By Jim Verdonik
I'm an attorney with Ward and Smith PA. I also write a column about business and law for American Business Journals, have authored multiple books and teach an eLearning course for entrepreneurs. You can reach me at JFV@WardandSmith.com or JimV@eLearnSuccess.com. Or you can check out my eLearning course at http://www.elearnsuccess.com/start.aspx?menuid=3075 or http://www.youtube.com/user/eLearnSuccessor or you can purchase my books at http://www.amazon.com/Jim-Verdonik/e/B0040GUBRW
Thomas Watson, Chairman of IBM, predicted in 1943 that: "I think there is a world market for five computers."
Now that the SEC is allowing business to advertise in Rule 506 (c) private placements, some pundits are following Mr. Watson by predicting that few businesses will advertise their private placements.
If that is true, the biggest restriction on advertising won't be reluctance to use advertising. People have been complaining for many years that that the anti-advertising private placement rules unnecessarily limit the ability of people to raise capital to start and grow businesses, unless they already know a lot of wealthy people.
The biggest reason why people won't advertise private placements is that the SEC has proposed rules that may make advertising impractical. We discuss these proposed rules in another article.
Of course, the dirty little secret about private placements is that they haven't really been private for a long time.
Since Internet use became ubiquitous, very little remains private. So, why should private placements be the exception?
Private placements have been sneaking around the corners of the Internet wearing thin disguises for over a decade. Even before the Internet, businesses began making presentations to investors in "venture capital" conferences, where advertising is used to solicit investors to attend the conference. Both venture capital and angel investors attend these public conferences. If a business rented a hotel conference room and did mass mailings and newspaper advertisements for investors to attend, the SEC would consider that to be illegal adverting and general solicitation, but the SEC has winked at other organizations inviting dozens of businesses to make pitches to investors solicited by advertising.
This happened because the private placement rules have never really made much sense. How do you sell something you can't tell people about?
So, Rule 506 (c) merely opens doors for businesses to do openly what they previously often disguised.
Of course, when some people think about securities advertising, the might be thinking about advertisements they see in The Wall Street Journal, which has had a long and very profitable reign as the Mecca of securities offering advertising. We're all familiar with tomb stone ads for deals and mutual fund advertisements.
Pundits might be correct in predicting that we won't be seeing a flood of similar advertisements in private placements – especially by young businesses.
The two primary reasons are cost and effectiveness. Traditional advertising costs too much for most businesses to afford and won't achieve the goal of generating sales.
So, most Rule 506 (c) advertising will take a different form and use different media than traditional public offering securities advertisements.
Scope of this Article
In July 2013 the SEC made the biggest changes to private placement capital raising rules since the SEC issued Regulation D more than three decades ago.
See the end of this article for links to other articles about these Rule 506 changes.
In this article, well talk about
- What media will work best?
· Which attributes of different media create risks you won't comply with securities laws?
· How can you use these new rules to raise the capital your business needs by balancing three competing factors: Advertising effectiveness, budget and securities law compliance?
Know Your Audience
Let's start by talking about the basic art of selling.
Selling is usually most effective when the salesman creates a bond with the potential buyer.
To accomplish this, salesmen try to know their audience and tailor their pitch to audience preferences. What works for one group can fail miserably with another group. This basic rule of sales applies whether you are selling cars, telling jokes, collecting for charity or selling securities.
That's why great salesmen don't start hitting you with information as soon as they meet you. Great salesmen ask you questions before they start telling you their pitch. They need to know you to tailor their pitch to your needs and preferences.
Great salesmen also continually re-assess whether they made the right decision about your needs and preferences by trying to understand how you are responding.
If you are advertising in a Rule 506 (c) private placement offering, you start off knowing one thing about your audience: Accredited investors are your only audience. That's because you are not allowed to sell securities to anyone other than accredited investors if you advertise. People who give investment advice to accredited investors are also in your audience.
So, the first thing to do when you plan your advertising is go to SEC Rule 501 (a) of Regulation D and look at the list of eight types of accredited investors. That list includes:
- Several types of institutional investors.
- Individuals with an annual income of $200,000 or more.
- Individuals with net assets of $1 million or more (not including their primary home).
Institutional Investors. Most institutional investors probably won't be looking at advertisements to choose their investments. They receive so many investment proposals from investment bankers and other sales people that looking through advertisements is a waste of time for them. So, you can probably exclude institutional investors from the target audience for your advertising.
Intermediaries. You might use advertising to attract a small investment banker, placement agent or other intermediary to try to sell your deal. But one of your biggest problems may be that your advertisements may attract offers of help from people who really can't sell your deal. As in any industry, the best people are busy. So, be prepared to sort through proposals of dubious value before you find someone who can really help you. Nevertheless, tailoring your advertising to the intermediary community might be a useful strategy. That means using the types of media the investment intermediary community looks at on a regular basis – industry newsletters, websites, chat rooms and twitter #hashtags. After you identify the best media, what should your message be? Two things attract placement agents and other intermediaries - a deal that is easy to sell and that is big enough that a percentage commission produces a good pay-off for the intermediary. If your deal has both these qualities, expect to be contacted by placement agents offering their help to sell your deal once you let them know about it.
Upper Middle Class and Wealthy Individuals. Accredited investors have above average net worth and incomes, but many of them don't live extravagant lifestyles. Many upper middle class people qualify as accredited investors. Some of them drive cars that are older and less expensive than their poorer neighbors. So, you have a wide range of people that often blends into the community. But mass media advertising is expensive. To avoid going broke trying to raise capital, narrow your advertising to the most relevant sub-markets to reduce advertising expenses.
Identifying the right media is relatively easy, because different media outlets market to different audiences. Media businesses track which demographic and economic groups their audience consists of, because advertisers want this information, including income and net worth. Advertisers trying to sell big ticket luxury goods place ads in media that appeal to people with high incomes and high net worth. So, looking at the ads other advertisers place in different media channels is a quick way to develop your list of potential media channels even before you discuss demographics with specific media outlets.
Before we discuss different types of media, let's remind ourselves about the purpose of advertising. Your advertising won't make a sale for you. But your ad will achieve its goals if it convinces people to ask you for more information about your business. That task is easier if you deal with people who already share a common interest with you. We'll call these people your "sweet spot" target investors.
So, your first step is to answer the question: Who are your "sweet spot" investors?
After that, you can look for the best media to reach your "sweet spot" investors.
How do you identify your "sweet spot" investors and the media to reach them?
Three ways to do that are to focus on media that appeal to specific types of "sweet spot" investors. Do that by considering whether your business would have special appeal to investors in any specific:
· Geographic group,
· Hobby or lifestyle
Let's discuss how you identify the best media to connect with each of these "sweet spot" investor groups.
- Geographic Focused Media. Many private investors like to invest in local businesses. A one hour drive is a useful rule of thumb for targeting investors in your geographic "sweet spot." So, advertising in media that focuses on your metropolitan area may be a useful strategy. Obviously, your advertisement should describe your business' local connection. Local news media are always looking for stories. If you have a compelling story, initially focus on public relations instead of paid advertising. PR may allow you to reach the audience you want without breaking your budget. But PR articles come and go. To create a steady communications channel with local investors, you may need to spend some money on paid advertising.
- Industry Media. People who know your industry have greater ability to evaluate whether your business has good investment potential than people outside your industry. The key to selling investments is helping investors overcome their fears. So, your sales task is easier if you target people who start out with lower fear levels than if your targets start with higher fear levels that you have to lower. People who know your industry usually understand the risks your business and industry present. Knowing what the risks are makes investing in your business less scary. You might also be able to kill two birds with one advertising stone. Advertising in an industry publication might attract an investor who also brings skills to your management team. You might find a partner, as well as an investor. But there is a downside. Advertising in industry publications might alert competitors to adapt their strategy to either copy you or to protect their customers from you competing with them.
- Hobby Interests and Lifestyle Media. Many businesses make products or provide services that appeal to people with specific lifestyles, hobbies and other personal interests. If your business makes camping equipment, advertising in outdoor media may help you find investors who are interested in learning more about your business. Computer games, sports, gardening, fashion and food are other areas that have very focused media that appeal to particular groups. Remember, that your goal is find people with significant wealth and income. Some hobbies and lifestyles will be better for this purpose than others. Most media organizations know a lot of demographic information about their audience, including statistics about income and wealth. They regularly tout these statistics to attract advertisers who are looking for specific demographic groups. Before you spend money on advertising, find out the statistics about the income and wealth levels of your media's audience. It can be as simple as calling the marketing department of the media outlets you are considering.
Of course, even targeted media ads cost some money. If that's beyond your budget, or if you want to supplement a small budget, then you'll definitely use social media to sell securities.
You can use the same "sweet spot" investor criteria we just finished discussing in your social media campaign.
If you target people who share common hobbies and lifestyle interests they sometimes share your information friends who have common interests. The friends in turn may do the same. If enough people do this, your information can go viral. Entering the right community with something compelling that spreads through texting, emails, chat rooms, Twitter and other social media can give you a big audience in your target group for a relatively small amount of money.
But before you jump into attempts to cut your offering expenses by trying to create something that goes viral within a target community, understand the potential integration problems we discuss in our article about integration issues in private placements.
Now, let's talk about how you can use specific types of social media. Since social media is in a constant state of change, this list and how you can use each type of social media will be quickly outdated, but it's worthwhile to give examples that illustrate basic principles.
- LinkedIn. You can passively advertise or you can be more proactive and search for people who fit your "sweet spot" investor criteria both in your contacts and in the contacts of your contacts. You can also participate in "Groups" of people who share a common interest.
- Twitter. Become a thought leader in an area that appeals to people in your "sweet spot." Twitter messages might be short, but they can link to a world of information about you. Be careful not to link to too much information. Many Twitter users are grazers. They like to keep on the move and sample a little of this and a little of that. If the see a large amount of information, they might just ignore it because they don't want to commit too much time to any one thing. To avoid overwhelming Twitter users, consider leading them through a meal of progressively bigger servings of information with each course. You can use your followers to spread your links. Or you can identify #hashtags that attract your "sweet spot" investors.
- Facebook. Facebook provides an environment to communicate less formal business messages. It is frequently adding additional tools for communicating with other Facebook users.
- YouTube. YouTube is a great way to create a personal connection with your potential investors. It’s the next best thing to meeting in person with someone. Create your own YouTube channel. Most people don't want to play long videos. Try to keep each individual video to less than two minutes. You can't tell our whole story in to minutes. But if you have multiple videos in the same place, you can tell a compelling story about your business in installments. What you leave out is as important as what you include. Each video should leave viewers interested in hearing more. If you answer all their questions too quickly, they might move on. You want them to contact you to ask you questions.
- Blogging. Establish your credibility as a thought leader with an area of expertise. Then, use that credibility to make your pitch that you can use that expertise to build a profitable business. This can be a long-term process that begins well before you begin selling securities.
- Company Website. Create an investor section of your website. Use search engine optimization (SEO) techniques to attract visitors to it.
- Third Party Websites. Establish mutual linking relationships with key websites that your "sweet spot" target investors often use. Post information about your business and industry on these websites.
- Investment Apps. You can get an app for your smartphone that compares hotel, airline and rental car deals for you across multiple travel websites. The day is not far off when similar apps will help investors search the Internet for investment opportunities. Be aware of how these apps work so you can help them find you.
As you can see, you have a wide range of inexpensive selling tools at your disposal. It's easy to fall into the trap of testing the waters to see if one works and then moving onto another. The reason that's a mistake is that what you say in one place may create legal issues. Sales materials have to be intriguing without crossing the line into misleading. As we discuss in other articles, both securities regulators and plaintiff's lawyers will use isolated misleading advertisements against you even if you later make all required disclosures.
The key to using advertising to sell securities is to design an integrated advertising campaign that makes sense as a whole and whose individual pieces don't get you into trouble.
Sales and follow-up materials don't have to duplicate one another. But it's critically important that one message doesn't contradict what you say in another message. When you piece it all together, it has to both tell the whole truth and be internally consistent. That why taking isolated sales efforts can get you into trouble.
Not Crowd Funding Yet. Now, let's discuss who is not yet in your advertising target. Don't confuse Rule 506 (c) advertising with "crowd funding." The JOBS Act also mandated crowd funding, but the SEC has not yet approved crowd funding rules.
The crowd funding securities offering rules mandated by the JOBS Act will eventually allow businesses to raise small investments from many investors via the Internet, who will not have to be "accredited investors." Generally, this will occur through websites that specialize in crowd funding.
The crowd funding mandate is intended to give business seeking to raise capital access to websites that are similar to those that allow people to pay for new products in advance so that the business can produce the new product to sell to them. Currently, in the U. S. these websites can only sell products. Businesses cannot offer their early customers the right to buy their shares through these websites – at least not in the United States. But the SEC has not yet approved crowd funding rules. Until the SEC approves the crowd funding securities offering rules mandated by the JOBS Act, these small investors are off limits. Therefore, your target audience for advertising should be guided the eight different types of accredited investors described in Rule 501 (a) and should not seek to attract smaller investors.
When crowd funding rules are approved by the SEC, you will face issues about how to separate your crowd funding sales efforts from Rule 506 (c) offerings and other private placement activities. In the meantime, be careful not to mix these commercial business activities with our capital raising activities, if you sell products through crowd funding websites.
The SEC and state regulators will be closely monitoring advertising that is designed to appeal to many non-accredited investors. Don't fool yourself into thinking no one is watching you.
Penalties for Non-Compliance
If you don't comply with Federal or state securities laws, the usual remedy is rescission. That means that investors have the right to get their money back, plus interest. If the business cannot pay the money back, officers and directors, investment bankers and others might have personal liability.
Articles in Private Placement Series
In July 2013 the SEC made the biggest changes to private placement capital raising rules since the SEC issued Regulation D more than three decades ago.
More than 90% of private securities offerings are affected by these changes.
The SEC's recent changes are a mixed blessing for businesses selling securities. These changes include:
- Prohibiting using Rule 506 if someone affiliated with your business or with your capital raising efforts has violated securities or other financial industry laws.
- Adding new Rule 506 (c), which allows you to advertise when you raise capital in a private placement.
- Rule 506 (c) also requires you to take reasonable steps to independently verify that all people who buy securities are "accredited investors," if you advertise your offering.
Our articles in this series about SEC Rule 506 private placements help you decide how you can use these new rules to raise the capital your business needs by balancing three competing factors:
- Advertising effectiveness
- Securities law compliance
You have to get all three right to successfully raise capital.
Here's a list of our articles that discuss the primary issues you will face when you try to balance these three objectives in your capital raising efforts:
- Advertising Messages Tweeting Your Way to Securities Fraud in 140 Characters: What Do you Say in SEC Rule 506 (c) Advertising in Private Placements? How do you decide what you say in your advertising? How do you say it? What current SEC and state advertising rules can you use to guide your advertising decisions? Can you combine effective sales messages with complying with securities laws? Or is it an either or choice? What's the point of advertising if securities laws prevent you from selling effectively? http://jimverdonikintersection.blogspot.com/2013/08/tweeting-your-way-to-securities-fraud.html
- Choosing the Right Media for your Advertising. Don't Tweet when You Should Have LinkedIn: Choosing Your Advertising Media in SEC Rule 506 (c) Private Placements How do you advertise within your budget? How do you identify your "sweet spot" target investors and the right media to reach them? What social media tools can you use? How do you attract accredited investors who meet SEC criteria for making investments? http://jimverdonikintersection.blogspot.com/2013/08/dont-tweet-when-you-should-have.html
- Building your Sales and Legal Team. Would You Let Your Lawyer Run Your Sales Department? How Can You Build the Right Team for Advertising in SEC Rule 506 (c) Private Placements? How do you build teams to help you do effective advertising while still complying with SEC and state anti-fraud rules? What role should your sales team play? What role should your lawyer play? How do you choose a lawyer who can help you create effective advertising that also complies with securities laws. http://jimverdonikintersection.blogspot.com/2013/08/would-you-let-your-lawyer-run-your.html
- Accredited Investor Verification. Will SEC Rule 506
(c)'s Permission to Advertise Cure Your Capital Woes or is Its Accredited
Investor Verification Requirement a Poison Pill? If you want to
advertise your securities offering, you must take reasonable steps to
verify that everyone you sell to is an "accredited
investor." You can't just rely
on the investor checking a box that tells you it is accredited. How much checking is
"reasonable"? How do you
qualify for the "safe harbor" the SEC included in Rule 506
(c)? What happens if you don't
obtain the right type of proof that the people you sell securities to are
Why will some investors refuse to comply with your verification
requests? What can you do to
reassure investors about privacy issues and make the verification process
more convenient for investors?
- Beware of SEC Integration Rules: SEC RULE 506 (c) Integration Pitfalls: Don't Use the SEC's New Advertising and Solicitation Private Placement Rule to Saw Off the Limb You are Sitting On Why should you look before you leap into advertising? What integration and related pitfalls does Rule 506 (c) create for businesses that choose to advertise or engage in general solicitations? How do you sell securities to people who are not accredited investors under another SEC private placement exemption, if your advertising doesn't attract enough accredited investors to finance your business? http://jimverdonikintersection.blogspot.com/2013_07_01_archive.html
· Getting Caught : How Will the SEC Know I'm Advertising in a Rule 506 (c) Private Placement? How will the SEC know about your advertising? Why isn't it a defense that everyone else is breaking the rules? How do you deal with the interim period when people are figuring out what the new rules let you do and don't let you do? http://jimverdonikintersection.blogspot.com/2013/09/how-will-sec-know-im-advertising-in.html
· Bad Actors: SEC's Bad Actor Rule: When You Lie Down with Dogs Expect to Get Fleas To use Rule 506 (with or without advertising) you have to verify that a long list of people who are affiliated with your business or with selling your securities offering haven't violated securities or other financial industry laws. How do you make sure the SEC's Bad Actor Prohibition for Rule 506 private placements from cut off your ability to raise capital? http://jimverdonikintersection.blogspot.com/2013/07/secs-bad-actor-rule-when-you-lie-down.html
- Identity Crisis at the SEC: Does Filing Your Private Placement Tweets with the SEC make Sense? What road blocks to effective advertising in private placements is the SEC erecting? Why are these blocking efforts doomed to fail? http://jimverdonikintersection.blogspot.com/2013/09/does-filing-your-private-placement.html
- Government Bouncer at the Capitalist Club: SEC RULE 506 (c): Who is Allowed to Be a Capitalist? Why is the Government using Rule 506 (c) to decide who is allowed to be a capitalist? Do you have what it takes to get past the Government bouncer standing in your way at the door to the capitalist club? Why can't you be a capitalist too? http://jimverdonikintersection.blogspot.com/2013_09_01_archive.html
If you would like to learn more about learning how to grow your business or other issues important to your success, you can reach me at JFV@WardandSmith.com or JimV@eLearnSuccess.com. Or you can check out my eLearning course at http://www.elearnsuccess.com/start.aspx?menuid=3075 or http://www.youtube.com/user/eLearnSuccess or you can purchase my books at http://www.amazon.com/Jim-Verdonik/e/B0040GUBRW