On April 5, 2012 President Obama signed into law the Jumpstart Our Business Startups Act, known as the “JOBS Act.” The law was designed to give start up and non public companies easier access to capital markets. Critics contend that lowering the bar for raising capital will open the door to abuse by unscrupulous operators. Nevertheless, in an election year, any bill with a catchy acronym promising jobs is going to be tough to defeat.
The law contains a number of provisions aimed at encouraging job growth by making it easier and less costly for startups to raise capital and eventually go public. There are three major components to the law. One section establishes a new category of companies called “emerging growth companies” that have less than $1 billion in annual revenues at the time they register with the SEC. These companies would face fewer regulatory barriers when raising funds. Another section of the law increases the number of shareholders before triggering when companies have to start public reporting. The third component is the most controversial, and deals with a capital-raising strategy known as “crowd funding” that would let investors take small stakes in private start-ups sold over the Internet.
The crowd funding provision exempts transactions from the registration requirements of the Securities Act of 1933. Crowd funding allows private companies to raise small amounts of money from investors online without having to register the offering at the federal or state level.
“Crowd funding” has historically referred to groups of people who invested money and resources through the internet to fund charities and invest in entertainment industry ventures.
Inevitably, venture capitalists caught on and a movement for funding small business via the internet gained momentum in 2011. The perfect storm of offshore jurisdictions providing lower barriers to entry, a sputtering U.S. economy and election year politics led to the introduction of legislation and the signing of the JOBS Act in short order.
The crowd funding exemption is limited to private companies that are not subject to the reporting requirements of the Securities Exchange Act of 1934 and are organized under the laws of a U.S. state. Investment companies and other statutorily excluded companies may not use the exemption.
Initially the offerings will be limited to $1,000,000, and individual investors may not invest more than 5% or 10% of their annual income or net worth, whichever is greater, and total investments may not exceed $100,000. Lower thresholds apply to investors whose income or net worths are below the $100,000 threshold.
At present Congress has yet to flesh out the details as to how the “funding portal” will work and just what level of disclosures companies will have to provide to investors in order to avail themselves of the crowd funding “safe harbor.”
The actual offerings will be conducted via an “intermediary,” which must register with the SEC and applicable SROs either as a broker or as a “funding portal.” Promoters, finders and cold callers are prohibited. No compensation can be paid to those working outside the company raising funds.
Investors must be provided a level of disclosure about the issuer and its officers to ensure that they understand the risks applicable to investments in small businesses.
In addition a company must provide to both the SEC and prospective investors information about itself and its directors, officers, and its larger investors, a description of the business and anticipated business plan, a description of the company’s financial condition, including the most recently filed annual income tax returns, and financial statements certified by the issuer’s principal executive officer (for offerings under $100,000); financial statements reviewed by an independent public accountant (for offerings of between $100,000 – $500,000); or audited financial statements (for offerings over $500,000.)
Investors must also be apprised of the stated purpose of the offering and intended use of the proceeds, a description of the ownership and capital structure of the issuer and regular updates on the progress of the offering. As with other private offerings under ‘Reg D”, securities issued under the crowd funding exemption may not be transferred by the purchaser for one year from the date of purchase except back to the issuer, to an accredited investor, or to a family member.
At present the SEC is still drafting final rules, which are due within 270 days after the enactment date of April 5, 2012.
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