Online Social Networks Great Tool, But Not to Raise Money

By Todd Taylor
Online social networks such as LinkedIn, Facebook, MySpace and Twitter are great for meeting potential business partners, discussing your business and networking. The ability to reach a large number of people you would not otherwise know makes it tempting to use to raise money for your company. However, it is for exactly the same reason that most uses of online social network sites to raise money violate federal and state securities laws and create risks for your company and the person posting the message. I use LinkedIn and frequently come across messages from business developers seeking investors. Facebook, MySpace and Twitter are used the same way. If you are doing this, stop now.

Every offer and sale of a security, including stock, LLC units, promissory notes, options and warrants must be registered with the Securities and Exchange Commission and sometimes state securities departments or be exempt from registration. Since registration, essentially an initial public offering (IPO), is expensive and time-consuming involving a review by the SEC, most start-up and developing companies avoid this process. Many companies are unaware these securities laws exist and go about trying to raise money any way they can.

If you are not conducting an IPO, the offer and sale of the securities needs to be exempt from registration. The most commonly used exemption is the private placement exemption under federal and state law. Most commonly, the specific exemption is found in SEC Regulation D, Rule 506, which allows a company to offer and sell securities to private investors without SEC review. The trade-off is that companies conducting a private placement cannot engage in general solicitation to attract investors. If they do, the SEC or state securities authorities can force the company to return the money and even pay fines.

General solicitation is not well-defined by the SEC, but generally means using communications methods that indiscriminately reach a broad audience. The SEC has analyzed whether a particular action is general solicitation based, in large part, on whether a significant relationship predated the offering and whether the solicitation intended a sale of securities.

If there was no significant relationship prior to the offering, it is likely a general solicitation. A significant relationship means more than being linked to someone on LinkedIn or a friend on Facebook. Analyzing whether a solicitation intended a sale of securities requires examining your intention for making the contact. Twittering or posting a discussion on LinkedIn talking about your new company while trying to raise money are obvious examples of intending a sale of securities and should be avoided.

If you cannot ask for investors or post your private placement memorandum, what can you do? You can use online networking sites to establish significant relationships with people, and then talk to them about your offering. You can talk about your company and its goals, but you should not do this as a cover for luring people to your company and hitting them up to invest, a violation termed "conditioning the market."

Online networking sites can significantly increase your network and potential for success, but you need to be careful not to take actions that could hurt your company in the long run. Investors don't like securities law violation investigations.

Todd Taylor is a shareholder in Fredrikson & Byron's corporate, renewable energy, securities and emerging business groups. Reach him at [email protected] or (612) 492-7355.