The startup community in Philadelphia is abuzz over a provision in Senate Banking Committee Chairman Chris Dodd’s (D-Conn.) draft financial reform bill that could impose significant costs and uncertainties on angel investing.
Angel investors are wealthy individuals who purchase equity or convertible debt securities to contribute much-needed seed capital to startup businesses. Angel investors are different from venture capitalists (VC’s) in that they are individuals rather than professionally managed investment funds and typically invest much smaller sums of money (usually a couple of million dollars or less) than would interest VC’s. (Angels are also less demanding in terms of the economic and participatory rights of ownership, such as liquidation preferences, vesting of entrepreneurs’ equity stakes, seats on the board, etc.) With VC funding virtually non-existent due to the Great Recession, angel investments are the lifeblood for many struggling startups.
Sales of securities to wealthy angel investors normally come under the private placement exemptions to the Securities Act of 1933, which as a general matter requires filing of a registration statement with the Securities and Exchange Commission (SEC) prior to sale (a costly and onerous process). Under the safe harbor granted in Rule 506 of the SEC’s Regulation D (give yourself a pinch if your eyes start to glaze over at this point!), a company can sell securities in a private placement (i.e., without a general solicitation) to accredited investors and certain sophisticated non-accredited investors without filing a registration statement. Compliance with Rule 506 also enables the company to take advantage of exemptions from state securities laws (also known as “blue sky laws”), which otherwise can impose requirements in addition to those in the federal securities laws.
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Author: andrew
