Tuesday, December 3, 2013

Should Startups Participate in Pitches and Demo Days?

Every day, New York City is the host to multiple startup pitch or demo events where hundreds of startup founders introduce their companies to the public and the investors. I have attended a number of such presentations. A pitch event typically starts with pizza and beer networking, followed by 5- or 1-minute pitches by pre-selected startup founders. During those pitches, the founders talk about the company in general and specifically mention their capital raising goals. There is a panel of VC representatives asking questions. The event ends with a panel discussion led by the VCs regarding funding and how to get noticed by investors. A demo day differs slightly because it is not the company but their products that are being showcased, so there is typically no mention of raising capital.

As a securities lawyer, I question whether presenting at a pitch or a demo event may cause the startup to violate the federal securities laws.

By far the most common securities law rule that startups rely on when raising capital is Rule 506(b) of Regulation D. This Rule allows companies to raise unlimited amount of funds from accredited and up to 35 sophisticated investors, so long as there is no general solicitation and advertising. Through a series of no-action letters and interpretive releases, the SEC established that the condition of no general solicitation and advertising is satisfied when startups approach only those investors with whom they have a pre-existing relationship that allows them to determine their financial circumstances or level of their financial sophistication. Alternatively, if the startups are working with a broker-dealer, they can access their network of potential investors.

Recently, the SEC implemented a new Rule 506(c) (which I described in this blog post in more detail). The new Rule 506(c) allows the startups to engage in general solicitation and advertising so long as they take reasonable measures to verify that all their investors are accredited. The pros of being able to generally solicit and advertise the offering should be weighted against the potential drawbacks of the new rule, which are the following:
  • The Rule 506(c) imposes a burdensome verification requirement on the issuers to ensure that all investors are accredited. Investors may be reluctant to share their tax returns with the startups to verify their status.
  • Complying with the new Rule 506(c) will likely increase the costs of the offering by adding extra attorney’s fees, fees of a third-party accreditation service and costs related to record keeping.
  • If the Rule 506(c) offering fails, the issuer cannot resort to other exemptions because none of the other exemptions allow general solicitation and advertising. The traditionally used Rule 506(b) is a non-exclusive safe harbor, which means that if the offering fails for some technical reason, the issuer can still claim exemption under Section 4(a)(2) of the Securities Act.
  • When the SEC additional proposed rules go into effect, the issuers will have to pre-file Form D, include legends and submit all solicitation and advertising materials to the SEC.
If the startup is raising capital at the time of the pitch or demo event, the analysis turns on whether their presentation constitutes an “offer” of securities as opposed to a routine presentation solely about the business and its operations. Remember, even presentations that do not mention the startups’ securities or the offering may be deemed to be “offers,” so long as they have the effect of conditioning the market or arousing public interest in the company and its securities.

So, the question really becomes: is presenting at a pitch or a demo event considered to be “making an offer of securities by using general solicitation and advertising”? The answer is: it depends on how that particular event is conducted. If the event is broadly advertised on the Internet and is available to the community at large, then presenting at such an event is likely to constitute offering securities using general solicitation and advertising, so the presenters would have to rely on the new Rule 506(c) in conducting its offering. If the startup wishes to resort to the traditionally used Rule 506(b), then it is best not to present at such an event even if they do not mention the offering.

If the event is only available to a pre-selected group of invitees and the startup has pre-existing relationship with all of the invitees, then an argument can be made that the presentation is not made by means of general solicitation and advertising.

Participating in demo days warrants the same analysis. If the offering of securities is not mentioned and the focus of the presentation is on the particular products of services rather than the company in general, then it may be possible to conclude that no offer of securities was made. The analysis here is very fact-specific.

The bottom line is, the company and its counsel should decide whether they are prepared to conduct a Rule 506(c) offering. If not, then perhaps it is best to not present at demo or pitch events at all.

This article is not a legal advice, and was written for general informational purposes only.  If you have questions or comments about the article or are interested in learning more about this topic, feel free to contact its author, Arina Shulga.  Ms. Shulga is the founder of Shulga Law Firm, P.C., a New York-based boutique law firm specializing in advising individual and corporate clients on aspects of business, corporate, securities, and intellectual property law.