Companies can now use public platforms to reach out to investors. But there are plenty of pitfalls to watch out for.
It just got a lot easier to reach out to investors.crowdfunding marketing
The Securities and Exchange Commission has lifted its long-standing ban on soliciting investments on public platforms. When the rule was laid down in 1933, public platforms meant things like magazines and billboards—but now they include the Internet. That could be a game-changer for small firms.
With a minimum of cost and effort, entrepreneurs can pinpoint potential investors and reach out to them on social networks and other online venues. But there are plenty of pitfalls that could lead small firms to stumble—and maybe even prevent them from soliciting more investments down the road.
The Wall Street Journal spoke with Sherwood Neiss, a principal of consulting firm Crowdfund Capital Advisors, about the implications of this change and what entrepreneurs need to know. Here are edited excerpts of the discussion.crowdfunding advertising
WSJ: What are the rules entrepreneurs should follow?
MR. NEISS: You can raise money from an unlimited amount of accredited investors [income of $200,000 per year for the past two years, $300,000 if married, or a liquid net worth, excluding home equity, of $1 million]. But you have to have an offering memorandum that talks about the business and the use of proceeds, you need to hire a law firm and an accounting firm, you have to go through disclosures and spend a good bit of money.
WSJ: How much might all that cost?
MR. NEISS: You have to spend between $20,000 and $40,000 to put together a private-placement memorandum to market to potential accredited investors.
WSJ: That seems like quite a lot if you're a small business.indiegogo marketing
MR. NEISS: If you have a little coffee shop somewhere, there might be crowdfunding platforms that can mitigate this and can help you come up with a very streamlined offering and documentations.…You can use standard documentation on some of these platforms, and they will help you put that together, and you can then go out to accredited investors.
WSJ: What else should you be aware of?
MR. NEISS: You have to follow the rules. The SEC requires that if you're going to do general solicitation of accredited investors, you [must] file with them 15 days before you go out there. The SEC is and will be looking for examples of people who have not followed the rules, and I would not want to be one of those first people who do not follow the rules and is held accountable. It's not going to be pretty for them.
WSJ: What are other potential pitfalls when promoting these marketing efforts?
MR. NEISS: The rules of the game don't change. You are asking for money from investors. They want to know certain things: about you, your company, how much money you are going to raise, how are you going to use that money, what the return is for them.…If you can't explain all this to them both in documentation and face-to-face interaction, you will not raise a dime from them.kickstarter marketing
WSJ: Does this make it more difficult to raise money, then?
MR. NEISS: What is going to make it more challenging for people raising equity money is that there's many means of communication. You can have someone, potential investors, saying, "You have not thought through your investment model." You need to go back to that comment, which is probably seen by everyone [on social networks and other online venues], and defend [your idea]. If you don't, you won't win…confidence and [you] will not get the money.
WSJ: Can you explain the SEC's "bad actor" rule in relation to the lift in the ban on general solicitation?
MR. NEISS: [If entrepreneurs] have anything in their past that would be considered as if they acted in a way that was frowned upon, I would not go out and raise capital. If you've done anything wrong that can come up in these databases that we have on all Americans, you will be disqualified from raising capital.
[In addition,] if you raise capital under one of the existing exemptions but don't follow the rules, you could become a bad actor. The bad-actor provision was put into place to keep people who have committed fraud from going back out and doing it again. The provision applies to more than just the business owner. It applies to executive officers, directors and promoters of the issuer. Owners of 20% of the voting equity of the issuer. Investment managers and principals of pooled investment funds and intermediaries and selling agents and their respective officers, directors and beneficial owners. While there are no set penalties, at most it is possible to go to jail if you are convicted of securities fraud.kickstarter project
WSJ: You are putting yourself on the line.
MR. NEISS: Yes, and it's a great thing. Think about if everyone knew who Bernie Madoff was, we could have probably stopped him from stealing a bunch of people's money.
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