In Part 2 of this two-part series (Click here to read Part 1 ), we take a closer look at recently adopted federal regulations governing communications about investment offerings, specifically at pitch events and when you want to “test the waters.” 

What if I’m invited to pitch at a showcase or angel investor event?

Even if someone invites you to an event specifically designed to connect you with potential investors, the same rules apply. Unfortunately, event organizers are often unfamiliar with the rules and may be exposing to legal risk without realizing it. If you haven’t yet chosen a securities compliance strategy, it is best not to make a securities offering at such an event. You can talk all about your business, its traction to date, and future plans, but don’t say anything about the fact that you are looking for investors. You can have those conversations one on one with attendees after the event once you have chosen your securities compliance strategy.

Didn’t the SEC adopt a new rule exempting “Demo Days” from the rules about public solicitation?

Yes, the SEC adopted Rule 148 in 2020 which states that issuers who participate in “demo days” or similar events that meet the requirements of Rule 148 are not deemed to be conducting general solicitation or general advertising.

However, this Rule does not preempt state law. So it is possible that when you make a public offering of securities in a way designed to comply with Rule 148, you may still be in violation of state law.

If you know that the federal compliance strategy you’ve chosen preempts state law, you can rely on Rule 148, but you need to make sure that the event sponsors and you comply with all of the requirements of Rule 148. These include the following:

• • The event must be sponsored by a college, university, or other institution of higher education, state or local government or instrumentality thereof, nonprofit organization, or angel investor group,^[1] incubator, or accelerator.
  • More than one issuer must participate.
  • The outreach materials for the event may not reference specific offerings of securities.
  • The sponsor may not

(i) make investment recommendations or provide investment advice to attendees of the event;

(ii) engage in any investment negotiations between issuers and investors attending the event;

(iii) charge attendees of the event any fees, other than reasonable administrative fees; or

(iv) receive any compensation for making introductions between event attendees and issuers or for investment negotiations between such parties.

If the event allows attendees to participate virtually, rather than in person, online participation in the event must be limited to:

(i) individuals who are members of, or otherwise associated with the sponsor organization;

(ii) individuals that the sponsor reasonably believes are accredited investors; or

(iii) individuals who have been invited to the event by the sponsor based on industry or investment-related experience reasonably selected by the sponsor in good faith and disclosed in the public communications about the event.

The type of information regarding an offering of securities by issuers at the event is limited to a notification that the issuer is in the process of offering or planning to offer securities, the type and amount of securities being offered, the intended use of proceeds of the offering, and the unsubscribed amount in an offering.

What about Testing the Waters?

In 2021, the SEC adopted new rules allowing potential issuers of securities to “test the waters” before deciding whether to embark on a securities offering. Testing the waters means that you can talk to potential investors to determine whether they would be interested in a future offering. The idea is that you should not have to go through a bunch of securities compliance steps when you’re not even sure anyone would want to invest.

Rule 241 states that at any time before making a determination as to the federal securities exemption you want to use, you can communicate orally or in writing to determine whether there is any interest in a contemplated securities offering. Such communications are still subject to the anti-fraud rules under securities law. While you are testing the waters, you may not sell any securities or even receive any kind of commitment from a potential investor, although you are allowed to collect indications of interest. You have to include several disclaimers in the communication.

Like with the demo days rule, there is no preemption of state law, so you need to ensure that you are not breaking any state securities law before testing the waters. Even though you are not yet selling securities, testing the waters about a potential securities offering is considered a securities offering!

Even worse, if you publicly advertise as part of testing the waters, you may not later raise funds using an exemption that does not allow public solicitation unless you exclude people that you publicly solicited during the testing the waters phase.

For example, let’s say you send out an email to your email list asking people to email you back if they are interested in a potential securities offering you are hoping to do in a few months. The communication is compliant with all of the requirements of Rules 241. You collect 50 names of people who express interest.

Two months later, you decide to conduct a securities offering under Rule 506(b). Rule 506(b) does not allow public solicitation. This means that you cannot invite anyone who you sent that email to to invest in your offering, because the email was a public solicitation. The only exception to this is if you established a substantive relationship with the potential investor prior to the commencement of the exempt offering prohibiting general solicitation.

There is a separate Rule that allows testing the waters under Regulation Crowdfunding. This should be used only if you are certain that you will conduct an offering under Reg CF.

Conclusion

As you can see “securities offerings” are broadly defined and they are extensively regulated. The easiest way to ensure you are complying with these rules is to get help from a lawyer who is familiar with all of the different compliance options to help you choose the best option for you and give you instructions for how to comply with your chosen option.

Failure to comply with securities laws can result in lots of negative consequences, most notably being exposed to lawsuits from investors and being required to disclose that legal risk to future investors for years to come.

 

Disclaimer: The information contained in this article is for general informational purposes only and does not constitute legal advice. The content provided should not be relied upon as a substitute for consultation with a qualified attorney. For specific legal questions or situations, please consult with a licensed legal professional who can provide advice tailored to your particular circumstances.

 

[1] a group of accredited investors that holds regular meetings and has defined processes and procedures for making investment decisions, either individually or among the membership of the group as a whole, and is neither associated nor affiliated with brokers, dealers, or investment advisers.