Dos and Don’ts of General Solicitation and the Use of Social Media in Debt/Equity-Based Crowdfunding
Online crowdfunding used to raise capital through the sale of debt and equity interests in companies has opened a new and much needed financing method for small and startup businesses. Online capital raising is also arguably at its core a “general solicitation” and intuitively lends itself to the use of the multitude of social media outlets. Unfortunately, in this rapidly developing space, much uncertainty exists around what constitutes a “general solicitation,” when it can be used, and the proper use of social media in conjunction with the different varieties of crowdfunding offerings.
For the past 80 years companies raising money through the sale of securities (debt or equity) had two choices
- Conduct a public offering registered with the Securities and Exchange Commission (SEC) or
- Conduct a private offering.
The time and expense of registration with the SEC pushed many companies to conduct private offerings with the hallmark of such “private placement” under the securities regulations being the absence of a “general solicitation.”
So what exactly is a “general solicitation”?
A general solicitation is simply public advertising or other public statements regarding a securities offering. Historically this was interpreted as newspaper articles, radio broadcasts and road shows where a specific offering of securities by a company was touted. Presently, a general solicitation could be conducted via an online portal, a facebook page, a tweet or an email blast. Importantly, demo days and promotional events plugging the products and services of a company (and not investment opportunities in the company) did not and currently do not fall under the scope of general solicitation.
The ban on general solicitation meant that financings were organized through private networks of investors (usually “accredited investors” who met certain income/net worth and suitability standards), brokers and agents and transaction information was disseminated through private placement memorandums or other similar documents.
Fast forward to April 5, 2012 when the JOBS Act was signed into law and Title II eliminated the restriction on “general solicitation” for certain private placements. Now, thanks to Rule 506(c), promulgated by the SEC pursuant to the JOBS Act, companies can broadly advertise or generally solicit “private” offerings of securities without registration as long as they follow certain requirements. Online offerings, as the most efficient way to generally solicit are becoming increasingly popular.
Other rules included in the JOBS Act, such as Title IV Regulation A (Reg A+) and Title III Crowdfunding (Reg CF), lend themselves to, or are required to use, an online intermediary for offerings of securities, respectively. The use of general solicitation for these types of offerings is not as clear and requires some analysis. The use of social media, to harness personal and self-identifying networks, advertise offerings and build communities around new enterprises, may be utilized within certain parameters. Below, I have outlined each of the new types of offerings provided for under the JOBS Act and the types of solicitations and social media communications that may and may not be used for each.
Title II – Accredited crowdfunding
Crowdfunding pursuant to Title II of the JOBS Act and Rule 506(c) promulgated under the Securities Act of 1933 (the “Act”), also called “accredited crowdfunding” has no restrictions on the type of general solicitations that may be made or the media that may be employed to made such solicitations. This means that a company raising funds via accredited crowdfunding (an “issuer”) is free to use facebook, twitter, linkedin, youtube and any other medium to advertise, describe and generate buzz about the offering. While this seems extremely broad, and is nothing less than a revolutionary change in this country’s securities laws, there are certain considerations that an issuer must be aware of and precautions that it must take.
Disclosure of compensation
Pursuant to Section 17(b) of the Act, all advertisements or promotional statements made, for which compensation is received, must include disclosure of such compensation and the type and amount thereof. Therefore, if the issuer, or any of its agents, pay for advertising or for the promotion of its offering in any way and via any medium, the compensatory relationship must be described in such ad or promotion. This includes tweets and even “likes” to the extent some compensation was being received for such favorable publicity. Compensation could take the form of cash, debt or equity interests (including options) in the issuer and other non-cash compensation such as perquisites.
Therefore, an issuer needs to maintain a clear policy regarding the promotion of its crowdfunding offering and actively manage the social media campaign it launches. Social media is often hard to contain so it is important that the issuer stay informed regarding how information about the offering is making its way through cyberspace. If the issuer is compensating a company or individual to promote the offering, it must include language in the promotion that such statement was paid for by the issuer.
It cannot be said enough that while accredited crowdfunding is exempt from the registration requirements of the Act, the antifraud rules still apply. Therefore, the issuer will be liable for any material misstatements it makes in connection with the offering.
Again, vigilance is the best approach and an issuer must review and ensure that all information it disseminates regarding the offering is accurate and not misleading about the company, its business model, its prospects, the members of its management, etc. In addition, any comparative or relative data, such as “the company is an industry leader” should be supportable with reliable third-party data.
The issuer should limit the universe of information that an actual investor is permitted to rely on when making an investment. An issuer can do this by creating an offering document or body of information (which can include videos, presentations, slide decks, etc.) and then inform the potential investor that it may only use (and get a representation at the time of sale from the investor that it is relying solely on) the defined universe of information provided and not other ancillary sources of information about the company. While this does not provide airtight protection from an investor lawsuit claiming that the company misstated material information on a facebook page or in a tweet upon which it relied, it does create a considerable defense.
Title III – Retail crowdfunding
Although not legal at this time, many people are preparing for crowdfunding permitted under Title III of the JOBS Act and currently proposed Regulation CF or “retail crowdfunding.”
When using social media it is important to remember that retail crowdfunding, as currently proposed, does NOT allow general solicitation and thus the use of advertising and promotional materials is strictly limited. Regulation CF allows for a “notice” advertising the offering limited to
- A statement that the issuer is conducting an offering, the name of the intermediary through which the offering is being conducted and a link directing the potential investor to the intermediary’s platform;
- The terms of the offering; and
- Factual information about the legal identity and business location of the issuer limited to the name of the issuer of the security, the address, phone number and website of the issuer, the e-mail address of a representative of the issuer, and a brief description of the business of the issuer.
This notice may be publicized though media channels, however the bulk of the information about the offering must be provided on the online intermediary website where the offering is conducted. Because an issuer may only use one online intermediary, the full-blown solicitation may only be conducted in one web location.
While not a general solicitation, the amount of information that may be disclosed in to the general public is not insignificant and should contain a link to the online platform where investors can find the comprehensive offering information.
The use of social media which often limits characters and content is an ideal medium to convey a brief statement and a link to the proper website. Companies who plan to take advantage of retail crowdfunding when the final rules are adopted should take care to adopt procedures to monitor social media disclosure and be prepared to direct potential investors to the online intermediary to access the substantive offering information.
Again any paid promotions must be advertised as such and the antifraud rules described above apply.
Title IV – Registered crowdfunding
Also still in the proposed stage, offerings under new Regulation A pursuant to Title IV of the JOBS Act may be conducted through an online intermediary. This offering type is unique in that it is quasi-registered and general solicitations are allowed even prior to registration as “testing the waters” activities. As long as all offering materials (including any ads, tweets or any other communications used to promote the offering) are filed with the SEC 21 days prior to the sale of any security, the company is free to use whatever public medium it desires to promote the offering, including social media.
It is important to remember that registered crowdfunding pursuant Regulation A, has many other requirements such as filing an offering statement on Form 1-A with the SEC, receiving SEC approval prior to any sales, ongoing disclosure requirements and a cap on the number of investors at 500 unaccredited and 2,000 total before becoming a public reporting company, as currently proposed.
Again the rules regarding disclosure of paid promotions and antifraud still apply.
Issuers may conduct concurrent accredited and retail crowdfunding offerings, but the SEC has provided guidance that the elements of both exemptions must be adhered to during the process (unless the two offerings are substantially distinct – such as completely different types of securities not subject to integration issues), meaning, information regarding the accredited offering may only be disbursed through the limited means allowed by a retail crowdfunding offering.
Similarly, concurrent retail crowdfunding and registered crowdfunding offerings may be possible if companies curtail any general solicitation to the limited advertisement allowed in a retail crowdfunding offering. Simultaneous accredited crowdfunding and registered crowdfunding offering seems acceptable at first blush, but guidance from the SEC will be required to ensure the parameters are clearly established.
A note about accredited crowdfunding under Rule 506(b)
Many crowdfunding sites are using Rule 506(b) of the Act, which in form predates the JOBS Act and does NOT allow for general solicitation, to connect issuers and investors.
These sites often have a wall up to prevent the appearance of a general solicitation and to screen for accredited investors prior to allowing access to investment and offering specific information. While such a wall is necessary, it is also important to remember the requisite of a preexisting relationship to remove the taint of a potential general solicitation due to the use of a web based medium. To not have a preexisting relationship with the potential investor or not allow for a waiting period and the development of a relationship (usually 30 days) prior to presenting offering specific information would conflate Rules 506(b) and 506(c) making them indistinguishable except for the heighted evidence of accreditation standards required by Rule 506(c). Such conflation is not a logical interpretation of the law. And of course, sites using the Rule 506(b) exemption are prohibited from using social media to advertise specific deals as such communications would be considered general solicitations.
Georgia P. Quinn, a senior associate in Seyfarth Shaw LLP’s Corporate department, has spent her career representing public and private companies and investment banks in a wide range of capital markets transactions, including registered offerings and private placements of debt, equity, and hybrid securities. Over the last year, Ms. Quinn has led Seyfarth’s Crowdfunding Initiative, helping clients stay at the forefront of the enacted and proposed SEC regulations. Georgia has conducted webinars, presented to the New York State Bar Association’s Securities Law Section and the Business Law and International Sections, has been featured on Crowdfund Insider and has been invited to chair a panel on Crowdfunding for the American Bar Association in April. All views and comments above are strictly her own views and do not reflect the opinion or position of Seyfarth Shaw.