September 20, 2013
I've worked with startups as both a legal advisor and founder. From those vantage points, I think the SEC's proposed regulations are seriously misguided and will result in unintended consequences that will eviscerate the purpose of the regulations and the JOBs Act.
The requirement that startups must notify the SEC 15 days before they publicly discuss raising money may sound reasonable in theory. In practice, this will derail startups efforts in at least a few ways:
1. Many founders are unsophisticated in securities matters. They will discuss their offering publicly, not realizing that it their comments have implications under securities law. The proposed regulations will prevent such companies from raising funding, simply because the SEC has an obscure, unintuitive rule that penalizes founders for engaging in this behavior.
2. If founders cannot discuss funding publicly, then they cannot gauge whether there is even a pubic demand for shares in their company. The consequences of making a failed offering are high, so what manager in their right mind would take the risk if demand hasn't been validated by real-world data?
The requirement that startups must file documents with the SEC every time they update their offering materials is equally burdensome:
1. It prevents the free flow of information and prevents startups from providing updated information to investors. It will make it costly for startups to provide information to the public, so startups will be less likely to provide it and investors will be less likely to invest.
2. This will create an additional layer of legal complexity, which means an additional layer of huge legal fees.
3. The extra legal cost will make small offerings uneconomical, even though small offerings seem to be what the bill is intended to allow
The requirement that startups include legal boilerplate every time they talk about their financing publicly will make it impossible to market the offering through conventional marketing channels, increase the risk of failure, add to the difficulty of successfully raising funds, increase legal costs, and increase risk of making a costly mistake.
Combined, these effects will have other unintended consequences:
1. Failed offerings by other startups will chill future startups from using the crowdfunding exemption.
2. Legal complexity/fees will chill startups from using the crowdfunding exemption, especially since success of an offering is not inevitable.
3. Some startups will inadvertedly break the rules and be penalized, leading to a chilling effect on other startups, which may fear what will happen to them if they make a mistake.
4. Lawyers will advise clients not to use the exemption, due to the legal uncertainties and risks surrounding these each of the proposed rule's complicated requirements.
5. Crowdfunding may not be a viable alternative to raising venture capital, due to the convoluted rules, disclosures, and processes that these regulations would place on crowdfunding but not venture capital deals.
6. Many founders will be unable to understand the regulatory requirements, increasing the risk of unintentional violations