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How Can An Entrepreneur Fundraise Without Getting In Trouble With the SEC?

Q:  If an entrepreneur is out meeting with people in order to find investors in a round of financing, is this “soliciting” investments in the eyes of the SEC? 

It is my understanding that the SEC doesn’t permit solicitations” unless there is a pre-existing relationship.  Therefore, if the entrepreneur doesn’t have a pre-existing relationship before he starts making the rounds looking for financing, he could be in trouble. 

I have a colleague who say that this is not a problem.  He said that it would be ok for the entrepreneur to hold these meetings–and even to use a “finder” to expand his network– as long as he wasn’t giving the prospective investors a private placement memorandum or suggested term sheet.  As long as the prospective investor comes back with a term sheet, he is not involved in an offering or “soliciting” an investment is, my friend’s logic.

A:  (Jason)  There is a simple legal answer to your question: this type of behavior that you and your colleague are discussing is an illegal solicitation under the law.  Note, that I’m assuming that people you are contacting are not accredited investors.  If the people that you are contacting are not accredited investors, you don’t have an exemption under the SEC’s interpretation of the law.  It’s irrelevant whether or not you have a pre-existing relationship with anyone and irrelevant whether or not you have a PPM or term sheet present in the discussion.  Your intent is to solicit investment and that’s sufficient to be considered an offering. 

Now if you are seeking venture financing, or angel investors, they should all be accredited and you have no issues.  If you are asking folks who don’t fall under this standard, then the question is whether or not the SEC will notice your activities.  Probably not.  You would most likely fall under the radar, but the biggest issue is that any money you take in would probably be subject to a right of rescission – in other words, any investor you take on would at any time be able to change his / her mind and take their money back. 

All of this, too applies to any finder you use.  Using a finder does not insulate you from any of these problems. 

**Per all posts on this blog regarding legal advice, we aren’t your lawyers – seek your own counsel.  **

October 14th, 2007 by     Categories: Fundraising    
  • http://www.famboogle.com Alex Lorenz

    Jason, some wise words. May I add that Rules 505 and 506 of SEC Regulation D do allow a number of unaccredited investors per offering, with the amount of the offering itself being limited. Different states impose different limitations and filing requirements on their own, so one should consider which states potential investors may reside in.
    Finally, I would consider relevant that “finders” must be licensed brokers in order to be compensated.
    Alex