Lightweight Investment Vehicle
An Open Investment Network model
Draft - In Progress
12/9/07
(Ohio specific)
Purpose: To create a lightweight investment vehicle for the purpose of raising seed capital.
Scenario: You are in the process of starting a company and need $50,000 of capital.
Existing options include: personal savings, friends and family, credit cards, banks, angels, VC. In most instances VC, banks, and angels can be quickly ruled-out as pre-revenue/pre-development projects are rarely funded through these channels. This leaves personal savings, friends and family and credit cards as the methods most commonly used. Though this model does work, many well known and very successful companies have been started this way, significant opportunities are essentially being left to chance. Given the present economic imperative and the reduced cost threshold associated with seriously launching certain types of technology companies, the sensible approach is to amend the process and provide 'paved road' where possible.
Under current Ohio law, raising small amounts of capital is, at best, challenging and, at worst, complicated and expensive. For example: a commonly used method is SEC Regulation D – 506. Under rule 506, a company can raise unlimited funds but the offering (the sale of securities) is limited to accredited investors and up to 35 sophisticated non-accredited investors ("...all non-accredited investors, either alone or with a purchaser representative, must be sophisticated—that is, they must have sufficient knowledge and experience in financial and business matters to make them capable of evaluating the merits and risks of the prospective investment.") Additionally, the offering can only be done privately. This means the offering can’t be advertised (web, print, etc.). (Are the OVA 5-minute pitches technically legal?) The reason for these limitations is fraud prevention (pump and dump, pyramid schemes, etc.). However, the regulations in place to prevent fraud also have the unintended consequence of making it very difficult for companies to raise seed capital. Major differences between DirectCap and existing methods are that DirectCap keeps the preparation/filing costs low and allows for direct public solicitation. DirectCap does not guarantee the microenterprise will get funding but it reduces the cost and simplifies the process of identifying and accepting capital. DirectCap is intended to allow microenterprises to simply and inexpensively pursue seed capital while maintaining safe-guards to minimize fraud.
DirectCap offers the following features:
- Maximum of $100,000 can be raised during preceding 12 months
- Maximum of $5,000 investment per non-accredited investor in preceding twelve months
- Maximum of $25,000 investment per accredited investor in preceding twelve months (needed?)
- Permits direct public solicitation (web, print, radio, etc)
- Ten page combined disclosure/registration document
- $1,000 (or less) in legal preparation costs
- $250 (or less) state filing fee
- Shareholder proxy/representation so that one (or a small group) shareholder votes and represents all the shareholders related to this registration ( an individual or small group of shareholders is authorized to act for all of the shareholders particpating in their round - trying to directly manage a large number of very small investors is likely problematic)
- Five day ‘change your mind’ refund provision
DirectCap is already permitted under SEC Regulation D – 504 (the seed capital rule) but is cost prohibitive given the present state of Ohio Blue Sky laws (OAC 1301:6-3-09 (Ohio Administrative Code), ORC 1707.09 (Ohio Revised Code) and the Ohio Merit Guidelines for Securities). A microenterprise must file SEC Form D on the Federal level, forms U-7 and U-9 (or equivalent) in Ohio. Form U-7 is a detailed 38-page disclosure document that acts as the prospectus in the offering. Form U-9 is the Disclosure by Registration document. Based on discussions with small business and securities attorneys, preparation of a RegD 504 costs between $10,000 and $25,000. An ‘opinion of counsel’ is required on form U-9, meaning that the document must be approved by an attorney before it can be submitted to the state.
DirectCap is specifically intended to reduce the cost, time and complexity associated with raising seed capital while maintaining adequate provisions to minimize fraud. Fraud protection is accomplished by the $100,000 cap on the offering and the limit on individual investors. Given this model, a legitimate microenterprise could raise $50,000 as $25,000 from two accredited investors, $5,000 from any ten investors, $1,000 from any fifty investors and all combinations in-between.
Direct public solicitation is integral as it allows the offering to be listed on web sites and allows for public events where the offering can be openly discussed.
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Reading state and federal law is like reading spaghetti code (it difficult to follow and barely resembles English) and different attorneys have different interpretations. We need a simple, easy-to-use, lightweight mechanism for microenterprises to raise capital.
DirectCap is just a simplified offering with specific maximums that allows a public solicitation. It is specifically intended for microenterprises to acquire seed capital.
Privately means with a known party. Though I occasionally see ‘investors wanted’ ads on websites and elsewhere, as far as I know then are technically a violation of the statute.
Implementing DirectCap requires the development of a simplified disclosure/registration form and amendments to the laws around the sale of securities in Ohio.
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To Do:
Definitions (microenterprise)
Historical context - why this is important
Where do we go from here
References:
Authors:
Rick Pollack
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