Intro to Angel Investing | Lecture #3 | Form C's & "Testing The Waters" - Taught by Garry Johnson III
Dear Students,
Startup companies that launch campaigns on various investment platforms are also regulated by the SEC, and must remain compliant if they hope to successfully raise money from Non-Accredited Investors. These businesses must file what's called a Form C with the SEC, which makes the fundraise a public offering of securities (via equity or debt)— it's like a mini IPO.
Each company has to put the legal paperwork together to offer a deal with specific investment terms, and the SEC has guidelines on what communications the startup can have as they publicly raise funds from private-market investors. This is important because the SEC wants to ensure there are no bad actors seeking to defraud investors, whether you’re “sophisticated” or not.
Watch Me Teach Lecture #3:
When a company files its Form C, it will include the specific deal terms of its investment offering. The deal terms are an agreement made between the company and its investors. It’s a legally binding contract where a business sets a price on its shares through a valuation, outlines an interest rate for a loan, and/or the potential investment multiple to be expected.
Investors have the power to decide
whether they enter an agreement or not.
Investment platforms (ie. Wefunder, Republic, & StartEngine) must clearly outline the deal terms of each investment offering and provide you with all of the materials necessary to evaluate an investment opportunity. At a minimum, investors should review each of the following documents before making a decision to invest in any particular company:
Pitch Deck or Business Plan
GAAP Financials
Form C
This is where you have the power as an investor to make an educated decision since you're able to review a company's background, its founders, the management team, revenue projections, outstanding debts & liabilities, assets, equity partners, or any lack thereof.
If a company does not provide this information, you're not able to make a fully informed decision.
It’s legally required for companies to provide you with this information, and if they don’t, it means they haven’t officially launched their investment campaign — they’re not actively soliciting investments from the public.
If you find a startup or a small business in this scenario, they’re most likely “Testing The Waters.”
“Testing The Waters” is legal, and it allows a startup or small business to essentially set up a draft version of their campaign on an investment platform and garner non-binding commitments from potential investors. This is a low-risk way for businesses to determine if their community, social media followers, or friends & family are even interested in investing in their business before the company goes through the hard work of filing their official paperwork and launching a fundraising campaign.
“Testing The Waters” is beneficial to founders as it helps them see how much money they might be able to raise if they were to officially launch a campaign.
It also frees them from having to disclose their financial information, and gives them time to develop their presentation materials, as well as anything else that would make for a more compelling case.
While in the “Testing The Waters” phase, a company can still adjust its investment terms and try to figure out which terms are preferable to investors. The company has until it files its Form C to continue adjusting those terms as it gauges interest from potential investors.
For example, a company could start by “Testing The Waters” through a debt round by providing a revenue-share loan where 6% of its annual revenues go toward repaying its investors. While the company is “Testing The Waters” and gauging interest with potential investors, it might start to get early interest. Some investors, however, may follow up with the fact that they'd love to invest in this company, but they’re only interested if the company is raising an equity round — they’d prefer for the entrepreneur to offer an ownership stake in the company in exchange for their investment capital. Since the company is still in the “Testing The Waters” phase, it can adjust and change its terms however and whenever it likes. Now, instead of offering a revenue-share loan, the company might decide to raise on a priced round — it can set a valuation on the company and sell shares or ownership units to investors.
As it continues to “Test The Waters,” the company may find even more people expressing interest in investing in this business because they see an opportunity to become owners in it as opposed to lenders to it. The company can then decide to file its official paperwork and make an investment offering that includes equity in the business as opposed to debt.
In order to get out of the testing the waters phase, the company must file its Form C and follow up with anyone who made an early commitment in order to finalize their investment. This means that investors can go back into the investment platform, analyze the updated terms and determine whether or not they’d like to invest in this particular offering. If that investor made a commitment prior to the filing of the Form C, then the investor did not make a binding investment — they did not subscribe to the investment terms. They have the right to rescind their commitment without facing any consequences, and the investment platform will refund any money that investors may have decided to hold in the platform’s escrow account as they waited for the startup to finalize its deal terms.
Alternatively, if you transferred funds into an escrow account through the investment platform, you could confirm your investment and subscribe to the updated terms. Once you subscribe to the updated terms, and a startup closes its investment campaign, that's when your investment is finalized with the company. Your investment dollars are then deposited into the company’s bank account and they then have a fiduciary duty to operate in your best interest as an investor in the company.