Recently a founder of FundersClub posted their stance on the [U.S. Congress and] SEC’s lift of the ban on general solicitation. While we respect Alex, Boris and the rest of the team and what they’ve accomplished, we were troubled by the apparent use of fear tactics in their misleading and self-serving commentary. We were particularly surprised as up until their No-Action letter from the SEC, there was substantial speculation that FundersClub were possibly violating SEC rules. We are now questioning whether FundersClub is trying to bully the rest of the industry away from a new and even more innovative business model?
In response to their wide-ranging allegations, we felt compelled set the record straight.
Under the Section 201(a)(1) of the JOBS Act, an issuer of securities may engage in general advertising or solicitation if they take reasonable steps to verify that each purchaser is an Accredited Investor as defined by the SEC rule. In addition to a principles-based approach to satisfy verification, the SEC’s amendment to Rule 506 actually articulates a set of non-exclusive methods an issuer may use to satisfy that purchasers are Accredited Investors. These include:
- Reviewing purchasers’ IRS tax forms
- Reviewing their bank statements, brokerage statements, securities holdings, tax assessments
- Verification by a third party such as an SEC-registered broker-dealer or investment adviser, a licensed attorney or a CPA.
We can tell you first-hand that the question of investor verification is a key concern that has been on everyone’s mind. In response, registered broker-dealers such as SecondMarket are offering services to both platforms and independent issuers to satisfy the verification requirements on their behalf.
So, we are perplexed when Alex called the practice of general solicitation a “gray zone” and suggested that VCs would not invest in companies that engage in general solicitation of their offerings. The JOBS Act clearly encourages this entirely legitimate mode of capital formation and the SEC has outlined the “rules of the road” for this market. Fundraising through general solicitations, professionally advised and properly implemented, is here and now.
We find it equally troublesome that FundersClub would try to discourage companies from listing on platforms engaging in general solicitation, suggesting that their operators are acting recklessly and have fly-by-night legal representation. The fact of the matter is that most other platforms share legal representation from the handful of quite large and reputable firms who have a very strong grasp of the law in this area and their client’s obligations. For FundersClub to imply that they have some kind of monopoly on quality legal advice is simply ridiculous.
What, then, are FundersClub’s motives in attempting to taint the well for general solicitations? Why is their method of private (from the SEC’s standpoint) fundraising somehow better for investors than general solicitations now that they can be accomplished completely legally?
First, companies on the FundersClub platform are already high profile companies, many coming out of top accelerators such as Y-Combinator and 500 Startups. Before the lifting of the ban on general solicitation, these companies were restricted from raising awareness about fundraisings, so it made sense for them to seek distribution on a platform like FundersClub. However, now these highly publicized companies can go straight to investors, there is no need for these high profile companies use a platform. It seems like FundersClub are using scare tactics to raise concerns about general solicitation so they can hold onto this monopoly.
Second, most of FundersClub’s 6,400+ members joined the site through old 506(b) rules, which permitted investors to self-verify their status as accredited investors. The dilemma for FundersClub is that if they were to engage in general solicitations, they would be obliged to verify that all members are in fact accredited. This could cause significant problems if it came to light that FundersClub was found to have issued securities to non-accredited investors due to the low-threshold accreditation model that they have adopted.
So while FundersClub claims to take the high road, the fact of the matter is that they are relying on a lower, and potentially more risky, verification-lite approach. This in turn may actually make FundersClub a more risky investment partner than platforms responsibly engaging in general solicitations. Platforms to which FundersClub has directed its unwarranted criticism.
It’s ironic that FundersClub, which is supposed to be about democratization and openness to markets, are acting like entrenched elite leaders trying to keep innovators out of the market place. Not too long ago they were the ones pushing the boundaries of the SEC, but now that their ox is being gored they take stance of protecting investors. How dazzlingly hypocritical!
_____________________________
Rob Leclerc is Co-Founder & CEO of Agfunder. He is an entrepreneur, venture capitalist, and founder of BabbleFlix. He has over 15 years of qualitative and quantitative experience as a scientist and engineer, and three years in the Agriculture sector. Rob has been published in the Harvard Business Review, Financial Post and Seeking Alpha, and twice in Nature journals. He has five degrees, spanning Philosophy, Computer Science, and Computational Biology, including a PhD from Yale University. A version of this article was previously posted on the AgFunder blog.