New federal rules could help startups connect with investors.

For decades, small firms faced a major obstacle when they went looking for investors. In a lot of cases, federal regulations prevented them from letting people know they were actually looking for investors.

That could be changing, though, thanks to a piece of the Jumpstart Our Business Startups Act (JOBS Act) that took effect at the end of September. The legislation aims to make it possible for startups and other small businesses to advertise their investment opportunities.

To get a better handle on the new rules, Thinking Bigger Business spoke with Jack A. Bowling, an attorney at Stinson Morrison Hecker LLP and an expert on securities law.

How It Used to Work

Under the Securities Act of 1933, business owners have to register with the U.S. Securities and Exchange Commission if they want to raise capital by selling equity in their company —or they can pursue a private offering under the registration exemption of Section 4(a)(2) of the Securities Act, including a private offering under Rules 504, 505 or 506 of Regulation D, which is a “safe harbor” under Section 4(a)(2).

Most companies raising capital privately use the Rule 506 safe harbor in connection with private offerings. The Rule 506 exemption lets companies raise an unlimited amount of money from as many “accredited investors” as possible or up to 35 non-accredited investors. The catch? Until now, the issuing company was prohibited from “generally soliciting” or advertising those offerings to people they didn’t already know—a potentially big hurdle for younger companies that don’t have many contacts.

“You couldn’t go out and advertise the investment,” Bowling said. “You had to basically only sell to people with whom you (or any registered placement agent you are using) had a preexisting relationship.”

How the JOBS Act Changes Things

The new rule allows companies to advertise that they are seeking investment, but they can sell only to accredited investors and these offerings using “general solicitation” will be subject to additional filing and informational requirements.

“Accredited” means the investor has an individual or joint net worth exceeding $1 million, not counting the value of a primary residence. An investor can also be considered accredited if he or she has an individual annual income over $200,000 in the past two years or a joint annual income over $300,000, with a reasonable expectation of same in the current year.

Any company using the new general solicitation rules under Rule 506 has to take reasonable steps to ensure the investors are accredited. Issuing companies can vet investors’ accredited status by requesting their bank statements, tax returns, brokerage statements or a letter from a certified CPA attesting to their net worth and income. Any company that continues to use the “traditional” Rule 506 offering instead of a “general solicitation” Rule 506 offering can continue to utilize the prior approach of merely getting representations or an investor questionnaire from investors as to their accredited status, but it may not be able to advertise the transaction.

“So they sort of heightened the issuer’s or the company’s due diligence standard,” Bowling said.

These aren’t the only rules that companies will have to obey if they want to do a general solicitation under Rule 506. Companies will have to submit any advertising for SEC review at least 15 days before it’s made public, for example. And those materials will have to include certain cautionary statements and legends.

“You’ll still want to coordinate with your lawyer and make sure you haven’t run afoul of anything,” Bowling said. “You’re still going to be subject to the anti-fraud requirements of the ’33 Act.”

Who Might Benefit?

Companies need to look at their existing pool of investors and ask themselves if they can raise the capital they need from those people or groups, Bowling said. If they can, it might not be worth the trouble to go the general solicitation route.

On the other hand, the new rules could help startups that need to advertise in order to attract investors.

“I think it’ll be more of a benefit to companies that haven’t raised capital yet or have only raised a small slug of capital or just don’t have access to deep capital pools,” Bowling said.