As a threshold matter, an uninitiated reader might best understand the JOBS Act by considering it section by section:
As noted above, Title I of the JOBS Act carves out a new category of filer under the federal securities laws: the “emerging growth company”, with the intention of providing such companies with an on-ramp to ease their transition from private to public status.
The JOBS Act defines an emerging growth company as one having total annual gross revenues of less than $1 billion as of its most recently completed fiscal year, with the exception of those companies that have held an initial public offering on or before December 8, 2011.
There are a number of benefits that come along with being categorized as an emerging growth company, including the ability to submit a confidential IPO registration statement to the SEC for non-public review. Such registration statement only becomes publicly available 21 days in advance of company’s roadshow, thereby protecting an emerging growth company from public scrutiny until that time.
In addition, as a result of the JOBS Act, emerging growth companies:
Prior to enactment of the JOBS Act, a company that had accumulated total assets in excess of $10 million dollars and a class of equity securities held of record by 500 or more shareholders, was required to register that class of equity securities under the Exchange Act and begin filing periodic reports.
As noted above, Title V of the JOBS Act increased the registration threshold from 500 shareholders of record to either 2,000 persons or 500 persons who are not accredited investors (excluding those persons who receive securities pursuant to an employee compensation plan in a transaction exempt from registration under the Securities Act of 1933 (the “Securities Act”)). In the case of a bank or bank holding company, Title VI of the JOBS Act increased the registration threshold from 500 shareholders of record to 2,000 persons.
Consequently, a private company may now raise several rounds of capital while at the same time using equity incentives to compensate management and employees without triggering Exchange Act registration requirements or being compelled to go public.
September 23, 2013 marks a sea change of precedent going back decades. It is the date on which it became permissible for issuers to generally solicit and publicly advertise in connection with certain private offerings of securities made in reliance on new subsection (c) of Rule 506 of Regulation D, promulgated under Section 4(a)(2) of the Securities Act. Rule 506 is by far the most popular of all private offering exemptions.
In its original state, Rule 506 (which will be retained in subsection (b) of the amended Rule 506) allows an issuer to offer and sell an unlimited amount of securities to an unlimited number of accredited investors and up to 35 non-accredited investors who either alone or with a purchaser representative meet certain sophistication requirements. While there are a number of conditions associated with Rule 506 offerings, perhaps the most limiting was that an issuer could not offer or sell securities through any form of general solicitation.
Under newly adopted Rule 506(c), an issuer will still be able to offer and sell an unlimited amount of securities but can now use general solicitation to do so (subject to the requirement that reasonable steps are taken to verify that all purchasers are accredited investors). This, in and of itself, has the potential to transform private capital markets.
First, and more obviously, it permits an issuer to make a much broader appeal: no longer will issuers be limited to reaching out to people with whom they (or their intermediaries) have pre-existing relationships.
Secondly and somewhat overlooked by many commentators, we believe the demand for such investments will increase over the next several years, with more and more accredited investors of all types entering the private capital markets. By some estimates there are upwards of ten million individual accredited investors in the United States.1 Yet historically, only a small fraction of that number has participated in a private placement. Why? We believe one of the major reasons is due to a lack of access. Simply stated, there are millions of individual accredited investors who do not have the kind of pre-existing relationships that would expose them to private investment opportunities. The ban on general solicitation has kept those investors in the dark about the private capital markets.2
For these reasons, Rule 506(c) has the potential to transform the private capital markets and make private offerings a viable alternative to registered public offerings for both private and public issuers.
While the rules have yet to be proposed and, therefore, much remains to be seen regarding the actual mechanics of crowdfunding, enough is known for us to conclude that crowdfunding will be of very limited utility.
First, an issuer is limited (by the language of the JOBS Act itself) to raising a maximum of $1 million in any 12-month from all exempt offerings if it utilizes Title III crowdfunding. Second, investors will be limited in how much money they can invest through Title III crowdfunding. Those whose income and net worth are not at least $100,000 will be limited to the greater of $2,000 or 5% of such their annual income or net worth. Those who meet the $100,000 thresholds will be limited to 10% of their annual income or net worth, but not to exceed $100,000.
These are significant limitations. For all but the smallest of issuers $1 million dollars over a 12-month period is not a great deal of money, especially when raising that $1 million could potentially require an issuer to take on hundreds of new investors. What’s more, in addition to the potential for corporate governance and investor relations difficulties, a Title III crowdfunding offering may have limiting effects on the future capital raising prospects of many issuers.
One point of clarification here: earlier we stated that the crowdfunding rules have yet to be proposed, and that remains true, but even now you may find platforms that appear to be operating as crowdfunding portals. These are not, however, Title III crowdfunding “portals”. Rather, they are “platforms” operating in reliance on a series of SEC no-action letters and, following September 23, 2013, in reliance on an exemption established by Title II of the JOBS Act. These platforms are limited to accredited investors and are not subject to the same constraints as Title III crowdfunding portals will be.
Our views as expressed in the preceding paragraph are limited solely to Title III crowdfunding portals.
The enactment of the JOBS Act marks a transformative period for the private capital markets, as it has made significant changes to the landscape of the federal securities laws. While you may have come to associate the JOBS Act with startups, or even just crowdfunding, we hope that you now recognize many of the provisions of the JOBS Act are universal in nature and have the potential to benefit to all manner of issuers.
1 – See Accredited Investor Definition
Vanessa Schoenthaler is a Partner with Sugar, Felsenthal Grais & Hammer. She focuses her practice on corporate and securities matters with an emphasis on private and public securities transactions, compliance and disclosure obligations and corporate governance matters. Her clients rely on her deep experience navigating the complexities of both the public and private securitiesregulatory environment.…
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