When U.S. companies seek to raise capital through the sale of securities they must either:
1) register the securities with the SEC or,
2) rely on an exemption from registration, most commonly Rule 506 of Regulation D.
Previously, Rule 506 allowed a company to raise an unlimited amount of capital from an unlimited number of accredited investors and up to 35 non-accredited investors. However, this was all done with the stipulation that the company NOT advertise (generally solicit) the offering and they could only offer the investment opportunity to accredited investors. Under the new rule, the general solicitation ban has been dropped and companies can publicly advertise, although companies can still only accept investment capital from accredited investors and they must take reasonable steps to verify that that investor is, in fact, an accredited investor.
Two of the most common types of Rule 506 securities offerings are offerings of shares of private company startups, which is the focused intent of the JOBS Act, and offerings of shares in private investment firms like hedge funds, which get to ride along on the coattails of the JOBS Act.
So what has changed in p2p world? Not that much actually, since Lending Club and Prosper already register their securities with the SEC and have been legally allowed to generally solicit for years. The new rule change will impact some of the smaller online lending platforms that have not gone through the SEC registration process and are relying on Rule 506 to sell to only accredited investors.
Realty Mogul is Seeing Astonishing Growth
For instance, if you have been driving around San Francisco the last couple of weeks you might have seen the billboard in the graphic above. Realty Mogul (profiled earlier this year) is running this promotion right now and according to CEO and co-founder Jilliene Helman the new rule is really helping her company. This is what she said in an email to me yesterday:
We’ve seen pretty astonishing growth, both in new accredited investors, new deal flow and funding. Where we have historically done around $1 million a month in transactions, I project a $5MM month for October. We’ve been doing an educational campaign that has been well received and there has been so much publicity around the change that it is driving a lot of new traffic.
Title II could also impact the new category of p2p hedge funds like Eaglewood and Ranger Capital, which are now allowed to advertise if they so choose. If they wanted, they could take out ads in the Wall Street Journal or CNBC soliciting for investors. However, according to HedgeCo.Net, as of October 4th, a grand total of only eight hedge funds have filed the paperwork to indicate that they will be taking advantage of this change. Most hedge funds are not currently designed for general solicitation and they prefer to guard their privacy. Plus, it is likely that most hedge funds will proceed slowly in order to avoid being targeted as an example by the SEC.
I asked Sara Hanks, CEO of CrowdCheck, a due diligence and disclosure company for online offerings, about what she has been hearing regarding this change. One of the large hedge funds said to her they are happy that they can now sponsor polo matches! Clearly, most of these companies do not have sophisticated new marketing plans ready to implement.
Equity Crowdfunding Seeing Big Changes
The big changes are happening on the startup/equity side of the equation. AngelList, the startup fundraising platform, has seen record transaction volume since September 23rd. In the first six days of general solicitation AngelList saw 1,900 startups capitalize on the new rules and raise $63 million collectively. With the new syndicate function available small investors can join very successful angels and even some VCs in making investments in startups.
In addition, more changes are on the way. Title III of the Jobs Act is still awaiting more detailed rulemaking from the SEC and FINRA. Title III will allow for a new type of exemption from SEC registration that will allow companies to sell up to $1 million to non-accredited investors outside of the SEC registration process. The idea is that by dropping the solicitation ban and opening the doors to non-accredited investors, the market for small business funding will dramatically expand. Naturally, our governing bodies are proceeding cautiously given that these changes to our laws could be subject to fraud. The last thing anyone wants is to destroy confidence in the capital raising system.
After many decades of advertising restrictions we will not see the finance industry change overnight. But as time goes on I expect we will see more investor promotions, particularly from new companies entering the space.
As I step back and think about these changes, it is interesting to note the huge difference in the amount of money that Lending Club and Prosper have raised on their platforms as compared to other p2p lending and crowdfunding platforms. While some of this is related to the incredibly attractive risk/reward investment opportunity, perhaps some of their success can also be attributed to the fact that they went through the cumbersome and costly SEC registration process years ago and therefore, they have been allowed to generally solicit for years. Maybe advertising really does work!
There have been many articles published in the last few weeks about these changes and there is quite a bit of misinformation out there. This article from CrowdFund Insider clears up a lot of the misconceptions.
I am interested to hear your thoughts on these changes. Please share in the comments section below.