Alert: JOBS Act to Simplify Capital FormationPrint PDFShare
On April 5, 2012, the Jumpstart Our Business Startups (JOBS) Act was signed into law. The JOBS Act provides a unique opportunity for the Twin Cities corporate finance community to reemerge as a leader in the financing and nurturing of locally-based growth companies. This community of investors, broker dealers and legal professionals previously provided access to capital and other support to young regional companies to such an extent as to achieve national recognition, and helped produce many of the successful locally based public companies that exist today. The JOBS Act turns back the clock on many of the capital raising impediments that have acted as a head wind in the last decade. Under the JOBS Act, local growth companies will have greater access to the liquidity provided by the public markets and this, in turn, will greatly enhance the appetite of investors to fund private placements, which also will be easier to complete under the JOBS Act.
The JOBS Act includes fundamental changes to the federal securities laws and pares back some of the requirements of Sarbanes-Oxley and Dodd-Frank. These changes will make it easier for companies to go public and will reduce reporting burdens for new public companies. Other highlights include permitting the use of general solicitation in certain private placements; exempting “crowdfunding” equity offerings from Securities Act registration; raising the threshold for Exchange Act registration to 2,000 shareholders; and increasing the maximum size of Regulation A offerings to $50 million.
The JOBS Act includes amendments to the Securities Act and the Exchange Act, which take effect immediately. Other provisions will require rulemaking by the SEC to be implemented.
Smoothing the Way for IPOs by Emerging Growth Companies
An emerging growth company, or an EGC, is a company that has total annual gross revenue of less than $1 billion during its most recently completed fiscal year, provided that it has not sold common equity pursuant to an effective registration statement on or before December 8, 2011. Once a company reaches certain thresholds (total annual gross revenues of more than $1 billion, issues more than $1 billion in debt, becomes a large accelerated filer), or five years pass after its IPO, the company no longer qualifies as an EGC. Because of the high annual revenue limit of $1 billion, virtually all IPO registrants qualify as EGCs.
- EGCs will only be required to provide two years of audited financial statements in their IPO registration statements, instead of the previously required three years. In addition, for later registration statements, EGCs need only provide financial data for the earliest audited period provided with their IPOs. Eliminating the need to audit additional historical periods reduces the time it takes to complete the deal.
- EGCs and their authorized persons, such as investment bankers, are permitted to communicate with qualified institutional buyers or institutional accredited investors about the EGC’s stock offering prior to filing a registration statement. Such communications enable companies to test the waters more quickly and inexpensively than waiting for the registration statement to first be filed.
- EGCs are also freed from some of the more costly provisions of Sarbanes-Oxley and Dodd-Frank. EGCs are not required to engage an independent auditor to attest to the EGCs’ internal financial controls and they are not required to comply with new or revised accounting standards until private companies are required to adopt such standards. EGCs are not required to put executive compensation to an advisory vote of shareholders and they are not subject to disclosure requirements regarding executive pay in comparison to performance and median employee compensation. An EGC may comply with the executive compensation disclosure rules in the same manner as a “smaller reporting company,” meaning Compensation Discussion and Analysis, also known as CD&A, is not required. However, unlike rules for smaller reporting companies, an issuer electing abbreviated disclosure is expected to take an all-or-none approach to such streamlining.
- An EGC may confidentially submit a draft registration statement to the SEC for nonpublic review prior to public filing. The initial submission and all amendments would be made public at least 21 days prior to the IPO road show.
- The JOBS Act allows securities analysts to publish research regarding an EGC at any time during the IPO process, even if the analyst is affiliated with the underwriter. Analysts may also participate with broker-dealers in discussions with EGC management.
Brave New World of Online Investing - The "Crowdfunding" Exemption
Title III of the JOBS Act is itself entitled the “Capital Raising Online While Deterring Fraud and Unethical Non-Disclosure Act of 2012,” or the “CROWDFUND Act.” Existing crowdfunding websites enable a startup to receive donations, but they are prohibited from selling securities in the startup. The new crowdfunding exemption will allow the sale of securities, subject to compliance with several new SEC regulations that must be adopted within 270 days of enactment.
The crowdfunding provision creates a new registration exemption for raising up to $1 million over a 12-month period from many small investors. An investor whose annual income or net worth is less than $100,000 can purchase securities in an amount of up to the greater of $2,000 or 5% of the investor’s annual income or net worth. An investor whose annual income or net worth is more than $100,000 can purchase securities in an amount of up to 10% of the investor’s annual income or net worth, not to exceed $100,000.
Under the crowdfunding exemption, an issuer must file the following information with the SEC:
- its name, legal status, physical address and website address;
- names of directors, officers, and holders of more than 20% of its shares;
- a description of its business and anticipated business plan;
- a description of its financial condition;
- a description of the purpose and intended use of the proceeds from the offering;
- the target offering amount and deadline to reach such amount;
- the price per share or the method for determining the price; and
- a description of its ownership and capital structure and related risks.
The depth of the financial condition description depends on the size of the offering. For offerings of less than $100,000, the company must file its tax returns for the most recently completed year. For offerings of more than $100,000 but less than $500,000, the company must file financial statements reviewed by an independent public accountant. Finally, for offerings of more than $500,000, the issuer must provide audited financial statements.
Other restrictions placed on these offerings are:
- The issuer may not advertise its offering except through notices directing investors to a funding portal or broker (described below).
- Promoters of an issuer’s securities must clearly disclose the compensation they received from the company for such promotion.
- Securities purchased under the crowdfunding exemption may not be transferred for one year after they are purchased, unless the securities are transferred as follows: back to the issuer; to an accredited investor; as part of a registered offering; or to the purchaser’s family members or equivalent or in connection with the purchaser’s death or divorce or similar circumstance. These permitted transfers will be subject to any other limitations that the SEC may determine.
- Participating in such an issuance subjects an issuer to making not less than annual filings with the SEC and its investors.
The crowdfunding provision expressly preempts the ability of state securities commissions to regulate these offerings, or even to require a notice and fee (as the states now do for Regulation D, Rule 506 offerings), except that the state of the issuer’s principal place of business, or where 50% or more of the purchasers are resident, may require a filing and a fee.
Requirements for broker-dealers and funding portals
The crowdfunding exemption also regulates broker-dealers and funding portals who participate in crowdfunding transactions. A funding portal is a securities intermediary that does not have to register as a broker-dealer if the portal does not: offer investment advice or recommendations; solicit purchases, sales, or offers to buy the securities offered on the website or portal; pay employees or other persons to solicit purchases, sales, or offers to buy, or based on the sale of, the securities offered on the website; hold, manage, or otherwise handle investor funds or securities; or other activities as the SEC determines appropriate. While funding portals do not have to register as broker-dealers, funding portals must belong to a national securities association and register with the SEC.
The crowdfunding exemption requires broker-dealers and funding portals to:
- provide the necessary disclosures, including disclosures related to risk, as the SEC determines appropriate;
- ensure that each investor reviews investor education materials and makes representations that the investor can bear the risks involved in the investment;
- perform background checks on each officer, director and 20% shareholder of every issuer whose securities they offer;
- provide the required issuer’s information at least 21 days before the first sale;
- retain the proceeds from the offering until the target offering amount is met and also allow investors to cancel their commitments to invest;
- ensure that the investor criteria set forth in the crowdfunding exemption are met;
- protect investors’ personal information and not compensate promoters, finders or lead generators for providing the personal information of potential investors;
- prohibit its directors, officers, or partners from having any financial interest in an issuer using its services; and
- meet such other rules as the SEC may determine for the protection of investors.
A company that makes an untrue statement of a material fact or omits a material fact in any of its written or oral communications in the offering or sale of its securities under the crowdfunding exemption will be liable to its investors. Investors may sue issuers for the amount they invested plus interest, but minus any income the investor received. If the investor no longer owns the stock they purchased, the investor may sue for damages.
A company’s directors, partners, principal executive officers, principal financial officer, controller and principal accounting officer, as well as any person who offers or sells the security in the offering, are also subject to this anti-fraud provision.
Within 270 days after enactment, the SEC is required to issue rules that it determines are necessary and appropriate to protect investors under the crowdfunding provision. In addition, within those 270 days, the SEC is required to issue a rule to exclude crowdfunding investors from the shareholder threshold that determines whether a company must become a reporting company under the Exchange Act.
General Solicitation Permitted in Regulation D and Rule 144A Offerings
The JOBS Act lifts the prohibition against general solicitations for, and advertising of, the sale of securities in private offerings under Regulation D and Rule 144A. As a condition, all purchasers under Regulation D must be accredited investors and all purchasers under Rule 144A must be qualified institutional buyers. The SEC must revise Regulation D and Rule 144A to so provide within 90 days after enactment.
This is a major federal law change to how private placements are now completed, and will open the door to all manner of advertising for securities offerings, both in print media and online. However, choosing to advertise involves a potential trade-off at the state level. Whereas many Regulation D offerings are exempted from state securities registration requirements by virtue of self-executing limited offering exemptions, those exemptions are typically conditioned upon the absence of advertising. If an issuer elects to advertise an offering not federally preempted by the National Securities Markets Improvements Act, a coordinated Form D filing may prove necessary in essentially all states where investors reside.
Cap on Private Shareholders Raised from 500 to 2,000
The JOBS Act raises the threshold number of shareholders that determines when a private company must register and file reports under the Exchange Act. Once a company has either 2,000 shareholders or 500 shareholders who are not accredited investors, such company will be required to register and file reports. The JOBS Act exempts from this threshold determination those shareholders who have received shares through an employee compensation plan. The combination of these provisions is significant because some issuers have been forced into inadvertently becoming reporting companies through exceeding the shareholder limit because of their private placements or the widespread use of equity compensation under their benefits plans.
The SEC is directed to issue rules implementing these provisions; however, there is no specific deadline for such rulemaking. In addition, within 120 days after enactment, the SEC is required to determine whether new enforcement tools are needed to prevent evasion of the shareholder threshold.
Size of Regulation A Offerings Raised from $5 million to $50 million
The JOBS Act raises the limit of offerings under Regulation A from $5 million to $50 million. Regulation A is often referred to as a “mini-registration” and was adopted to promote capital formation for small businesses. However, it has fallen into disuse in recent years due to the low dollar threshold, as well as disclosure requirements and the need to comply with state securities laws, which made Regulation D offerings under Rule 506 more attractive. However, there are various advantages to a Regulation A offering, including that securities sold under Regulation A are not “restricted securities” and can be sold to non-accredited investors. The increased dollar limit on such offerings may revitalize this method of capital formation.
The SEC is directed by the JOBS Act to create rules and regulations implementing the revised exemption.
Review of Regulation S-K
The JOBS Act also directs the SEC to review how the requirements of Regulation S-K (the primary regulation setting out what information is required to be publicly provided by reporting companies) can be updated and simplified, and report its recommendations to Congress within 180 days after enactment. Streamlining Regulation S-K could make IPOs and ongoing compliance activities of public companies less costly. Furthermore, since private placement memoranda are frequently drafted to parallel the provisions of registration statements, simplifying Regulation S-K would likely streamline capital raising for private companies as well.
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