Editor’s note: This post was republished with permission from the Ewing Marion Kauffman Foundation’s Policy Dialogue blog.
Stemming from the 2012 Jumpstart our Business Startups (JOBS) Act, SEC regulations take effect today. However, it appears work still needs to be done. At the Angel Capital Association Summit in Philadelphia last week, I talked to investors about a bill moving swiftly through Congress to remove an unintended consequence of today’s new rules.
The “unintended consequence” came from SEC Regulation D 506(c), which allows private issuers to use general solicitation when raising capital as long as they take reasonable steps to verify that the investors who purchase their securities are “accredited investors” – a category of individuals deemed sophisticated enough under securities laws to need less protection in the marketplace. The affected ecosystem actors: startups who wish to participate in the various forms of “demo days” and who don’t have the means to vet attendees.
Demo days allow startup founders to meet and exchange ideas with potential future investors, peer entrepreneurs, and business experts who may become mentors. They are a built-in component of many entrepreneurship education programs and accelerators, which typically end in a demo day. The finals of university business plan competitions are also a form of “demo day.” Other forms are the “pitch days” and “venture fairs,” where entrepreneurs showcase innovative products. While I have not always been much of a fan of business plans, the value of such competition initiatives is clear.
Under current SEC regulations, demo days can be considered “general solicitations” for capital. To avoid unnecessarily putting entrepreneurs at risk of regulatory violation and discouraging potential investors from participating in demo days, House Small Business Committee Chairman Steven Chabot (R-Ohio) introduced in February the Helping Angels Lead Our Startups (HALOS) Act. The bill seeks to give both entrepreneurs and investors more certainty. Specifically, HALOS clarifies the SEC definition of general solicitation to ensure startups may participate in educational demo days without having to verify that attendees are accredited investors.
The HALOS Act would repeal the Regulation D requirements for demo days which are sponsored by a government entity, nonprofit organization, angel investor group, venture association, a college or university, a trade association or other entity permitted by the SEC, so long as the advertising for the event does not make specific investment offerings and no specific securities offering information is communicated at the event.
That the bill is moving swiftly through Congress was welcome news for angel investors at the Angel Capital Association (ACA) Summit I spoke at in Pennsylvania. Having enjoyed bipartisan support in the House where it was approved by vote of 325 to 89, the Senate received it in late April, where it was referred to the Committee on Banking, Housing, and Urban Affairs.
Marianne Hudson, Executive Director of the Angel Capital Association, officially expressed support for the HALOS Act. She explained:
“Demo Days have been an important part of the entrepreneurial financing process for literally decades, often with lead sponsorship by federal, state and local government entities for the purpose of economic development … We are not aware of investor fraud issues connected to these events. Requiring verification of accredited investors for these events creates a new burden for participating entrepreneurs and makes investors less likely to invest in participating companies because they are concerned about the requirements of the SEC rule … Further it is important to understand the reasons that demo days should include unaccredited investors as attendees. Their education and economic development purposes might be even more important than connecting entrepreneurs to potential investors.”
However, the HALOS exemption has also raised investor protection concerns – for many legislators, the very essence that inspired the passage of the JOBS Act. Prior to the JOBS Act, investors self-certified that they were accredited investors. Opponents to the bill now under review in the Senate fear that individuals, say on a college campus, could walk into the pitch, and purchase the offering on the spot with little to no understanding of the risks associated with the investment (see “Minority Views”, here).
It is important to note that the HALOS Act would maintain existing accredited investor verification requirements and exceptions under Rule D for the actual purchase or sale of securities. Nonetheless, fears of abuse are not completely irrational.
For the most part, demo days are open to the general public. However, those who participate in these events are generally part of the startup ecosystem rather than “people walking off the street,” Marianne Hudson recently told The Hill.
As this case demonstrates, entrepreneurship policymaking is an ongoing process. In many cases, dealing with difficult roadblocks has led to a policy experimentation approach, which integrates monitoring and feedback at the policy design stage.
In this case, would the HALOS exemption for demo days help improve the quality and efficiency of our nation’s regulatory framework? We welcome your comments.
Jonathan Ortmans serves as president of the Public Forum Institute, an independent, nonpartisan, not-for-profit organization dedicated to creating the most advanced and effective means of fostering public discourse on major issues of the day.