[author: Michael L. Hund]
On April 5, 2012, President Obama signed into law the Jumpstart Our Business Startups Act, also known as the “Jobs Act.” The Jobs Act will effect dramatic changes in the law as it applies to companies seeking capital by way of private placement stock offerings, overturning certain restrictions that have been in place for decades. The Jobs Act also added a brand new concept, “crowdfunding”, to the array of choices for private placement offerings.
The overall intent of the Jobs Act, which was passed with broad bipartisan support, was to ease regulatory burdens on capital raising by smaller companies with the hope that such easing would lead to job creation and growth in the U.S. economy. In addition to opening up new capital-raising opportunities for small, privately held companies, the Jobs Act also added some fairly significant relief for companies that have recently gone public or that intend to go public in the future. There is a new category of companies identified under the Jobs Act known as “emerging growth companies,” a classification that most observers have deemed a misnomer since it includes companies with up to $1 billion in annual revenues, a size that includes a lot of older, established companies not normally thought of as being in the emerging growth phase. These emerging growth companies will now get a break on the path to public status through a process that is slightly more streamlined than the process encountered in the past. Additionally, once public, these companies will enjoy a five-year holiday from some of the more onerous disclosure and compliance provisions of the Dodd-Frank Act and the Sarbanes-Oxley Act, including a pass from the controversial auditor attestations on the internal controls of a company.
While the provisions relating to newly public companies are interesting and will surely be helpful to those companies, the provisions in the Jobs Act relating to private placement stock offerings are the more compelling and newsworthy parts of the new law. These new provisions will be especially important for companies planning to engage in a search for outside capital through the sale of shares of stock to investors. The two parts of the Jobs Act that give rise to this are the relaxation of the prohibition on general solicitations under Rule 506 of Regulation D, adopted under the Securities Act of 1933, and the implementation of the crowdfunding concept.
The Jobs Act mandates that the Securities and Exchange Commission (“SEC”) remove the long-standing ban on general solicitations for private placement offerings completed under Rule 506 of Regulation D. General solicitations include all attempts to sell shares except for offers made to a small, discrete group of persons who have some prior connection to the company making the offering. The removal of the ban on general solicitations is important because, both in terms of dollars raised and number of individual transactions, Rule 506 of Regulation D forms the basis for almost all private placements conducted by companies in the United States. Historically, offerings conducted under this rule were required to be structured to avoid making any widespread offering, i.e., a general solicitation. Now, under the Jobs Act, so long as all purchasers under such offerings qualify as “accredited investors”, there is no longer a prohibition on offers extended more widely, including those in which a general solicitation is made. Accredited status for individual investors is fairly easy to achieve and consists of any person with a net worth of at least $1 million (excluding personal residence) or $200,000 in annual income ($300,000 joint income with spouse), including a reasonable expectation that such income will continue into the current year. This new relaxation on general solicitations is significant because it allows companies to avoid the excruciating process of conducting private placement offerings that are indeed truly private in the sense of how they are conducted. Companies will still need to ensure that the actual purchasers are accredited investors, but a relaxation on the prohibition on general solicitations is likely to be deemed a significant benefit to companies conducting such an offering.
The second major capital formation change affecting private companies included in the Jobs Act is the introduction of the concept known as crowdfunding to the capital formation process. Used previously to harness the power of a crowd to solve a problem, the Jobs Act will allow private companies to raise small amounts of capital by selling shares of its stock by the use of this process. Crowdfunding offerings are limited as to size and must be done by way of numerous and significant requirements. For instance, a company is able to use this process to raise no more than $1 million in any 12-month period. The aggregate amount sold to any one single investor is based on the investor’s income. The investment limit is $2,000 or 5% of the investor’s income, whichever is greater, for investors with annual net income of up to $100,000. For investors with higher incomes, an investment of up to 10% of annual net income is permissible, with a cap of $100,000 per investment. Further, requirements will be put into effect by the SEC to require that crowdfunding offerings be conducted by a third-party intermediary rather than by the company raising capital. There will be specific disclosure requirements (including audited financial statements for most offerings) and subsequent financial and other reporting to be done by the company after completing the offering by the use of crowdfunding. The companies raising capital will generally be prohibited from advertising such offerings. Third-party intermediaries will need to be registered either as broker-dealers or as funding portals and will be required to engage in specific steps to make information available to investors, perform background checks on the principals of the company issuing securities, and collect and control the distribution of offering proceeds in the offering.
The SEC has up to 270 days from the April 5th effective date of the law to issue rules before the various new provisions concerning general solicitation relaxation and crowdfunding offerings will be allowed. Until then, the old rules and requirements remain in effect. Most observers believe that the SEC will be late in releasing the new rules because of the significance of the change in the landscape of private placements brought about by the Jobs Act. Once the rules are promulgated and these new paths for private placement offerings become available to issuers, it is anticipated that the relaxation on general solicitations for 506 offerings will likely prove to be helpful to many. It is hard to see how the crowdfunding alternative will be deemed particularly useful, however, given the extensive conditions for its use and considering that there are existing private placement offering alternatives already available for small offerings without nearly as many hurdles and impediments. On balance, it appears as though the new crowdfunding alternative is appealing because of its trendiness and creativity, but it probably has more political appeal than substantive merit. Some critics also fear that it will create new opportunities for fraud and deceit.