By Chris Brummer & Daniel Gorfine
On September 23, the SEC officially implemented Title II of the JOBS Act by lifting a decades-old ban on the mass marketing of private securities offerings – meaning those securities not formally registered with the SEC. This has triggered enormous excitement in startup and small business communities as entrepreneurs consider ways to raise funds through newly available capital-raising tools. But even with the increased media coverage and interest, there is still a good deal of confusion about what portion of the law went ‘live,’ and how this portion relates to other provisions in the legislation.
Much of the confusion can be tied to the habit of conflating different aspects of the JOBS Act and calling it all “crowdfunding.” The fact is that the JOBS Act tackles access to capital in a number of distinct ways, each with its own set of opportunities, risks, and questions. And while the law includes aspects related to use of the Internet and social media – elements that most people associate with crowdfunding – large sections are also focused on creating new opportunities for wealthier investors and private capital markets. Understanding these distinctions is critical for entrepreneurs and investors alike. To help, here’s a quick primer on the more prominent features of the JOBS Act.
- Crowdfunding. Let’s start with the term ‘crowdfunding.’ Crowdfunding refers to the process by which capital is raised for a project, venture, or enterprise through the pooling of numerous and relatively small financial contributions or investments from the public, usually via the internet. Donation-based or ‘non-financial-return’ crowdfunding is already in existence and has been made popular by platforms such as Indiegogo and Kickstarter. While the success of this non-investment model certainly inspired some of the thinking driving the JOBS Act, it is important to note that this kind of crowdfunding is not directly impacted by the law. For the sake of clarity, let’s call donation-based or non-financial-return models: crowdfunding.
- Title I of the JOBS Act: the IPO On-Ramp for ‘Emerging Growth Companies.’ The first part of the JOBS Act deals with companies looking to go public through an initial public offering (IPO). In response to a trend of declining IPOs over the past few decades, Congress created special rules for so-called “emerging growth companies” (EGC) – defined as a company with less than $1 billion in revenues over the past fiscal year – whereby the company would be exempt, or at least partially exempt, for a period of time from certain disclosures that were thought to deter companies from choosing to go public. An EGC is also permitted to file a confidential IPO registration statement with the SEC that must be made public at least 21 days before it begins actively promoting the sale of its offering, and can ‘test the waters’ with certain qualified buyers to gauge interest in the offering. This is all intended to jumpstart a laggard IPO market, especially for small companies. This provision went ‘live’ with the legislation, and is what Twitter is relying on for its planned IPO. This portion of the law can be referred to as: the IPO On-Ramp.
- Title II of the JOBS Act: General Solicitation and Accredited Investors. The second part of the JOBS Act is what has been drawing attention in recent days due to significant changes in rules governing certain private offerings. Historically, a Regulation D, Rule 506 offering has been exempt from SEC registration provided that the offering is not publicly advertised and that the purchasers are largely qualified institutions or “accredited” investors – those whose net worth is greater than $1 million (excluding a primary residence) or whose individual income exceeded $200,000 ($300,000 for couples) for the past two years with the expectation for that level of income to continue in the current year. Title II of the JOBS Act called for the SEC to lift the ban on mass marketing these offerings, provided that the issuer reasonably believes and has taken reasonable steps to verify that the buyers of the private securities are in fact accredited. Unlike Title I, this portion of the law required the SEC to issue final rules before going ‘live.’ September 23 was the day that the SEC’s new rules went into effect lifting the ban, and providing parameters as to how an issuer might go about verifying the status of investors. Notably, the SEC also has issued newproposed rules that would impose additional filing and disclosure requirements for those issuers taking advantage of general solicitation, but these rules have not been finalized or put into effect. Let’s call this portion of the law: 506(c) investing.
- Title III of the JOBS Act: Public Securities Crowd Investing. This next part of the JOBS Act is probably what the law is best known for: legalizing securities crowd investing. More specifically, a company can raise up to $1 million within a 12 month period from the general public through a broker-dealer or ‘funding portal’ website. Investors are subject to annual investment caps based on their income or wealth, and there are investor education requirements, as well as limits on general advertising. This portion of the law also requires SEC rulemaking before it can ‘go live.’ The SEC is now nine months late on issuing new rules, although the prevailing expectation based on Commission statements is that proposed rules will be out this fall. Nevertheless, until final rules are issued, securities crowd investing is not permitted. Instead, only close cousin 506(c) investing is available to a limited percentage of the population. For the sake of clarity, let’s differentiate between non-financial-return or donation-based ‘crowdfunding,’ Title II 506(c) investing, and Title III: crowd investing.
- Title IV of the JOBS Act: Regulation A+. This next title of the JOBS Act potentially increases the attractiveness of another securities registration exemption. Regulation A has permitted the sale of securities to both accredited and unaccredited investors so long as the issuer files a mini-registration with the SEC and complies with relevant state law requirements in each state where funds are solicited. One online issuer, Fundrise, has used this exemption to raise money from investors in Washington, D.C. and Virginia for a local commercial real estate project. Title IV of the JOBS Act increases the offering limit from $5 million to $50 million in a 12-month period, requires that certain filings be provided to investors, and provides for annual audited financial statements. This portion of the law requires SEC rulemaking before going live, which has to date not yet occurred. For the sake of clarity, lawyers and wonks tend to call this portion of the law: Reg A+ investing.
- Title V of the JOBS Act: Private Companies Stay Private Longer. This final portion of the JOBS Act raises the threshold on the number of shareholders a company can have before it is subject to Exchange Act annual reporting requirements (e.g. a 10-Q or 10-K). Previously, a private company could remain private until it reached 500 shareholders. Title V changes this limit to 2,000 shareholders, or 500 shareholders who are unaccredited. In combination with Title II of the JOBS Act, this change means that many private companies may be able to raise more money privately and remain private longer than in the past. On the one hand this may potentially be in conflict with the goals of the IPO on-ramp, though on the other hand this may help facilitate a pipeline of companies mature enough to confidently enter public markets.
While the above explanation of some of the key provisions of the JOBS Act is by no means exhaustive, it is intended to shed light on key distinctions in the law. It is critical that market participants understand these distinct capital-raising tools and related risks and opportunities. And remember, the JOBS act isn’t just “crowdfunding,” but a heck of a lot more.
Chris Brummer is a professor of law at Georgetown University and a Senior Fellow at the Milken Institute; Daniel Gorfine is the Washington-based Director of Financial Markets Policy & Legal Counsel for the Milken Institute.