New Legislation Eliminates Securities Law Prohibition on General Solicitation and Authorizes Crowdfunding
The Jumpstart Our Business Startups (JOBS) Act is a package of six separate bills that President Obama signed into law today, April 5, 2012. Together, these bills significantly alter several longstanding securities rules impacting private companies that are raising capital and the private investors seeking to invest in them. In brief, the changes are as follows:
The JOBS Act removes the prohibition on advertisements and other general solicitations in private offerings conducted under Rule 506 of Regulation D. So long as an issuer under Rule 506 takes reasonable steps to ensure that all purchasers are accredited, general solicitation (including solicitation that reaches unaccredited investors) is now permitted. Accredited investors are individuals with income in excess of $200,000 or net worth in excess of $1 million (excluding their primary residence).
The ban on general solicitation had been in effect since 1983, and the SEC strongly opposed its repeal. However, repeal of the ban gives entrepreneurs and companies significantly greater latitude to search broadly for investors in private offerings, which removes one common hurdle for such offerings. The prior restriction on general solicitation was interpreted broadly, and not only limited direct advertising but also effectively prohibited any mention of a private financing in news coverage or in any open forum. It also significantly restricted the ability of a company to raise funds from any investor who did not have a pre-existing relationship with either the company or its management.
The JOBS Act legalizes "crowdfunding," within certain parameters. Crowdfunding became popular in recent years as a means of raising funds through the internet from small contributions made by hundreds or even thousands of individuals. The SEC previously permitted crowdfunding only if the contributors received no equity in the company for their contributions, thereby greatly limiting the usefulness of this approach. The new crowdfunding law allows an entrepreneur or small business to sell securities to an unlimited number of small investors, who need not be accredited. An issuer may utilize this new exemption to raise up to $1 million. An investor with annual income or net worth in excess of $100,000 may invest 10 percent of that investor's annual income or net worth in any particular crowdfunding offering, up to a maximum of $100,000. An investor with income or net worth of less than $100,000 may invest the greater of $2,000 or 5 percent of that investor's annual income or net worth. It is unclear whether investors other than natural persons (such as corporations, partnership, LLCs or trusts) will be eligible to invest in crowdfunding offerings.
Any issuer conducting a crowdfunding offering is required to use an intermediary that is registered as a broker or as a funding portal. The intermediary will be required, among other things, to provide investors with basic risk disclosures, to conduct background checks on an issuer's principals and to file certain reports about the offering with the SEC. The issuer will be required to provide basic information about itself and about the terms of the offering. Existing securities laws that require investors be provided with all information necessary to make an informed investment decision will be applicable to crowdfunding financings. Securities purchased in a crowdfunding transaction may not be resold for 12 months, except to the issuer or to an accredited investor. The new crowdfunding exemption supersedes any inconsistent State registration requirements.
In most cases, crowdfunding offerings will not be attractive for issuers targeting accredited investors, given that general solicitations are now permitted under Rule 506 of Regulation D.
- A new category of smaller public firms has been created, called "emerging growth companies," which are permitted to delay compliance with some of the more costly disclosure requirements applicable to public companies generally, for a period of five years after an IPO or until the firm exceeds $1 billion in annual gross revenue. Companies that first sold publicly-tradable shares before December 8, 2011 are ineligible to be classified as emerging growth companies.
- The limit on the number of shareholders a company may have without going public was increased from 500 to 2,000. No more than 500 of those 2,000 shareholders may be unaccredited. In addition, securities issued to employees under employee compensation plans no longer count against this 2,000 shareholder limit. Securities purchased in a crowdfunding offering are also exempt from this limit.
- A private company may now raise up to $50 million in a public offering without itself being required to become a public company. Previously, the limit was $5 million.