In 2012, President Obama signed the Jumpstart Our Business Startups (JOBS) Act into law. The JOBS Act contains a number of provisions that are designed to facilitate capital raising and other activities by startup companies. These include:
Streamlined IPO Process and Post-IPO Regulations for Emerging Growth Companies
Emerging Growth Companies (EGCs) are defined to include companies with less than $1 billion of annual revenue for their most recently completed fiscal year. The JOBS Act contains a number of provisions applicable to EGCs designed to facilitate the IPO process:
- EGCs may offer securities to institutional accredited investors prior to filing a registration statement (a practice generally prohibited under prior law)
- EGCs may initiate the registration process confidentially with the SEC (thereby enabling EGCs to maintain the confidentiality of their financial statements and other information until they definitively decide to go public)
- Only two, rather than three, years of audited financial statements are required to go public
- Research analysts will be allowed to publish reports on EGCs immediately after they become public companies
Once public, EGCs will benefit from a number of scaled down reporting requirements during a post-IPO period of one to five years, depending on the size of the company.
Amendment to “500” Holder Rule
Under prior law, companies with more than $10 million in assets and 500 record holders of a class of equity securities at fiscal year-end were required to become reporting companies under the Securities Exchange Act of 1934, irrespective of whether they had completed an IPO. This rule has been relaxed under the JOBS Act such that the requirement to register under the Exchange Act is now triggered only if a company has either 2,000 record holders of a class of equity securities or 500 record holders of a class of equity securities who are not accredited investors. Securities issued to employees under an employee compensation plan pursuant to an exemption from registration (such as upon exercise of stock options) will not be counted toward these thresholds.
“It remains to be seen whether crowdfunding will become a practical alternative to traditional private placements.”
Elimination of Prohibition on General Solicitations in Certain Private Placements
Under current law, companies seeking to raise capital in a private placement are prohibited from engaging in a general solicitation of the securities they are trying to sell. The JOBS Act directs the SEC to amend its private placement safe harbor to eliminate this prohibition with respect to private placements to accredited investors. Although the SEC has not yet adopted rules to implement this directive, the SEC’s proposed rules indicate that general solicitations would be permissible if:
- The issuer of securities takes reasonable steps to verify that purchasers of the securities are accredited investors
- All purchasers in the offering are in fact accredited investors or persons or entities that the issuer reasonably believes are accredited investors at the time of sale
- Certain other requirements set forth in the SEC’s “safe harbor” regulation for private placements are satisfied
As of December 2012, the SEC has not formally adopted these new regulations and, as a result, companies should not engage in general solicitation activities without first confirming with their counsel that the new rules in this area have taken effect and familiarizing themselves with the content of the new rules.
The JOBS Act also contains provisions that are intended to make it possible for companies to raise equity through so-called crowdfunding” offerings. However, there are several restrictions that will apply to these types of financing, including:
- An issuer may raise no more than $1M from investors (including securities sold in reliance on the crowdfunding exemption) during any 12-month period
- The aggregate amount sold to any investor during any 12-month period may not exceed the greater of $2,000 or 5% of an investor’s annual income or net worth (for investors with an annual income or net worth of less than $100,000) or 10% of an investor’s annual income or net worth, not to exceed $100,000 (for investors having an annual income or net worth greater than $100,000
- Sales must be conducted through intermediaries registered with the SEC as a broker or funding portal
- Issuers must comply with statutory disclosure requirements (including audited financial statements for offerings of more than $500,000) and forthcoming SEC rules
The crowdfunding exemption set forth in the JOBS Act requires SEC rule marking and will not become effective until after the SEC proposes and adopts rules to enable crowdfunding, which will not occur until an unspecified future date. Given the existing limitations and restrictions on crowdfunding in the statute, as well as additional limitations and restrictions expected in any final rules, it remains to be seen whether crowdfunding will become a practical alternative to traditional private placements.