On April 5, 2012, President Obama signed the Jumpstart Our Business Startups Act (the JOBS Act). The JOBS Act relaxes the regulation of securities offerings by private companies and smaller public companies, as well as the reporting obligations of many newly public companies. Some provisions of the JOBS Act are immediately effective, while others will not become effective until the SEC adopts implementation rules (discussed below).
The JOBS Act is intended to facilitate capital raising through private offerings and small public offerings without SEC registration, to allow private companies with larger numbers of shareholders to delay becoming a public reporting company, and to ease the IPO process and post-IPO regulatory burdens for “emerging growth companies” (defined as companies with less than $1 billion of total annual gross revenues during their most recently completed fiscal year).
Easing of Restrictions on General Solicitation and Advertising
The JOBS Act directs the SEC to adopt new rules permitting the use of general solicitation and advertising in connection with private securities offerings pursuant to Rule 506 of Regulation D if all of the purchasers are accredited investors and the issuer takes reasonable steps to verify that each purchaser is an accredited investor. In addition, online and other “platforms or mechanisms” that permit the offer or sale of securities or general solicitations or advertisements for Rule 506 offerings are exempt from the broker-dealer registration requirements under the Exchange Act so long as certain conditions are met.
Rule 144A will be revised to permit offers of securities by means of general solicitation or advertising, provided the securities are only sold to persons the seller reasonably believes are qualified institutional buyers.
The JOBS Act permits small companies to raise up to $1 million during any 12 month period through “crowdfunding” (i.e. small investments from large numbers of investors) without registration. The JOBS Act sets limits on the amount each investor may purchase in a crowdfunding offering. For investors with an annual income or net worth of $100,000 or more, the aggregate purchase limit during any 12 month period in reliance on the crowdfunding exemption is 10% of the investor’s annual income or net worth, but not to exceed $100,000. For investors with an annual income or net worth of less than $100,000, the aggregate purchase limit during any 12 month period is the greater of $2,000 or 5% of the investor’s annual income or net worth. The securities in a crowdfunding offering must be sold through an intermediary, which must be either a registered broker or a funding portal.
The intermediary must provide risk disclosures to potential investors and take appropriate measures to reduce the risk of fraud in the transaction (as the SEC shall establish by rule), among other requirements. The issuer must file with the SEC and also provide and make available to potential investors its anticipated business plan, a description of its financial condition, the intended use of proceeds, the price of the securities and other terms and conditions of the offering, and a description of the ownership and capital structure of the company. The issuer may not advertise the terms of the offering except for notices that direct investors to the registered broker or funding portal, and must file with the SEC and provide to investors not less than annually reports of the company’s results of operations and financial statements as determined by SEC rulemaking.
Securities issued in compliance with the crowdfunding exemption are “covered securities” and therefore exempt from registration with state securities commissions, although the states have the authority to take enforcement action against any issuer or intermediary for fraud, deceit or other unlawful conduct. Further, the state of the issuer’s principal place of business and any state in which purchasers of 50% or more of the aggregate amount of the crowdfunding offering are residents may require a notice filing and fee.
Securities issued in a crowdfunding offering may not be transferred for one year except to the issuer, to an accredited investor, or pursuant to a securities offering registered with the SEC.
The legalization of crowdfunding may assist many small and early stage companies which are unable to raise funds from angel investors or venture capital funds. It seems unlikely, however, that crowdfunding (with its $1 million limit) will replace the need for angels or venture capital funds, and time will tell whether companies which obtain crowdfunding (with their resulting large numbers of shareholders) will find it more difficult to attract subsequent investors. The investor protection requirements, including the requirement to file financial statements and other information with the SEC, may lead some companies to decide the burdens of complying with the crowdfunding exemption are prohibitive and therefore to rely instead on a general solicitation offering to accredited investors under Section 506 of Regulation D.
Expanded Regulation A Offering Exemption
The Regulation A small offering exemption for private companies has been increased from $5 million to $50 million. Unlike offerings pursuant to the crowdfunding exemption, offerings made pursuant to the expanded Regulation A exemption are subject to registration under state securities laws unless the securities are offered or sold on a national securities exchange or offered or sold to qualified purchasers only.
Increased SEC Registration Thresholds
The shareholder threshold triggering the public company reporting requirements under the Exchange Act has been increased from 500 to 2,000 shareholders of record, provided there are no more than 500 non-accredited investor shareholders. For banks and bank holding companies, the new threshold is 2,000 shareholders of record (increased from 500) without regard to the number of non-accredited investors. In addition, the threshold for terminating public company reporting requirements for banks and bank holding companies (“going dark”) has been increased from 300 to 1,200 shareholders of record.
The shareholder of record calculation has been amended to exclude securities issued pursuant to the crowdfunding exemption or to employees pursuant to an employee compensation plan in a transaction exempt from the Securities Act’s registration requirements (such as Rule 701 offerings).
“IPO On-Ramp” Measures
The JOBS Act amends the Securities Act and Exchange Act to create a new category of public company defined as the “emerging growth company.” It reduces the costs and regulatory burdens associated with going public for these companies, and also reduces some of the costs and obligations of being a public company for so long as the company continues to qualify as an emerging growth company. These provisions (generally referred to as “IPO on-ramp” measures) phase-in certain public company regulatory requirements for qualifying companies over a period of up to five years following an IPO. In addition, the “test the waters” provisions will allow companies to determine whether there is sufficient interest from investors prior to incurring the time and expense associated with an IPO. The IPO on-ramp measures are immediately effective.
Timetable for SEC Rulemaking
The SEC has 90 days from the enactment date of the JOBS Act to revise Securities Act Rules 144A and 506 to allow general solicitation and general advertising, 270 days to adopt rules to implement the crowdfunding exemption and related provisions, and one year to adopt rules to implement the increased public company reporting and going dark thresholds for banks and bank holding companies. The JOBS Act does not set a deadline for the adoption of rules to implement the changes to Regulation A or for revising the definition of “held of record” in its rules to implement the bill’s exclusion of employees who acquire securities pursuant to an employee compensation plan. The SEC has questioned the feasibility of these rulemaking deadlines, so it remains to be seen how quickly this will all come about.
For more information about the JOBS Act and its impact on your business, please contact any member of Wyatt's Corporate Service Team.