Editor’s note: Rob Leclerc is the CEO of AgFunder, an online investment marketplace for agriculture and agtech opportunities.
The first rule of raising capital is: you do not talk about raising capital.
That was the de facto credo of nascent startup companies looking to secure investors before the fall 2013. Then on September 23, 2013, the SEC promulgated the new Title II rules of the JOBS Act, which permitted the general solicitation and advertising of private investment opportunities under a new exemption called Rule 506(c) of Regulation D, provided that an issuer verified that all investors in an offering were accredited investors.
Prior to the inclusion of Title II, an entrepreneur had to have a “substantial and pre-existing relationship” with a prospective investor in order to receive funding for their startup business. Broadcasting your offering was completely off the table. That meant no ads, no e-mail solicitation, no talk of fundraising during press interviews or conferences and certainly no financial outreach efforts across social media platforms.
Sound antiquated? From the perspective of contemporary entrepreneurs trying to get off the ground, absolutely.
Look at it this way: If consumer product companies like Apple needed to have close ties with each individual customer in order to sell iPhones, or if an emerging author weren’t allowed to sell his new book on Amazon without an established reader base, it would be extremely cumbersome — impossible even — for either of them to get their products into the market. That’s essentially how the private securities world had to operate up until the new SEC exemption took effect, and it shaped investment banking in the Information Age.
Investing in a Pre-Title II World
Before the Google era, the motivations behind the restrictions on advertisement and solicitation were sound. The SEC wanted to protect grandma from being baited by nameless cold callers and investing her life savings into small, private companies that would most likely fail. Today, however, sequestering information is a tall order — and in an increasingly Internet-savvy culture, it’s probably a bad idea anyway.
In early 2011, the New York Times reported that Goldman Sachs was setting up a special purpose investment vehicle to invest in Facebook and was going to raise as much as $1.5 billion, with a minimum investment of $2 million, from some of the wealthiest clients in the world (certainly not grandma’s life savings, that’s for sure). Nevertheless, once the SEC got wind of this, it opened up an inquiry and Goldman Sachs promptly shut down the offering to U.S. investors.
Foreign investors were still able to participate because they’re not subject to SEC restrictions, but the deal was officially off limits to American investors. If the new Title II rules had been in place, Goldman Sachs could have promoted the deal on CNBC or other major broadcast networks. Or alternatively, Facebook could have skipped Goldman Sachs altogether and promoted the same offering themselves.
Either way, tearing down the Title II restrictions on advertising and solicitation feels fundamentally more democratic; even if you and I don’t have enough money to sit at the big table, at least we can stand by and watch.
The Impact
The morning of September 23, 2013, was surprisingly quiet. Hedge funds weren’t tying up phones at 9 a.m. There were no random text messages about oil wells in the San Francisco Bay. The jumbo screens in Times Square were not overrun by flashy Wall Street ads, and girls in string bikinis weren’t handing out prospectuses on 5th Avenue.
Sparks didn’t fly, and the world of investment banking didn’t implode. But from investors and entrepreneurs alike, there was a collective sigh of relief lofting through the air on that early Monday morning last fall.
As CEO of AgFunder, an equity crowdfunding site for Accredited Investors focused on the agriculture and agtech space, I can vouch for that. If there was ever a sector that needed help connecting with investors, it’s agriculture. Since we launched our investment marketplace in February 2014, listed companies using the new 506(c) exemption have raised over $10 million and have been able to connect with investors and other potential stakeholders from across the country, and helped to break geographic boundaries that limit the flow of capital.
Our best case study for using the new Title II rules comes from a new San Francisco-based health bar company called Kuli Kuli, led by Lisa Curtis who had successfully led a $50,000 campaign on rewards-based crowdfunding platform Indiegogo the previous year.
Kuli Kuli sources moringa, a highly nutritious (and largely unknown) plant, from women’s farming cooperatives in West Africa, and once in powder form, uses it as the chief ingredient in its products. Today, Kuli Kuli’s moringa bars are sold in over 100 major stores on the West Coast, including major retailers like Whole Foods and Krogers—a direct result of two successful public fundraising campaigns.
Curtis, who embarked on a campaign last spring, met her target of $355,000 in just 60 days. Leveraging the new 506(c) rules, Kuli Kuli had their fundraising covered in a number of blogs and publications. Kuli Kuli also promoted its campaign on its website. The company was able to leverage this public campaign to broadcast its story to thousands of potential investors, including celebrity venture capitalist Brad Feld, as well as Mary Waldner, the founder of Mary’s Gone Crackers. Feld even tweeted about his investment in Kuli Kuli while the campaign was still live.
In addition to Kuli Kuli’s victories, interesting dynamics can also play out during investor webinars. For our own investor webinars, we typically see about 90 or so registrants, of which approximately 50 percent are accredited or institutional investors. But what’s also interesting is that these webinars are attracting other potential stakeholders, including channel partners, customers, press and industry professionals, which may be far more valuable to a company than capital.
This open format also provides investors with a chance to study how a company responds to concerns and questions from potential partners, customers, and even competitors. While only accredited investors can invest in these opportunities investors win when they can gain insight into issues or opportunities they may not have considered otherwise. If an investor were to hire consultants to tackle such an inquiry, it could cost tens of thousands of dollars.
Slow Adoption
At the end of March 2014, six months after the new Title II rules were passed, Keith Higgins of the SEC reported that only 900 companies had used the new 506(c) exemption to raise $10 billion in new capital. Compare that to over 18,000 Regulation D filings for all of 2012 for $900 billion in new capital.
Similarly, most marketplaces have not fully embraced the new Title II rules. On CircleUp, only 45 percent of companies are currently using the 506(c) exemption, so CircleUp must still erect an accredited investor verification wall to protect those companies that are not using 506(c). Consequently, even companies that are using 506(c) are still missing out on opportunities to engage with other stakeholders, while investors miss out on an opportunity to see how the company interacts with these stakeholders.
Similarly, Realty Mogul purportedly engages in 506(c) offerings, but first-time registrants are still greeted with an accredited investor verification wall followed by a cooling-off period before they can view the investment opportunities. Under the old rules, a cooling-off period was considered necessary to establish the SEC’s requirements for a “substantial and pre-existing relationship,” but this is no longer necessary under the new exemption.
Still, the new 506(c) exemption may not be viable options for some types of investment marketplaces. For instance, syndication platforms such as FundersClub or AngelList Syndicates, which aggregate investors into special purpose investment vehicles that invest in one or more underlying companies, might not be able to advertise their fund. Not unless all of the underlying companies are also engaging in 506(c) offerings.
The biggest hurdle to widespread adoption of 506(c) offerings centers around the extra step that issuers must take to verify their Accredited status as well as some minor hesitation amongst startup lawyers who haven’t yet dealt with a 506(c) offering. In practice however, we’ve seen no pushback from investors when asked to provide the necessary documentation, and the SEC presented a number of guidelines so that investors do not have to turn over sensitive information.
The Future
With Title II putting an end to the financial exclusions of yesteryear, investment marketplaces have an opportunity to offer a more collaborative and transparent fundraising process. And as they evolve and mature, they may become the precursor to new types of eInvestment Banks leading the globalization of private capital markets.