Rule changes are seen restricting angel investing

Security and Exchange Commission rule changes that include requiring angel investors to file financial information with a third party in order to invest in startups that do public solicitation for funding has investment groups and entrepreneurs in Rhode Island and across the nation up in arms.
“The proposed SEC rules will kill startup funding and startups – the only net new-job creation engine in the country,” said Max Winograd, CEO, president and co-founder of NuLabel Technologies, a 4-year-old East Providence company. “We’re in a slightly different stage now, transitioning to larger rounds with strategic corporate investors, but our first dollars that came in the door were angel investors.”
An SEC rule change approved in July that go into effect Sept. 23 were adopted to implement the Jumpstart Our Business Startup Act and lift the ban on general – which means public – solicitation for funding. General solicitation could include situations such as public comments that a startup is seeking funding during a business-plan competition or in online information.
Companies such as NuLabel, which have successfully navigated the startup process, continue to support the blossoming of the ecosystem, which is threatened by the new SEC regulations, Winograd said.
The SEC’s new rule permits companies to use general solicitation and general advertising to offer securities, but when that type of solicitation is used, it puts the burden of verifying “accredited” investors on the company, rather than allowing investors to self-certify, which is still allowed in private solicitation. The new rule requires the issuer of the securities to take “reasonable steps” to verify that purchasers are accredited investors when using general solicitation.
An SEC spokeswoman who declined to be identified last week also pointed out the new rule includes the word “may” when describing the options issuers have for verifying an accredited investor.
Such ambiguity could create unwanted legal issues for startups, says Winograd. “Someone who appeared to be an accredited investor and looked great when the deal was made could use that ambiguity in court when the deal goes south. So a company will have to be prudent and ‘may’ will mean ‘shall.’ ” Attorney Dan Meyer of the Providence firm of Partridge Snow & Hahn LLC, which sometimes advises companies participating in the startup-accelerator Betaspring, agrees that “may” doesn’t really offer a choice.
“The main task, particularly for a startup, is that they’re going to have to be extremely careful, if they want to use general solicitation and advertising, that not one of their investors is unaccredited,” said Meyer.
With Rhode Island’s emerging startup community attracting entrepreneurs through accelerators such as Betaspring and angel investment groups, the SEC changes could put a damper on one of the most promising signs in the state’s business landscape, according to critics.
“The major change that has spurred all this conversation was one that was meant to make it easier for companies to raise financing,” said Allan Tear, managing partner of Betaspring.
“Originally, you could only privately solicit accredited investors. If you were to advertise the sale of a private stock you were violating the law,” said Tear. “Now SEC has set rules around general solicitation that are so onerous they’ll prevent startups from using general solicitation at all.”
Under the proposed regulations, startups seeking funding have to notify the SEC 15 days in advance of general, or public solicitation, for raising capital.
“From an entrepreneurial perspective, it’s making the consequences higher,” said Aaron Horowitz, CEO and co-founder of Providence-based Sproutel, a 2-year-old company that creates interactive games to help children cope with chronic illnesses.
The current rules, before the changes go into effect, allow the startup to notify the SEC after the funding rounds, said Horowitz.
Sproutel raised $278,000 from 16 angel investors in its first round, Horowitz said. The company is currently in its second round of raising money.
In a July statement explaining the adoption of the new rule SEC Chairperson Mary Jo White said, “As we fulfill our mission to facilitate capital formation and maintain fair and efficient markets, the commission must always focus on strong investor protections.” •

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