In the spring of 2012, President Obama’s Jumpstart Our Business Startups Act was signed into law with the stated purpose of promoting American job creation and economic growth by improving access to the public capital markets for emerging growth companies. Included in the new law are significant reforms intended to ease IPO requirements and facilitate capital-raising for small businesses. These reforms will have significant implications on both public and private companies, as well as broker-dealers, private investment funds and small business startups. The provisions in the JOBS Act are centered around the following four pillars:
1. Easing requirements for initial public offerings and reporting burdens on emerging growth companies
Under the JOBS Act, the emerging growth company is defined as a new category of issuer (i.e. a company which seeks to raise capital). Emerging growth companies (“EGCs”) are subject to lighter compliance costs and disclosure obligations within the IPO process. Under JOBS, the guidelines for the public reporting of an EGC are intended to be less stringent. For example, an EGC is asked for only two years of audited financial data when registering their IPO, instead of the previously required three years.
Generally speaking, if a company’s annual gross revenues are less than $1 billion, it can be considered an emerging growth company. This status lasts for at least one year after an IPO and can continue for as long as five years, or until one of the following takes place:
- company revenues exceed $1 billion in the previous fiscal year
- the company incurs more than $1 billion in non-convertible debt over the previous 3-year period
- the company becomes classified as a “large accelerated filer,” (loosely defined as a large public company which has been subject to the SEC’s reporting requirements for at least one year).
2. Relaxing the restrictions which prevent companies from seeking private offerings through general solicitation and general advertising
Before the JOBS Act, small businesses had been required to comply with strict SEC regulations under Rule 506 of the Securities Act of 1933. Under Rule 506, issuers are barred from raising capital through public solicitation and advertising for investors. The JOBS Act requires the SEC to relax the prohibitions of solicitation for private offerings, as long as all investors are accredited. Companies are required to take reasonable steps (as detailed within SEC rules) to verify that purchasers of securities are indeed accredited investors.
SEC Rule 501(a) sets forth the definition of an “accredited investor.” Included are wealthy individuals as well as entities such as banks, corporations, insurance companies, trusts or other entities with more than $5 million in assets, including entities that are wholly owned by accredited investors. Generally speaking, an accredited investor is someone whose net worth (or joint net worth, with a spouse) exceeds $1 million, excluding the value of their primary residence. New rules also dictate that accredited investors may also be individuals whose annual income exceeds $200,000 (or $300,000 when considered jointly with a spouse).
After the new SEC rules go into effect, private companies will be free to market their offerings through print and broadcast advertisements, as well as internet ads, websites without password protection and other forms of communication. Companies will be able to access a significant layer of the investing public, and as long as the investors who actually purchase securities are accredited.
3. Legalizing ‘crowdfunding’, to raise online investments through multiple investors
The JOBS Act also provides for “crowdfunding,” which allows issuers to raise small amounts of capital from a large group of investors through the internet and social media. For companies to avoid having to register their offering with the SEC (which they must do if a crowdfunding or other exemption does not apply), investments earned via crowdfunding must not exceed $1 million over a one year period. The crowdfunding rule can be used along with other exemptions, but is not available to investment companies, to companies based outside the United States, or those that are already reporting to the SEC. Issuers face limitations on how much they may accept from a single investor within a 12-month period, subject to each investor’s individual personal finances. Each single investment is capped at $100,000.
Issuers must conduct crowdfunding either through registered broker-dealers, or through a ‘funding portal,’ a new financial intermediary created by the JOBS Act. Funding portals are exempt from broker registration, but must register with and submit to the SEC’s oversight and rulemaking authority. This is accomplished by requiring funding portals to join a national securities association. It will be some time before the new rules go into effect, as the SEC has been directed to fully adopt the crowdfunding exemption by December 31, 2012.
4. Expanding the public offering exemption within Regulation A
JOBS also amends a rule laid out in Regulation A of the Securities Act, which sets the maximum amount of funds issuers could raise at $5 million. Under the new rule (referred to as Regulation A+), that figure has been raised to $50 million (within a 12-month period). Every two years, the SEC will review the limit and make recommendations to increase the amount as it sees fit. If no change is implemented, the SEC will explain to Congress its reasoning for not raising the limit on Regulation A offerings.
In addition to adopting new rules detailing the provisions above, the SEC has been asked to conduct a series of studies on these topics and report back to Congress. The SEC’s stated mission is centered on protecting the investing public, and a number of SEC Commissioners have already expressed unease regarding the JOBS Act’s potential reduction of investor security. We will continue to monitor and update regarding JOBS Act developments as they unfold. If you have any questions or would like to learn more, please do not hesitate to contact Simone Yatrakis or Chintan Panchal.
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