When the JOBS Act was passed in the spring of 2012, all the “buzz” was about the imminent advent of “Crowdfunding.” But as legal practitioners, business persons, and pundits looked closer at the details under the Crowdfunding rules contained in Title III of the JOBS Act, it became readily apparent that Crowdfunding for equity was a long way off and might never be of significant value for emerging companies. What was overlooked in the JOBS Act by much of the press and public, however, was the proposed sea change in Rule 506 for private placements as contained in Title II of the JOBS Act. The SEC has now published the final rules for the new Rule 506 and that sea change (which may turn out to be a tsunami) is about to occur.
Effective as of September 23, 2013, Issuers of shares may use general solicitations to effect a private placement. The amount that can be raised is unlimited. There is no requirement for review of the offering by any State Securities Commission (blue sky laws) and there is no review of the offering by the SEC. Solicitations can be online or offline and made to any potential investor. The completed sales, however, must only be to “accredited investors”1 and the Issuer has the burden to verify that the investor is “accredited.” In effect, the new Rule 506 may well become the “crowdsourcing” tool that emerging companies have long been looking for.
The new Rule 506 may prove to be a very effective tool for emerging companies to raise capital directly. No need to engage a middle man; no need for a broker. If a Company has a strong affinity group or user base, it could simply email its registered users or customers and ask if they would be interested in learning about investing directly in the Company. A short video could be attached as part of the invitation. Or, a Company could simply have a link on its website inviting those interested in investing to click through to learn more. Using the Web or mobile apps, a Company could come up with some very creative solicitations. Of course, the Company will have to make sure that all solicitations are accurate and that they do not include puffery. Further, Companies will need to make sure that each potential investor receives a full private placement memorandum and the Companies will be required to verify that each investor is indeed “accredited.” Additionally, Companies will need to think about how to make sure that any confidential information included in a private placement memorandum remains confidential. But these limitations can be easily managed and raising capital directly from a Company’s user base could become a powerful form of crowdsourcing.
Funds may also use the new Rule 506. For example, if a Fund is targeting a specific type of investor, it will be able to use a mailing list and make a targeted email campaign to persons or institutions on that list. That type of mass solicitations to specific groups was not permitted for private placements prior to the enactment of the new Rule 506. Again, the solicitations must be truthful and completely accurate and investors will need to be provided with a private placement memorandum, but General Partners or Managers will clearly have the ability to access a wider pool of potential investors.
The foregoing are samples of the new ways to raise capital under the new Rule 506. Various types of offerings will be specifically crafted to fit the particular needs of each Issuer and to comply with the technical requirements of the new Rule 506. One thing, however, is certain: crowdsourcing under the new Rule 506 will change how many Issuers raise capital.
1 Regulation D of the Securities Act of 1933 specifies eight types of accredited investors. For individuals, the standard requires either a net worth of $1 million (excluding the value of any primary personal residence), or income exceeding $200,000 in each of the two most recent tax years or joint income with a spouse exceeding $300,000 for the previous two tax years and a reasonable expectation that an individual expects the same level of income in the current year.