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New rules open door to ads for private placements

September 15, 2012

One of the main reasons Oren Shatken travels to tech networking events is to find money to grow his West Lafayette software company.

Yet when he and other entrepreneurs take the stage in Austin, Texas, or Boston, they don’t talk about their capital-raising missions. And they certainly don’t blurt out dollar amounts.

Even now, as Shatken reels in a likely venture-capital backer he met through Indianapolis entrepreneur Matt Hunckler, he can’t talk particulars without running afoul of securities law.

“It’s completely an introduction-based business,” said Shatken, a Purdue University graduate who started making the FoundOPS software for field-service businesses with co-founder Jonathan Perl while they were still in school. “That can be really, really frustrating when you first start up and you don’t know anyone.”

Soon, though, the coquettish dance around capital-raising will come to an end. In accordance with the Jumpstart Our Business Startups Act, the Securities and Exchange Commission will lift the long-standing ban on “general solicitation” of unregistered securities.

That means anyone peddling an investment opportunity, whether in a tech company or a real estate development fund, can announce it to the general public.

The end of the ban could be a watershed event similar to the late 1977 U.S. Supreme Court case that paved the way

to attorney advertising. Fund managers, business owners and brokers could buy ads, tweet or hold seminars about their offerings.

“The world of possibilities is really wide open,” Indiana Securities Commissioner Chris Naylor said.

Under current rules, securities issuers who want to skip all the disclosure that comes with a public offering have to accept a trade-off on marketing. They can solicit only investors with whom they’ve had a previous relationship or find them through registered broker-dealers.

Despite that hurdle, there have been 37,000 private offerings with a median size of $1 million since 2009, nationwide. The SEC doesn’t collect state-level data on exempt offerings.

JOBS Act proponents argue the act will spur economic growth by making it easier to start businesses. Local attorneys think the law will open doors for clients and cut the time they spend networking, instead of building their businesses.

However, finance professionals think it will be used mainly by people starting second-rate investment pools, and they predict a flood of fraud.

Private placements still would be limited to accredited investors, a category that includes institutions such as pension funds and insurance companies, plus broker-dealers. Individual investors must have a net worth, excluding their primary residence, of $1 million, or annual income of $200,000.

The idea is that certain investors are better equipped to understand risks that come with untested businesses or illiquid ventures such as real estate development.

The minimum standards for individuals, which haven’t changed since the 1980s, are no guarantee of sophistication. As Naylor noted, many victims of Bernie Madoff, who pleaded guilty in 2009 to charges related to operating a massive Ponzi scheme, met the definition of an accredited investor.

The SEC came out with its proposed rule Aug. 29, and Indianapolis attorney Brian Powers was happy to see it wasn’t loaded with detailed instructions. Securities issuers must simply take “reasonable” steps to verify that their investors are accredited, the SEC said.

“I have plenty of clients raising anywhere from $1 million to $80 million that are anxiously awaiting these regulations to be finalized so they can take advantage of them,” said Powers, who specializes in private securities law.

Powers advises a number of tech startups, and he has clients in manufacturing and real estate. One of his clients is trying to build an overseas medical tourism facility.

Finding the right investors is often more difficult than hitting the dollar target, Powers said. “In general, it’s better to raise money from fewer investors.”

That makes managing investor relations easier, and reduces the risk of lawsuits, Powers said.

Advertising could help Midwest startups get noticed by angel investors and venture funds, which are more plentiful on the coasts. Under the current system, Indiana startups face the additional hurdle of extending their personal and business networks across the country, Powers noted.

Karen Woods, a partner in law firm Krieg DeVault LLP, has seen many businesses suffer for lack of capital, especially since the recession.

“A lot of times, people don’t have wealthy family or wealthy friends,” Woods said. “They scrape by for a few more years until they find someone willing to invest. Sometimes it kills the business.”

Woods can see businesses taking out so-called tombstone ads or adding a section to the company website—“Click here to invest.”

Securities issuers are still going to have to back up their advertising with proper offering documents, she said: “Accredited investors are going to want to see that.”

Anyone hoping for access to the likes of Carmel-based wealth manager Oxford Financial Group probably will be out of luck.

Oxford puts its clients’ money in several categories of privately placed securities—hedge funds, private-equity funds, real estate and natural resources, Chief Investment Officer Mark Green said. But Oxford deals only with institution-grade investments, the same stuff insurance companies and pension systems are buying, he said.

Those tend to have high minimums—$5 million or more—and waiting lists for new investors, Green said.

“A big part of our job is to keep clients out of trouble,” he said.

Green doubts that ending the ban on general solicitation will have any real economic impact. He thinks the real motivation for the law was to make life easier for small hedge funds and other private investment managers, which are competing with a new class of publicly traded mutual funds and exchange-traded funds that purport to follow “alternative” investing strategies.

The ultimate audience, Green predicted, will be retail investors who want to “dabble” in private securities.

At least one Indiana-based company appears to be counting on the private-placement market to make good on its promise of a new factory and hundreds of jobs.

Carbon Motors hopes to build a new type of police car in a shuttered Visteon factory in Connersville, but its future is in doubt since the Energy Department rejected its application for a $310 million loan for alternative-fuel vehicles.

Carbon Motors said in June that it had added a venture capitalist to its board, and the company popped up recently on the local finance scene. Aldebaran Capital LLC principal Ken Skarbeck said his firm recently heard a presentation from a Carbon Motors executive.

Skarbeck, an investment adviser, doesn’t work with private placements but said he was curious about the company. Because of the current ban on general solicitation, he declined to say how much Carbon Motors is seeking.

A Carbon Motors spokesman did not respond to a voice message.•

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