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Sunday, 18 August 2013 22:00

Angel killer? New SEC rules could create new burdens for angel investors

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Angel investors worry that new federal rules designed to make it easier for startup companies to solicit prospective investors could do the exact opposite.

While lifting the long-held federal ban on advertising or promoting a general solicitation, the new rules from the U.S Securities and Exchange Commission also require companies using that process to take “reasonable steps” to verify that their investors are accredited.

That provision could seriously hurt the ability of companies to secure capital through a general solicitation of private securities, since investors would have to provide personal financial data to companies to prove that they are accredited, said Ken Kousky, executive director of BlueWater Angels Investment Network in Midland.

“We have to prove our angels are angels,” Kousky said.

Kousky, as well as the Angel Capital Association and others, say angel investors simply won’t want to divulge their personal financial information to companies through tax returns or financial statements. He argues that the provision in the SEC rules could very well cut off the new flow of capital through general solicitations before it even begins.

“It’s going to put a chill on everything,” Kousky said. “I think what our members are going to say is, ‘This is not worth it. You’re making it too hard.’”

A company doing a general solicitation could satisfy the rule by having a third party such as their accountant, financial adviser or attorney certify someone as an accredited investor. But “I don’t think your accountant’s going to do it without billing you,” which adds cost to the process of raising capital, Kousky said.

Third-party verifications for each investor also add time to the process, Kousky said. The SEC will also require companies to update verifications every three months under the new rules, according to the Angel Capital Association.

Another concern is how the rule will affect pitch meetings at events such as the annual Great Lakes Entrepreneurs Quest and the Michigan Growth Capital Symposium where startup companies present to prospective investors.

Jody Vanderwel, president of Holland-based Grand Angels, wonders whether the SEC will consider routine pitch meetings or so-called “demo days” as general solicitations. If the SEC does that, it would require a company that ultimately secures an investment that originates from the session to verify that their investor is accredited. Pitch sessions typically serve to “grease the skids” and provide a forum for an initial introduction between entrepreneurs and an interested investor.

“If you’re going to have to worry about that, that’s really going to hamper the networking that goes on,” Vanderwel said. “I’d hate to see that as something that’s no longer possible to do without crossing the threshold into a general solicitation.”

The Angel Capital Association is seeking clarification from the SEC on how the new rule affects pitch meetings.

The SEC issued the final rules July 10. They take effect 60 days after they are published in the Federal Register.

In drafting the rule, the SEC sought to balance lifting the ban on advertising a general solicitation with protections for investors.

“We want this new market and the private markets in general to thrive in a safe and efficient manner, and these rules we adopt and propose are designed to facilitate that objective,” SEC Chair Mary Jo White said in a statement last month that announced the final rules.

The rules stem from the 2011 federal JOBS Act that sought to spur the U.S. economy, including increasing the flow of capital to small businesses.

The concern about the new rules comes as angel investing in Michigan grows.

The number of angel investors in Michigan increased to 242 high net-worth individuals in 2012, up from 185 in 2011, according to an annual research report from the Michigan Venture Capital Association.

Most recently, a new angel group formed earlier this year in Muskegon, and the $2 million Michigan Angel Fund launched last month in Ann Arbor with more than 70 members looking to invest in early-stage companies.

Pre-seed and angel investing in Michigan totaled $12.5 million through 40 deals in 2012, which compares with $9.5 million invested in 50 companies in 2011, according to the MVCA. Even with the decline from 2011, the 2012 deal volume was still more than double the number of companies that received angel funding two years earlier in 2010.

Nationally, angel investors put nearly $90 billion into more than 67,000 companies in 2012, according to the Kansas City, Mo.-based Angel Capital Association. Angel investors account for some 90 percent of the outside capital raised by startups, the trade group said.

Despite the concerns about the SEC rules, attorney Tony Barnes of the firm Law Weathers in Grand Rapids doubts they will have much impact at all on how angel-backed deals generally originate today: through personal referrals, networking or startup companies submitting a business plan directly to an angel network.

The new SEC rules only allow a “new way” — through promoting a general solicitation — to raise capital, said Barnes, a partner in the corporate practice group at Law Weathers.

“The old way still applies,” Barnes said. “But it does give (companies seeking capital) an alternative.”

Given the SEC requirements and coming regulations that may prove burdensome, Barnes believes that most companies that are legitimately seeking to raise private capital “would be crazy to go the general solicitation route.” Likewise, he doesn’t see many angel investors pursuing deals by checking out the general solicitations to see what’s available.

Most investing — whether angel, venture capital or private equity — “is going to continue being done, I think, the same way it’s been done before.”

“Most angel investors aren’t kind of sitting at home on the Internet looking for investment opportunities,” Barnes said. “They’re already kind of plugged into networks where good, previously vetted opportunities have already made their way to their desks. They’re already seeing a ton of stuff.”

Grand Angels’ Vanderwel said the 44-member investment group plans to continue avoiding pursuing potential investments that come to its attention through general solicitations.

“We don’t intend to change a thing,” she said. “I don’t think our members are interested in disclosing that kind of information.”

Attorney John Novak, head of the venture capital and technology group at Miller Canfield’s Kalamazoo office, doubts as well that the new rules will drive many companies to seek capital through a general solicitation.

Novak believes many startup companies will not want to assume the liability of verifying their investors are accredited. He also doubts companies with a promising technology or innovation will want to put it through a general solicitation.

If an idea has merit, he said, investors will find it and support it.

“I don’t think it’s a panacea to making capital flow more efficiently and to a startup,” Novak said of the new rules.

Read 4309 times Last modified on Saturday, 17 August 2013 10:24

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