When the Jumpstart Our Business Startups (JOBS) Act passed recently, many columnists and bloggers began weighing in with varying opinions, and some conjecture that may have muddied the waters.
As I've written before, thousands of us entrepreneurs will benefit from the law. This could become a very viable and exciting way for small companies to raise capital. But not yet. The Securities and Exchange Commission (SEC) has nine months to draw up the regulations.
As regular readers know, I've been writing about crowdfunding to raise investment capital since February 2011. My dream was shattered almost immediately by my trusted attorney, Chuck Hertlein, a partner of Dinsmore and Shohl in Cincinnati, who quickly pointed out that SEC rules prevented me from using crowdfunding in a way that would reward small investors with real investment opportunity while enabling me to raise additional capital to create jobs in rural USA.
The JOBS Act will change the environment for crowdfunding. Chuck's conclusion: "The JOBS Act contains some real goodies, and does have the potential to reinvigorate middle-market financing in the U.S."
Ahh, the dream is alive! As we wait for the crowdfunding regulations, I sat down with Chuck to get his insights.
Chris: Why was the JOBS Act needed?
Chuck: Until 2002 or so, the public financing markets in the U.S. were thriving. Things like crowdfunding, or public equity financing, by small- and mid-sized companies were economically feasible and pretty common. Then came Enron and other huge accounting scandals -- which gave birth to the Sarbanes-Oxley Act (SOX).
SOX had the practical effect of making small- and mid-sized public financings, and indeed the very existence of small- to mid-sized public companies, economically impractical. A small IPO could cost hundreds of thousands of dollars just in legal and accounting fees. So the small financing markets pretty much dried up and many smaller public companies either sold out or went private.
Either way, SOX forced them to rely on the private equity and debt markets because it prohibited any advertising or general solicitations for private financings. So, 21st century concepts such as online crowdfunding were legally impossible.
Chris: The JOBS Act reverses that course. What can we look forward to?
Chuck: Small investors and small companies can seek each other out. It will be easier to find and attract investors, be they large, small or in between. And small public companies won't have the same legal requirements of the giants: The Microsofts and Intels of the world.
It will allow hundreds or thousands of individual investors to make small investments, even online, in promising new companies. The JOBS Act creates a new crowdfunding exemption that will permit a qualifying company to raise up to $1 million a year from individual investors in increments potentially ranging from $2,000 to $100,000 per person - there are limits based on investor income and net worth.
Chris: The devil, they say, is in the details.Chuck: The JOBS Act does have some requirements concerning crowdfunding:
- The transaction must be done through either a registered broker-dealer or an online crowdfunding portal registered with the SEC.
- The company must provide prospective investors with certain financial information, from a tax return for offerings under 100,000 to fully audited financial statements for offerings of more than 500,000.
- The company must provide basic information like a business plan, description of the corporate structure, risk factors, and some other items.
- The investors have to demonstrate an understanding of the risks involved.
- The offering cannot be advertised other than through a registered crowdfunding portal.
Chris: Much better than before the JOBS Act. What are the downsides?
Chuck: There are a couple. For one thing, the law requires companies using crowdfunding to start filing annual financial statements with the SEC. That is a radical change for private companies that have never before been required to publicly disclose their financial statements.
Crowdfunding will not be available for any sort of pooled investment funds or other vehicles formed solely to invest in other businesses. That means no crowdfunded private equity or venture capital funds.
Chris: The JOBS Act eases restrictions on advertising for small investors. How does that relate to soliciting large investors?
Chuck: The SEC's Regulation D banned any "advertising or general solicitation" in private securities offerings. Investment opportunities could only be made available to investors with a pre-existing relationship with the company or its broker. These provisions tended to place a high premium on the services of expensive intermediaries such as brokerage, venture capital, and private equity firms. Those were the only legal ways for companies to connect with potential investors they didn't already know.
The JOBS Act eliminates the no advertising rule in offerings limited to accredited investors -- an individual with $1 million net worth exclusive of their home, or having $200,000 annual income, and several other categories. This is a massive sea change! Be prepared for a glut of investment advertising.
Chris: There is something new in the JOBS Act that we should discuss. That is the new term of Emerging Growth Company (EGC).
Chuck: Yes, and this is where there is a potential for really ramping up small public offerings. When most people think of "public companies," they think of the huge corporations that drive the stock market. But with the advent of SOX in 2002, even the smallest of public companies (having at least 500 shareholders and $10 million of assets -- a relative pittance in today's economy) became subject to the same set of draconian accounting and governance rules. The JOBs Act addresses this in two ways. First, the shareholder threshold for registration under the Securities Exchange Act of 1934 (where much of public company regulation resides) is increased dramatically -- the SEC's public company rules
won't apply to companies with fewer than 500 "unaccredited" shareholders and unlimited accredited investors, or 2,000 total shareholders (or simply 2,000 shareholders for community banks). Also, employees who hold shares are no longer counted for this purpose. So far fewer companies will be forced -- often prematurely -- into the SEC regulatory regime.
Second, stay under $1 billion in annual revenue, and you are an "emerging growth company" or EGC. As an EGC, you will be subject to some SEC public company regulations, but the SEC's most burdensome SOX regulations won't apply to you. The goal of Congress is to make it economically feasible for middle-market companies to go public and remain public.
Also, the SEC has required full federal registration for offerings of more than $5 million since the 1930s, with a simplified registration process (Regulation A) available under that amount. Again, $5 million is not what it used to be. So the JOBS Act raises the Regulation A threshold to $50 million.
So instead of one-size-fits-all regulations designed for the corporate giants, we'll have a tiered system of regulations that get more comprehensive as company size increases -- call it right-sizing the rules.
Chris: This seems to be an appropriate point for a disclaimer.
Chuck: This is a simplified description of the JOBS Act and decades of SEC regulations. Plus, the JOBS Act regulations won't be implemented for at least nine months, and in some cases it will take a year. If the SEC remains true to Congress's legislative intent, our public capital markets could become far more dynamic. As companies increase in size, the regulatory requirements will increase correspondingly. This makes far more sense than the present one-size-fits-all system. It should be fun to watch.
Chris: Last Thoughts?
Chuck: Entrepreneurs can't just sit on their hands while waiting for the SEC regulations. Now is the time to get your ducks in a row, your financials in order, and be prepared to take advantage of this legislation. It's called the JOBS Act, and it will certainly help fulfill the goal of creating jobs in rural America.
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