New federal rules designed to make it easier for startups to attract investors have sparked complaints from investor groups that say the rules could end up making fundraising more difficult.
Organizations that represent angel investors, wealthy individuals who provide essential capital to startups in exchange for an ownership stake in the business, are upset about Securities and Exchange Commission rules that emerged earlier this month. The rules, which permit startups to openly solicit funding from investors, also include new financial disclosure requirements that have upset the angel community.
“We value our privacy,” said Elaine Bolle, president of RTP Capital, a group of nearly 40 local angel investors who collectively have invested in about 10 startups over the past two years. “The requirement that we provide our financial information to an entrepreneur is going to really tamp down angel investing.”
The Angel Capital Association, a national organization, also contends fewer angels will be willing to invest in startups under the SEC rules that take effect in September.
“I have not talked to any angel who would want to provide any of their private financial documentation to an entrepreneur,” said Marianne Hudson, the association’s executive director. “This is an extra roadblock that will take some angels out of the game.”
Angel investors are a crucial source of funding for information technology and life science startups that haven’t yet matured to the point that they can seek larger sums of money from venture capitalists. The seed funding that angels provide often enables startups to take their technology to the “proof of concept” stage.
Last year angel investors forked over nearly $23 billion to more than 67,000 companies, according to the Angel Capital Association.
Several organized groups of angel investors have emerged in the Triangle in the last few years.
“We’re fortunate in this area that we have multiple angel groups and a whole lot of active individual angels,” said Jay Bigelow, director of entrepreneurship at CED, a Triangle nonprofit that supports entrepreneurs.
The rules were triggered by the Jumpstart Our Business Startups Act, a law passed by Congress last year. The rules end a prohibition on “general solicitation or general advertising” that has been in effect since 1933 and which has forced startups, hedge funds and venture capital funds to raise funds from accredited investors behind closed doors.
The SEC defines an accredited investor as someone with an annual income of more than $200,000 or a net worth of more than $1 million after excluding the value of their primary residence. Startups are restricted to soliciting funds from accredited investors because such investments are risky and an accredited investor presumably can take the financial hit if the investment tanks.
Lifting the ban will enable startups and others to openly solicit investors – advertising, via websites and social media, etc. They’ll even be able to talk to newspaper reporters about their fundraising plans, which is something the SEC has frowned upon.
The tradeoff, under the new rules, is that startups must take “reasonable steps to verify” that an investor is accredited in order to accept their money. That’s in contrast to the current practice of investors simply attesting “under penalty of law” that they qualify, said Hudson.
The rules don’t spell out precisely what reasonable steps startups should follow, but they serve up examples that worry angels. They include providing W-2 forms or income tax forms. Or the investor could submit a statement from their attorney, accountant or investment advisor attesting that they qualify as accredited.
Hudson said providing that third-party proof could be costly as well as “a hassle.”
The newest angel fund to surface in the Triangle is Physician Fund, which announced Monday that it has attracted $5.1 million from angel investors – mostly physicians – to invest in emerging healthcare companies. Physician Fund has targeted raising a total of $15 million.
Cam Patterson, an advisor to Physician Fund, said that the impact of the rules is uncertain in the absence of SEC guidelines on how it will interpret them.
“Having said that, I think the rules needlessly create anxiety at a time when angel investors are just getting back into the startup market,” said Patterson, who is associate dean of UNC Healthcare Entrepreneurship and chief of cardiology at the UNC Center for Heart and Vascular Care. “The timing of this is awful. My hope is that they simply did not think through the implications of what they are doing and that they are either going to patch this or provide us with more direction promptly.”
Startups retain the option of eschewing general solicitation altogether, instead raising funds under the system that has existed for decades.
‘Wild West’ atmosphere
But attorneys who work with startups say they expect many of their clients to widen their fundraising net by openly soliciting investors in one way or another.
“I don’t know a lot of people interested in mass mailings or whatever, but there are definitely people who want to put a button on their website that says, ‘Are you interested in investing?’ ” said attorney Don Reynolds of Raleigh’s Wyrick Robbins Yates & Ponton.
Raleigh lawyer Jim Verdonik of Ward and Smith predicts that the uncertainty unleashed by the new rules will create “a Wild West kind of atmosphere” for the near-term because people and companies will be feeling their way in unchartered territory.
“Eventually the rules get worked out ... but it can take a year, two years, three years for law and order to be restored,” he said. “Until then, it is people kind of guessing what you can and can’t do.”
At least for now, Reynolds is advising his clients to try to raise money the old-fashioned way first.
“If that doesn’t work, then go with general soliciting,” he said.
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