Flynn's Harp: SEC's struggle with rules for start-up fundraising troubles some angel investors
The federal JOBS Act aimed at opening the door for entrepreneurs to reach out to crowds of potential investors on the internet appears, ironically, to be hung up at the Securities and Exchange Commission (SEC) on the issue of tighter restrictions on entrepreneurs who seek more sophisticated investors. In fact, angel-investor leaders are concerned that the SEC's deliberations may produce rules that make it harder for entrepreneurs to raise money from those wealthier individuals, referred to as "accredited" investors.
The reason is that Congress decided that entrepreneurs would have to validate investor accreditation, rather than being able to take the word of investors that they were "accredited," as has been the case until now. But the lawmakers left it to the SEC to figure out how to impose rules for such "validation."
"I don't think anyone in Congress was thinking about the actual impact the change would have on accredited-investor rules," said Liz Marchi, whose Frontier Angel Fund, Montana's first angel fund, has become one of the nation's most successful angel-investor groups. "That's why I think you see basically nothing being done at the SEC."
The legislation, officially the Jumpstart Our Business Startups Act, was passed by Congress in April and was designed to be a job creator by making it easier for entrepreneurs to raise capital and thus launch companies and create jobs. The first part of the bill would ease raising start-up capital through "crowdfunding" on the Internet and the second part to eliminate the prohibition against advertising and soliciting traditional "accredited" investors.
The SEC was given until yearend to determine the rules that would govern operation of crowd-funding efforts. But the portion dealing with accredited investors called for the SEC to figure out by July 4 how to implement rules to eliminate the prohibition against general solicitation and advertising in securities offerings.
The regulatory body missed that deadline but SEC chairman Mary Shapiro told Congress the agency would have the rules in place by end of summer. That target has now become year end, and the betting is that it'll be sometime in the new year before the rules are put forth.
The Angel Capital Association and angel investors like Seattle's Dan Rosen, who are closely involved in following the SEC deliberations and seeking to influence them, are hoping to get final SEC rules simple enough that entrepreneurs "don't have to jump through enormous hoops to prove investor accreditation."
The phrase angel leaders are using to indicate what's needed for those entrepreneurs seeking accredited investors is "safe harbor," meaning a safeguard for entrepreneurs that they have actually done some due diligence on the investors.
Rosen, a leader of Seattle's Alliance of Angels, says "we've been working with the SEC to come up with a compromise that will ensure there is a safe harbor. But if they come out with a rule that is not acceptable, we will go back to Congress and seek changes there."
What's causing much of the teeth-gnashing for entrepreneurs and those like ACA and Rosen looking out for their interests is the apparent difficulty the SEC is having figuring out just what are the "reasonable steps," that will be required of entrepreneurs.
The irony of, in essence, tightening the screws on entrepreneurs seeking funds from qualified investors is that those entrepreneurs, rather than the ones seeking limited amounts of money from crowds of small investors, are the ones most likely to be job creators.
Bill Payne, viewed by many as the dean of angel investors and a member of Marchi's Kalispell-based Frontier Angels, is critical of how Congress packaged the JOBS Act.
"The legislation does not appear to have been well thought-out and seems to be our Congress simply finding something upon which they could agree," said Payne, who was Entrepreneur in Residence at the Kauffman Foundation and was named angel investor of the year in both the U.S. and New Zealand.
In fact, the JOBS Act brought the best example of bipartisan support evidenced by Congress in the past four years.
"Congress was motivated on this legislation because the lawmakers finally figured out that entrepreneurs are at the heart of this country's future and there were few tools by which Congress could feel like it was playing a role in the country's economic future," said Marchi.
Marchi's angel fund has been proving recently that angel investing can be profitable for the angels as well as important for jobs and the economy.
Two of the fund's investments, Coeur d'Alene-based Pacinian, a maker of wafer-thin keyboards, and Bozeman-based LigoCyte Pharmateuticals Inc., were acquired by major companies in the past few months. Frontier had substantial stakes in both and thus got substantial rewards.
Pacinian, which represented 10 percent of Frontier's total fund, was sold to Silicon Valley tech firm Synaptics this summer for an initial $15 million plus a substantial additional amount in the future based on various factors.
And a substantial bridge-round investment Frontier made about four years ago in LigoCyte Pharmateuticals Inc. paid off big last month with the announcement that Japan's Takeda Pharmaceuticals' wholly-owned U. S. subsidiary was buying the Montana vaccine maker. The agreement provided for an upfront payment of $60 million and "future contingent considerations" for LigoCyte, whose lead product, a vaccine to prevent norovirus gastroenteritis, is in clinical development.
Marchi declined to discuss specifics of Frontier's multiples from the two sales. But she noted that the two exits will have returned the original investment capital to her members, "and perhaps even some profit. So every one of our other 10 investments can produce profits."