Why can’t I raise money and why should I use Regulation D?
[fb_button]If you’ve been trying to raise money for a new business, you’ve probably noticed the complexities of the NEW capital markets. Our staff has been raising capital for businesses for over 20 years and we’re simply amazed at the amount of red tape.
Just a few years ago, someone with a decent education, a great idea, and a well written business plan, could manage to find investors and get their idea off the ground. But after Wall Street tumbled in 2007-2008 something profound happened, The Dodd-Frank Act.
Although much of this legislation has yet to be implemented, the damaging part of the law was immediately put into place in 2010. We’re talking about the ‘exclusion of an investors personal residence’ as a measure of one’s ‘accredited status.’
- For example: Let’s say Facebook was just getting started in 2014 and wasn’t going public yet. A stock broker approaches you to invest $50,000 in Facebook. The broker pitches a nice return after 2-3 years. After you agree to invest the broker asks you to fill out some paperwork to qualify for the investment opportunity. You’re excited because you think you’ll have no problem qualifying as accredited. You earn $180,000 per year in income and you have plenty of assets to cover yourself if you lose the money, however, your net worth is $850,000 ‘without’ the equity in your personal residence.
If you were allowed to include the equity in your personal residence, as you would have been prior to Dodd-Frank, your net worth would be $1,000,000, which would qualify you as accredited, and allow you to invest in this deal. Since you don’t qualify the broker then doesn’t call you back, and doesn’t allow you to invest in this amazing opportunity. However, the people included in the upper 1% of America’s wealth are ‘qualified accredited investors’ and indeed are the only people invited to invest. Sort of like in an IPO, right? You hear about the IPO, you ask your broker to buy-in but your broker says you can’t buy shares because you don’t qualify.
Due to this small adjustment in Regulation D Rule 501, The Dodd-Frank Act disqualified as many as 1/3 of investors from investing in small business start ups. The JOBS Act did nothing to increase the number of accredited investors, but made it possible to advertise to the now smaller group of accredited investors.
To its credit, The JOBS Act did pave the way for Equity Crowdfunding, but if you’re watching closely you’ll notice that the SEC, FINRA and Attorneys have hijacked the law and caused 2 Republican Senators to introduce ‘The JOBS Act 2.’ All of this new red tape is due to an effort by the SEC and FINRA to appease the professionals that work in the capital industry, who stand to lose income if Equity Crowdfunding is available to the general public with unfettered access to lucrative business investments.
Currently states like Texas and California are implementing licensing standards for Crowdfunding Portal Owners, implementing licensing fees and forms that mimic the FINRA forms. Even more red tape? You bet.
So how does a small business owner find investors?
Here’s the easiest method:
- Use Regulation D Rule 506(b). With this rule you can take investments from up to 35 non-accredited investors. So the scenario talked about above, where the investor almost qualifies, but not quite, would be able to invest. To make this work, you (the business owner), simply need to include an audited financial statement, for your business, in your PPM. Include it as an Exhibit in your Private Placement Memorandum (see PPM Templates). Most new businesses have very little to audit, so the audit fees are minimal, especially if you’re a start up and your auditing a $0 balance sheet.
You can’t advertise to investors with this rule, however, you can start contacting investors one by one. You can’t pitch your investment directly, but you can introduce your company and drop hints that you’re looking for investment capital. The trick is to get the investor to ask for a Prospectus (PPM).
Even with all the hurdles it’s highly possible to raise capital for a new business idea.