SEC Lifts Ban on General Solicitation for Certain Private Offerings



On April 5, 2012, President Obama signed the Jumpstart Our Business Startups Act (the “JOBS Act”) into law.  The JOBS Act is intended to “increase American job creation and economic growth by improving access to the public capital markets for emerging growth companies.”  To accomplish this goal the JOBS Act seeks to ease the application of various securities regulations to startups and other small, privately-held businesses.  Titles II and III are probably the most important (and closely-watched) parts of the JOBS Act for startups and growth-stage companies in the U.S.

Title II – Access to Capital for Job Creators  

The SEC recently voted in favor of implementing Section 201(a) of the JOBS Act, which lifts the ban on general solicitation and permits startups – and other privately-held companies – to openly advertise to the general public that they’re raising money in private offerings. 

Until now, such activity was prohibited unless (and until) a company decided to “go public” by registering its securities in an IPO.  A startup can now advertise its privately-offered securities under new Rule 506(c) of Regulation D (a regulatory safe harbor for private offerings of securities promulgated under the Securities Act of 1933) if it takes reasonable steps to verify that any actual purchaser of the securities is an “accredited investor” prior to completing the sale of the securities to that investor.  It is worth noting that the securities offered in private offerings conducted pursuant to new Rule 506(c) may be sold solely to accredited investors, and issuers of such securities will be subject to certain enhanced notice filing and disclosure requirements when general solicitation and advertising is employed. 

To qualify as an accredited investor you generally need to have income of over $200,000 ($300,000 for joint filers) for the two most recent years, plus a reasonable expectation of the same in the current year, or a net worth of $1,000,000 (excluding your primary residence).  Prior to the passage of the JOBS Act (and the implementation of the regulations promulgated thereunder), most private issuers relied on an investor’s self-certification of his/her accredited investor status through the use of investor questionnaires and/or investor representations and warranties in subscription agreements.

However, under Section 201(a) of the JOBS Act, the SEC has given guidance as to new, non-exclusive methods for verifying a prospective investor’s accredited status.  Each of these methods will be deemed by the SEC to have satisfied the “reasonable steps” requirement (for accredited investor verification) imposed by Section 201(a) for Rule 506(c) offerings.  The verification methods are as follows:

  1. Natural Person Income Test: (a) review of any forms filed with the IRS to report the individual’s income, including a W-2, 1099, K-1 or 1040, for the preceding two years, plus (b) a written representation from the individual (and spouse, if applicable) that he/she reasonably expects to reach the income threshold for the current year.
  2. Natural Person Net Worth Test: (a) review of documents no more than three months old that verifies the individual’s assets, including bank statements, brokerage statements and other statements of securities holdings, CDs, tax assessments and independent third-party appraisal reports, plus (b) for liabilities, a credit report from at least one national credit agency, plus (c) a written representation from the investor that all liabilities have been disclosed.
  3. Third-Party Verification Method: receive written certification from a registered broker-dealer, and SEC-registered investment adviser, a licensed attorney or a CPA that the third-party professional has, after taking reasonable steps, determined in the last three months that the investor is an accredited investor.
  4. Grandfathering: if a natural person invested in an issuer’s Rule 506(b) offering prior to July 10, 2013, as long as they remain an investor, written confirmation of accredited investor status at the time the investor acquires the newly-offered securities will suffice.

Title III - Crowdfunding

Section 302(c) of the JOBS Act required that the SEC issue final rules governing Crowdfunding activities no later than 270 days after the date of the JOBS Act’s enactment, or by December 31, 2012.  The SEC failed to meet the deadline imposed by Section 302(c), and to date the SEC has not issued final rules governing Crowdfunding beyond the general Crowdfunding guidelines set forth in Section 302 of the JOBS Act itself.  These general guidelines include the following:

  • Privately-held companies are allowed to use government-registered Internet “funding portals” to raise capital from investors, including unaccredited investors.
  • There is a yearly aggregate limit on the amount an investor may invest in Crowdfunding offerings, which limit is tied to the investor’s net worth or annual income (e.g., (i) $2,000 or 5% (whichever is greater) for an investor earning (or worth) up to $100,000; and (ii) $100,000 or 10% (whichever is less) for an investor earning (or worth) $100,000 or more).
  • The amount of capital a company can raise annually under the Crowdfunding exemption is limited to $1,000,000; also, a company looking to raise between $100,000 and $500,000 must provide reviewed financials (and audited financials for capital raises in excess of $500,000).

Even with limitations on the amount an individual investor may invest in a Crowdfunding offering, we anticipate that the new Crowdfunding exemption will be used by startups and growth-stage companies with greater frequency than the new 506(c) offerings because of the ability to attract investments from unaccredited investors.  In fact, we note that a limited number of Crowdfunding portals have already emerged despite the lack of final regulations from the SEC.  We suspect that these early pioneers in the Crowdfunding space will ultimately force the SEC’s hand in adopting final regulations.  However, until that happens we only know the limitations and guidelines set forth in Section 302 of the JOBS Act (some of the key limitations and guidelines are summarized above).  But given the anticipated popularity of Crowdfunding for startups and growth-stage companies, we will continue to closely monitor the SEC’s Section 302-rulemaking activities and provide our clients with updates regarding same.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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