This is a follow up to my last post regarding the concept of crowdfunding in general and the progress of the JOBS Act through Congress (full name – Jumpstart Our Business Startups Act). Since then, the Senate revised and passed the JOBS Act in a 73 to 26 vote. The House then, voting on the amendments made by the Senate, passed it by a vote of 380 to 41. This is something that both parties agree on, and were eager to work together to implement. Josh Earnest, the White House Deputy Press Secretary, stated that President Obama will sign the JOBS Act into law this Thursday, with a bipartisan public announcement. The President and Eric Cantor, one of the champions of the JOBS Act, will appear together for the signing of the bill into law.
This post will detail the provisions of the JOBS Act and how they will affect companies going forward. The JOBS Act can be found here if you’d like to take a read. After it is signed into law, the SEC has 270 days to promulgate regulations. Expect the SEC to claim that they need more time, as the JOBS Act is a monumental change, and there are various consumer (i.e. the new investor) protections required, especially to prevent fraud which, unfortunately, could run rampant if left unchecked. Hopefully Congress can put enough pressure on the SEC to get the regulations complete in the actual 270 day time period, and the regulations will actually have some teeth with respect to fraud without stifling startup’s ability to raise money.
There are sections of the JOBS Act that will affect many different businesses. We’ll break it down.
The Act allows crowdfunding in the true sense of the word. To allow for it the SEC is directed to adopt new rules under the new crowdfunding law (new Section 4(6) of the Securities Act). The company doing a crowdfunding offering cannot publicly advertise the terms of the offering, but it can make public announcements directing potential investors to the broker or funding portal conducting the crowdfund. The Act will allow non-accredited investors (those whose net worth is under $1M) to be able to invest more freely in startup companies, subject to certain maximum limits discussed below. It appears that the states will be preempted from regulating crowdfunding as the JOBS Act has designates the shares sold as “covered securities” subject only to federal regulation, but we’ll have to see how that plays out at the state level.
To rely on the crowdfunding exemption the company must ensure that the following conditions are met:
(1) it must be a non-reporting U.S. company;
(2) the total amount of securities sold by the company within the last 12 months, including the sales pursuant to the crowdfunding, cannot exceed $1M;
(3) the securities sold in a crowdfunding offering cannot be to a person who has spent over $2,000 in the last twelve months on purchases via crowdfunding. Increased limits are available if the investor provides a certificate showing their annual income or net worth. If the investors annual income or net worth is under $100k, then that investor can purchase securities for a total value of 5% of their annual income or net worth, and 10% if the investors annual income or net worth is over $100k; and
(4) the crowdfunding offering must be made through a broker or funding portal (ie website) that must be registered with, and regulated by, the SEC. The registration and regulation looks to be somewhat burdensome on the intermediary. The Act puts a lot of the obligations to prevent fraud on the intermediary including certain disclosures, and background checks on the principals of any company trying to crowdfund, among many others.
In addition to the above, to receive the crowdfunding exemption, the company doing the offering must file with the SEC and provide certain information to investors (or to the funding portal):
(1) background information on the company;
(2) the names of officers/directors owning more than 20%;
(3) description of the business and its business plan;
(4) a description of the financial condition of the issuer, which varies based on the amount being raised:
If the company is raising $100,000 or less, the income tax returns from the last year as well as financial statements certified by the CEO
If the company is raising between $100,000 and $500,000, financial statements reviewed by a CPA
If the company is raising $500,000 or more, audited financials are needed
(5) detail on the purpose and use of funds raised;
(6) the target offering amount and deadlines;
(7) the price to the public of the securities or the method for determining the price, as well as information informing the investor that it can rescind its purchase committment; and
(8) the capitalization table of the issuer, as well as how the securities are being valued and examples of methods of valuation taking into account future corporate actions
The Act creates a new classification – an “emerging growth company” which is a company that has less than $1 billion in revenues prior to going public. The company remains an emerging growth company until it has $1 billion in revenues or 5 years pass from its IPO. It has been said that this is an “IPO on-ramp” as it will make it easier for smaller companies to go public, by relaxing the rules for such companies’ registration statements. Being designated growth company exempts the company from various burdonsome regulations, including the new “say on pay” rules (regarding shareholder’s vote on executive compensation), will only have to give two years of audited financials prior to IPO (instead of the current 3), exempt from the Dodd-Frank pay for performance and pay equity disclosure requirements, and most notably, exempt from Sarbanes Oxley Section 404(b) which requires a third party CPA firm to give an opinion on the company’s financials, and can conduct IPO with research reports before and after the quiet periods.
Relaxation of Regulation D
Usually, when a company is doing a private placement, it cannot make any general solicitations. In other words they need to keep the offering private and not announce to the public (ie through Twitter or Facebook) that they are offering equity for purchase. The JOBS Act will allow for general solicitations in private placements, provided all investors are accredited investors.
Amendment to Reg A
Regulation A allows a mini-public offering with a smaller circular approved of by the SEC. The Act raises the limit on an Reg A offering to $50M, and does not require audited financial statements. A Reg A offering is now exempt from blue sky securities laws if the securities are sold to “qualified purchasers” (the SEC will define this term).
There are also provisions related to the way the SEC uses decimals when quoting securities, and a disclosure provision of Reg S-K to be updated. Additionally, the SEC must amend the rules relating to resale of securities in Rule 144A to allow for general solicitation provided certain requirements are met. Also the point when a company is forced to go public either due to its number of shareholders, or assets is being raised.