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Startups can now ask for your money, but you can't give it to them

Startups can now ask for your money, but you can't give it to them

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Advertising ban lifts for startups, hedge funds in first step toward making everyone an investor

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techstars flickr andrew hyde
techstars flickr andrew hyde

Hoping a Silicon Valley hotshot will bankroll your app? In the past, you’d have to pitch investors discreetly in meetings and over email, or risk being penalized. But thanks to a not-so-new law that just came into effect, you can now tweet, blog, and shout from the rooftops that you’re looking for funding. The ban on "general solicitation" — asking for money in public instead of behind closed doors — for startups and hedge funds expires today, thanks to the slow-moving but wide-reaching Jumpstart Our Business Startups Act.

What does that mean for the average person? Basically, it just means we’ll see more advertising. Startups will tweet, post on Facebook, and set up websites to hawk their pitch decks. Meanwhile, hedge funds will take out billboards and magazine ads boasting about their latest portfolios. The JOBS Act is supposed to make investing accessible for more people, but for now, "general solicitation" means just that: solicitation. Companies are allowed to ask for money in public, but they won’t be allowed to accept money from just anyone until the next phase of the JOBS Act comes into effect. For now, investment is restricted to only the wealthy, under the assumption that they can afford the risk.

For now, investment is restricted to the wealthy

In addition to lifting some regulations, the law also adds a few restrictions. A startup that raises money privately from so-called "accredited" investors — people with $1 million in net worth or $200,000 in income — does not have to verify any information from those investors. But if a startup engages in general solicitation, it is suddenly required to verify every investor’s income with documentation such as tax returns. This is to prevent unsophisticated investors — widows and orphans, as they’re referred to in the finance industry — from being taken for a ride.

The Securities and Exchange Commission (SEC), which implements these rules, is also indicating that there will be real penalties for companies that violate them. In the past, startups flouted the general solicitation ban by fundraising on stage at that Silicon Valley staple, the demo day. Under the new rules, startups that don’t comply will be banned from fundraising for a year.

Really, this change is just a small step in a larger revolution. It is the other, yet-to-manifest provision of the JOBS Act that had people really excited: equity-based crowdfunding, which is like Kickstarter except that backing a startup gets you stock. Right now, only the wealthy can invest in startups. Anyone will be allowed to invest in startups once the new rules come into play, which won’t happen for an estimated nine months.

The JOBS Act was signed into law in April of 2012, promising easier fundraising for startups and looser regulations for public companies. It was greeted with whoops and cheers in Silicon Valley, but the law’s advocates didn’t realize how long the wait would be. Regulators hammered out the specifics for almost a year and a half before any of the law’s major provisions took effect.

This change is just a small step in a larger revolution

Not everyone is happy with the new rules, including some startups and investors who are worried that the requirements for startups filing with the SEC are too strict. "These rules could put a huge dent in funding and support of the innovative startups that create jobs in America — the exact opposite of what Congress intended in the JOBS Act," the Angel Capital Association said in a statement.

Criticism of the law also came from state regulators and other interest groups that warned looser rules around advertising would open the door to fraud. Inexperienced investors can easily lose their money to scammers, or simply to well-intentioned but overly optimistic CEOs.

This type of startup fundraising is already the biggest source of securities fraud investigations, says Heath Abshure, president of the North American Securities Administrators Association (NASAA), the 95-year-old organization that represents state and local securities administrators. Allowing startups, entrepreneurs, and potentially scammers to advertise private offerings will make the abuse worse, NASAA and other critics say. Imagine scammers cold-calling seniors, encouraging them to bet their retirement funds on the next Facebook. Imagine seeing ads for startups pop up on late-night TV.

"Lifting the advertising ban on these highly risky, illiquid offerings, without requiring appropriate safeguards, will create chaos in the market and expose investors to an even greater risk of fraud and abuse," Abshure says.

But despite the opposition, companies are jumping to take advantage of their new freedom. TechShop, the fast-growing coworking space for hardware builders, just announced it will be raising $60 million. AngelList, the fast-growing private social network where startups connect with accredited investors, just announced that companies can opt to make their fundraising visible to anyone. AngelList will also be handling the investor income verification checks for any startups that raise money on its platform.

Companies are jumping to take advantage of their new freedom

"It’s the first step in a long process," says Nick Tommarello, founder of WeFunder, a company backed by the prestigious Y Combinator incubator that serves as a platform for startups raising money.

WeFunder is planning for the future when startups will be allowed to accept funds from anyone, says Tommarello. He’s hoping that non-accredited investors — which would be your average internet user — will see that nifty new startups are fundraising and start to pressure the SEC to hurry up on its rulemaking on equity-based crowdfunding.

"No one really knows that they can’t invest in startups, because they never hear about it," he says. Starting today, that’s no longer the case — so don’t be surprised if the calls for fundraising suddenly outnumber the baby pictures in your Facebook feed.

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