An 80-year ban on general advertising and solicitation of private investment funds is coming to an end. The revised SEC rules apply to hedge funds, private equity groups, venture capital firms and other private funds. Previous to the change, firms could only solicit to “accredited investors” after they’ve been properly verified as accredited. The revised rules will allow advertising by methods previously prohibited such as television ads, brochures, full-page print advertisements, and content rich websites with information about the fund’s philosophy, process, risk controls, investment team, etc.
Purchasers of private funds must still be considered “accredited investors” with assets of at least $1,000,000 (excluding primary residence) or annual income of at least $200,000 in each of the two most recent years with a reasonable expectation of similar earnings in the current year. Since general advertising increases the possibility of risk of sales to unqualified buyers, the SEC has actually tightened the verification procedures of accredited status by firms using general advertising. No longer will investors be able to simply check a box stating that they qualify as an accredited investor. Firms utilizing general advertising will need to document, a) income with 1040’s or W-2’s, and b) net worth requirements with bank and brokerage statements or written confirmation from third parties like broker-dealers, registered investment advisers, attorneys or CPA’s.
The revised general advertising rules may open the door to fresh sources of capital by reaching smaller accredited investors that do not have assets of at least $5,000,000. The SEC estimated that at least 8.7 million households qualified as accredited investors in 2010 but only 234,000 participated in Rule 506 offerings . This new source of capital may be especially important to start-up funds who may be willing to accept a $250,000 or $500,000 investment which is well below the $1,000,000+ minimums that many larger more established firms have established.
This broader access to smaller accredited investors poses other potential problems, including:
- Larger number of smaller investors with less experience will require more cost and attention, necessitating increased operations and staffing.
- More advertising will bring increased SEC attention
- Designing, executing and evaluating the performance of advertising is expensive and generally beyond the scope of a small fund.
While the revised rules on general advertising may open the door to more investors and capital, spurring growth in new offerings, the larger well-established funds with access to institutional money may be less responsive to the increased ability to advertise. Having 5 investors with $500,000,000 each is much less work than 5000 investors with $500,000 each.