“Join the Crowd? Not Yet” –
Crowdfunding Eases Private Capital Formation (But SEC Rules Await)
On April 5, 2012, President Obama signed the Jumpstart Our Business Starts Act (the “JOBS Act”) into law. The legislation, which recognizes and embraces “crowdfunding” as a means of raising capital for small business, is aimed at providing smaller companies access to the capital markets and reducing certain regulatory requirements for smaller companies going public. The details of the new legislation have been left to the Securities and Exchange Commission, which has been given 270 days to develop rules and regulations to implement these groundbreaking initiatives. A comment period will follow, and the rulemaking process likely will delay the implementation of the JOBS Act for several months. Nevertheless, the new law has been greeted generally with enthusiasm by entrepreneurs, start-up businesses, the securities industry and financial communities.
Two of the main goals of the new law are (i) to simplify private capital formation, and (ii) to reduce the administrative burden for a fledgling business seeking start-up capital. The JOBS Act amends the Securities Act of 1933 by allowing a company that does not register with the SEC to raise up to $1,000,000 in a year from many individuals, whether accredited or non-accredited, by satisfying certain conditions that are intended to be less burdensome than current requirements.
There are limits to the amount a company can receive from individual investors. If an investor has a net worth or annual income of less than $100,000, the investor cannot provide more than the greater of $2,000 or 5% of such investor’s annual income or net worth. If an investor’s net worth or annual income exceeds $100,000, such investor cannot invest more than 10% of his or her income or net worth. This requirement appears to codify a “suitability standard” that companies sometimes adopt on their own when conducting private placement offerings, but it is far easier to satisfy than “all accredited investors” private offering under Regulation D of the Securities Act.
The JOBS Act also requires that a company seeking investment through this new exemption use a registered broker or funding portal (which may explain why the brokerage industry has reacted so favorably to the new law) and prescribes a series of basic guidelines for the broker or funding portal. In addition to registering with the SEC and any applicable self-regulatory organizations (e.g., FINRA), the broker or funding portal must provide necessary disclosures to investors as the SEC may prescribe, perform due diligence and background checks on companies seeking investment, protect investor privacy, avoid conflicts of interest, and ensure that any individual investments do not exceed the dollar limits described above. No investment proceeds may be released to the issuer (the company seeking capital) until the target amount to be raised has been reached.
In addition, the JOBS Act: (i) prohibits any advertising other than a notice directing investors to the funding portal or broker, (ii) requires that a “disclosure document” (the equivalent of a private placement memorandum) be filed with the SEC and furnished to investors and the broker or funding portal, (iii) prohibits undisclosed compensation to the broker or funding portal, or others, for promoting the offering, and (iv) requires that the company file with the SEC and provide to investors an annual report of operations and financial statements.
Many in the securities industry are heralding these “revolutionary changes” to the securities laws by shifting the administrative burden away from the company seeking investment and toward the intermediary. The reality, however, is that the company, not the broker, will be largely responsible for generating, with the assistance of counsel, the “disclosure document”, and the SEC will be developing rules that may well strip the JOBS Act of the intended benefits of simplicity. The disclosure document must include, among other things, a business plan, a description of the offering, its purpose, a target offering amount, a deadline for reaching the amount, investment risks, and audited financial statements for offerings of more than $500,000 – plus “such additional information as the SEC may prescribe”. In other words, the same effort and cost that is put into a private placement memorandum will be spent on satisfying the requirements of the “crowdfunding” portion of the JOBS Act.
Stay tuned, and keep the champagne on ice before toasting the “revolution in securities legislation”. It is entirely possible that the SEC’s rules may increase, rather than decrease, the overall regulatory burden of doing a “Crowdfunding Offering”.