing process, and the crucial role that angels play in providing seed and early stage capital.
I will be discussing this and other issues related to angel investing, and the impact of the JOBS Act on corporate finance and securities legislation, in a webinar on Dec. 18.