By Chad Trainer
When visiting an online investing platform, have you been frustrated that you can’t view all of its open investment opportunities immediately, right on the landing page? Has your frustration escalated upon realizing that just to see these opportunities, you’re not only obliged to sign up for the platform but to answer personal questions about your income and net worth? Has it seemed to you that the platform is forcing you into a position of “show me yours before I show you mine”?
If you use an online equity investing platform like Propel(x), then you’re most likely familiar with the term “accredited investor”. The reason is that to join such a platform, you have to certify that you are an accredited investor. For those of you who don’t know, in simple (but certainly not exhaustive) terms, an accredited investor is someone who makes over $200,000 annually or has a net worth of at least $1 million, excluding his or her primary residence. In other words, a high net worth individual.
Another term you might be less familiar with is “general solicitation”; but you definitely have encountered the effects of securities regulations surrounding the term. “General solicitation” boils down to an advertisement of an investment opportunity to the general public. In the online investing space, general solicitation rules have their greatest impact on determining what sort of investment opportunities can be displayed on an investment platform’s landing page versus being presented behind a login and password.
“To generally solicit or not to generally solicit?” – That is the question
When raising funding, most startups choose to employ the exemption provided by Rule 506 of Regulation D under the Securities Act of 1933. By choosing this path, they avoid the general requirement that a company selling securities register with the SEC – a prohibitively costly and burdensome process for a startup. Regulation D’s Rule 506 provides an exemption from the registration requirement for private offerings, and avails startups of two different funding paths. The first option, Rule 506(b), places no limit on the number of accredited investors a company can have, and allows it up to 35 non-accredited investors, but prohibits the company from generally soliciting. The second option, Rule 506©, allows a company to generally solicit; but investments are restricted to accredited investors.
At first glance, restricting an offering to accredited investors (and losing the possibility of having 35 unaccredited investors) would seem like a small price to pay in exchange for gaining the ability to advertise the offering to the public. After all, accredited investors are typically the ones with the money and risk appetite to make significant investments in startups. Also, it would seem much easier to attract a critical mass of exclusively accredited investors through public advertising than a critical mass of accredited and unaccredited investors without public advertising. But, the choice is not so cut and dried.
Companies that choose the 506© road not only face the burden of limiting their offerings to accredited investors: they also face the burden of having to take extra steps to verify the accredited status of their investors. This can include steps such as obtaining confidential financial documents from their investors, which investors are understandably loathe to release. Companies raising funding under 506(b), on the other hand, need only have their investors self-verify their accredited investor status through a questionnaire.
Getting in line online: General solicitation offerings in the front, all others in the rear
Because the choice between raising funding without generally soliciting and raising funding with generally soliciting is a tough one for a startup to make, the online investing space has a smattering of startups choosing both routes. When an investment platform features both startups that can generally solicit and those that can’t, its landing page will feature those that can generally solicit, while the rest will be behind a login. Propel(x), on the other hand, currently features only startups raising funding under 506(b) – without general solicitation. For this reason, all of its open investment opportunities are behind a login.
At this point, you might be asking yourself: Does the difference between publicly advertising (i.e. generally soliciting) and not publicly advertising really boil down to the difference between publishing investment opportunities on a landing page, on the one hand, or behind a login, on the other? After all, the general public could always just sign up in order to gain access to the investment opportunities behind login, right? The answer is: not really.
Relationship status – “It’s complicated”
The SEC has determined that an offering is not a general solicitation when there is a substantive, pre-existing relationship between the offeror and the offeree. To the frustration of many, the SEC has yet to compile a black-and-white list of what qualifies as general solicitation or its antithesis – an offering made as part of a substantive, pre-existing relationship. Nonetheless, it has issued a number of “no-action” letters, which, taken as a whole, provide some clarity as to what the SEC views as compliant with general solicitation rules.
As applied to internet platforms, the SEC has suggested that a pre-existing, substantive relationship can be formed by requiring a user to not only sign up for the platform but also complete a questionnaire in order to validate the user’s accredited investor status (See e.g., IPONet (available July 26, 1996)). In other words, the accredited investor questionnaire is used for more than verifying the investor’s accredited investor status. It is also used by the platform as a tool to hurdle the general solicitation bar by establishing a relationship between the platform and the investor. And that’s how the seemingly disparate issues of general solicitation and accredited investor status converge in the online investing space.
So, now that you have a fuller understanding of the regulatory framework governing online investing platforms like Propel(x), you will know where to look when you visit a landing page that leaves you wondering “Where’s the beef?”. The investment opportunities you seek are behind the log-in, because that’s where they’re required to be. And you’ll better understand that when you’re filling out an accredited investor questionnaire, you’re not only verifying that you’re authorized to invest in the companies behind the log-in, but you’re also building a relationship with the site in order to see what’s behind the doors, closed off from the general public.
(Disclaimer: This article is meant to provide a simplified overview of a complex legal topic. It involves some interpretation and by no means shall be considered legal advice.)