What are the Exceptions to the Prohibition on General Solicitation?

A business that seeks investors will need some method of attracting outside investors. In light of the prohibition against general solicitation of the public, there are specific rules in place that allow for solicitation of outside investors. A business can actively solicit any qualified investor. 

Who is a Qualified Investor?

Who is a qualified investor depends upon the applicable exemption. For example, a statutory exemption under section 4(a)(2) requires that a purchaser have the requisite amount of business or financial sophistication. 

Other exemptions, such as those under Rules 505 and 505, may require that an investor be accredited. 

As previously discussed, an accredited investor is anyone who falls under the list of individuals found in Rule 501(a), which is based upon institutional status, net worth, and annual income. 

The topic of who is a qualified investor under each exemption is discussed further below and in context of the applicable exemptions. The issue or question for the entrepreneur becomes, how do you know an investor is qualified without approaching the investor about the business venture? 

In partial answer to this question, the SEC makes exceptions for solicitations toward investors with whom the Issuer has a prior existing business relationship. The relationship must be sufficient "enable the Issuer to be aware of the financial circumstances or sophistication of the persons with whom the relationship exists or that otherwise are of some substance and duration. 

Taken together, this means that in order to make an offer of sale of securities to a potential investor, the investor must either be qualified under the applicable exemption or someone with whom the Issuer has a pre-existing business relationship. 

Many, if not most, startups do not yet have many on-going business relationships or connections with qualified investors. Businesses are forced to look toward alternative methods to establish business relationships. For example, the business may employ the services of a broker who has significant prior existing business relationships with clients. 

The statute allows for affiliates or agents of the business to act on the agents behalf in offering to sell the securities. The rules still require that the broker have a pre-existing business relationship with the purchaser that was established prior to the beginning of the business Regulation D offering. 

The statute appears to focus more on time than the extent of the prior-existing business relationship. For example, the brokers past solicitations to potential clients that contains "sufficient information to evaluate the prospective offerees' sophistication and financial circumstances," without more may be sufficient to establish a working relationship. 

In any regard, "there [must] be sufficient time between establishment of the relationship and an offer so that the offer is not considered made by general solicitation or advertising. 

The rule has even been interpreted to allow the use of electronic communications, such as websites or portals, to identify potential investors. Several other exceptions to the prohibition on general solicitation exist. 

The broadest exception is under Rule 135, which allows an Issuer to announce an offering if the 33 Act does not require that the offer be registered. 

The most recent, and perhaps most important, exception to the general solicitation prohibition applies to Rule 506(c) The JOBs allows created rule 506(c), which provides an exception from registration for issuances of securities to accredited investors. Rule 506(c) eliminates the ban on general solicitation.