It is almost impossible to read a small business magazine or blog these days without finding an article about perfecting your pitch to investors. Heck, there is even a reality show about it! But who are these investors and why do so many entrepreneurs have to rely on them if they want to start or expand their business?
Well, it all comes down to the law governing how companies are able to sell shares in the United States. Per the “Securities Act of 1933, any offer to sell securities must either be registered with the [Securities and Exchange Commission (SEC)] or meet an exemption.” So all companies seeking investors in the U.S. have to comply with this law or one of its exemptions.
- Public Shares
Offers of debt or equity that are registered with the SEC are called “public offerings” and these are the type of stocks we generally see on the stock exchanges. Companies selling these shares have to adhere to very stringent disclosure requirements to ensure that a regular person has sufficient knowledge of the risks associated with making an investment. After a company complies with these rules, it is allowed to sell its shares to anyone in the general public.
However, setting up an initial public offering requires millions of dollars in upfront investment from investment banks. So, unless your business has a proven track record that leads these entities to believe you will become a multi-billion dollar growing concern (e.g. Facebook, Twitter, etc.), this investment path is almost 100% closed to you.
- Investment via “Accredited Investors”
That being said, there are people out there who are willing to invest in companies that are in the very early startup stage because they believe in your idea and vision. Under the Regulation D exemption of the Securities Act, the SEC allows you, as a private company, to issue your debt or equity without registering them. However, given the elevated risks, the SEC only allows individuals & entities deemed to be “accredited investors” to buy these types of securities. Other members of the general public cannot take part in these private placements.
As Daniel Thorpe explains, an accredited investor is someone who can fulfill one of the following requirements:
"1) Have had an individual annual income of $200,000 for the past two years with an expectation that it will continue;
2) Have had a household annual income of $300,000 for the past two years with an expectation that it will continue;
3) Have a net worth of at least $1 million, excluding a primary residence."
In today's economy, though you can try to pitch individual accredited investors (or angel investor), angel investment groups are usually the gatekeepers for the funds provided by accredited investors. So, if you want to get access to their money, you have to impress them in your pitch meeting. This is the reason why everyone is so focused on perfecting their elevator pitches.
But, as Amelia Oliver notes, when Congress enacted Title II of the 2012 JOBS Act, it “legalized general solicitation or publicly raising capital”. In so doing it also opened the door for startups to immediately raise capital via equity crowdfunding at sites funded by accredited investors (like Crowdfunder.com and CircleUp.com). So, if you have a good idea and business plan, you may still get access to accredited investor cash - all while bypassing the Shark Tank like pitching process. That being said, you will still have to meet the requirements outlined by these sites before your business will be listed.
- Equity Crowdunding.
Ok, let me start off this section by saying that as of now, this method of raising capital is NOT legal in the United States. That being said, it is expected that the SEC will raise this restriction by the end of 2014 or early 2015.
Now that that disclaimer is out of the way, let’s get on with it. As soon as the SEC issues its final rules, private companies will be able to raise capital by selling equity to the general public (not just to accredited investors) without registering these securities with the SEC. This exemption to the Securities Act of 1933 is based on Title III of the 2012 JOBS Act which per Ms. Oliver,
“permits the sale of securities to an unlimited number of non-accredited investors without registration, provided all transactions are made through registered-broker dealers or SEC licensed ‘funding portals.’”
In order to protect the public from the relatively higher risks associated with these securities, there are quite a bit of restrictions included in this exemption:
(a) You’ll only be able to raise a maximum of $1,000,000 per 12 month period;
(b) You will only be able to use SEC approved equity crowdfunding sites that are required to “perform background checks and a full review of each startup company and their disclosures in order to approve an organization for funding on their website.”
(c) There are caps on the amount individual non-accredited investors can invest in these types of shares for every 12 month period
As you can imagine, it is expected that this new change in the law will not only increase access, but also enlarge the pool of investment funds available to small business owners like you. And, for a semi-introvert like me, the best thing about this is that you don’t have to be a show man to be successful.
So there you have it… everything you ever needed to know about the people who will give you the money you need to take your business to the next level.
