In a prior article in this series we outlined the broad definition of security and provided a brief overview of how they are regulated. Essentially, any time you promise an investor something in return for their investment, you are dealing securities and need to be mindful of how you approach such transactions. One key consideration in determining how to best raise capital is to determine who you may target for investment and what methods you can use to target them.

The guiding principle in virtually all securities legislation and regulation is simple, the protection of the individual investors. However, not all investors are viewed equally in the eyes of the Securities and Exchange Commissions (SEC) and other regulators. At a basic level, investors are typically split into two categories, “accredited investors” who meet certain qualifications set forth in Rule 501 of Regulation D, and everyone else who does not meet those qualifications, commonly referred to as “non-accredited investors.” The qualifications to be considered an accredited investor are generally split into two categories. The first category permits an investor to be considered accredited if they meet certain financial thresholds that the SEC has determined indicate they are able to withstand loss (e.g. >$1M net worth, certain income standards, etc.). They second permits accreditation if they meet certain knowledge requirements (e.g. key principal of the issuer, holds certain FINRA licenses, etc.).

Painting with broad strokes, the regulations surrounding raising capital from accredited investors will typically require less disclosure and regulatory hoops than raising capital from non-accredited investors. When seeking capital from non-accredited investors, issuers will typically be required to provide the non-accredited investors with more financial information and will need to take some efforts to ensure they are adequately situated to make an investment. Some exemptions preclude seeking investment from non-accredited investors while others do not, and it is important to consult with legal counsel in determining which exemption will give you access to the types of investors you plan on raising capital from.

Another key consideration in identifying suitable investors is to what extent you will need to use general solicitation to access their capital. General solicitation is defined as the act of marketing a capital raise publicly and is generally prohibited except in certain specific circumstances. So when are you engaged in marketing a capital raise publicly? The SEC determines whether or not you offering is public by whether or not you are seeking investment from prospective investors with whom you have a “pre-existing substantive relationship.” A “pre-existing substantive relationship” has been characterized by the SEC as a relationship that precedes the contemplated securities offering and in which the issuer has substantial knowledge of the prospective investor’s financial situation and overall business acumen. In short, if you approach an investor that you do not know prior to launching your capital raise, you are engaging in general solicitation which is generally prohibited under the securities laws.

There are several work-arounds for the issue of general solicitation for those seeking to raise capital without robust investor networks. Issuers can retain the services of a registered broker dealer to help facilitate relationships and complete avoid the general solicitation analysis altogether. Issuers can partner with well-connected individuals and make them a key principal of the issuer, thereby enabling access to their capital network as long as they aren’t paid a commission on investments brought in by that individual. Alternatively, issuers can rely on certain exemptions which permit general solicitation subject to certain restrictions.

In summary, businesses seeking to raise capital need to be mindful of the types of prospective investors they are targeting and the methods by which they do so as it will greatly impact the analysis surrounding what exemptions they should be leveraging when fundraising. Violating securities laws by raising capital from the wrong people can subject issuers to serious penalties and jeopardize their ability to raise capital in the future.

To discuss resources, securities laws and how to safely and effectively source capital or other general securities compliance questions, contact Adam Ott at Parsons Behle & Latimer by sending an email to aott@parsonsbehle.com or by calling 801-536-6910.

Adam Ott is an associate attorney at Parsons Behle & Latimer who focuses his practice in all aspects of corporate and securities law. He routinely represents businesses in a wide range of matters, including mergers and acquisitions; complex transactions; capital formation efforts; reorganization matters; contract matters; and corporate financings. He has helped form and counsel numerous venture capital funds, private equity funds, hedge funds and startup incubators.


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