The fifth anniversary of the signing of the JOBS Act marks a significant milestone. For the first time, we can begin to take the full measure of the law, now that all of its six provisions have gone into effect. So how is it living up to its promise to channel more capital to the nation’s job creators and revitalize the capital markets?
Based on the evidence so far, the landmark legislation is indeed helping a diverse range of small businesses get access to the capital they need to grow. Adoption of the new rules has been slow and steady, even modest, and that should come as no surprise. This is just the beginning of what could be a fundamental transformation of the capital-raising landscape—one that benefits small businesses, everyday investors and their communities.
The underlying factors that drove the JOBS Act are just as urgent now as when the law was conceived in the aftermath of the Great Recession. As Raymond J. Keating, Chief Economist for the Small Business & Entrepreneurship Council pointed out recently, angel investments, venture capital and bank lending to small business have still not reached their pre-recession levels.
The wealth gap also continues to grow and wages remain stagnant. By allowing all Americans to invest in startups and small businesses and participate in their success (or failure), The JOBS Act can potentially help create wealth in communities and a sense of shared prosperity.
This landmark legislation—passed by a bipartisan Congress and signed by President Obama—is a grand experiment in democratizing finance. And it’s a work-in-progress. In the months ahead, we’re likely to see improvements and fixes rolled out, such as a way to organize many small investors into one entity and mechanisms to buy and sell JOBS Act securities on the secondary market.
In the meantime, here’s a progress report for the JOBS Act at Year Five.
Title I – Reopening American Capital Markets to Emerging Growth Companies
Title I created a new category of issuers called “emerging growth companies,” defined as an issuer with total annual gross revenues of less than $1 billion during its most recently completed fiscal year. To encourage these growth companies to go public and address an alarming drop-off in IPOs, Congress created an IPO “on-ramp” for ECGs by relaxing regulatory requirements for going public, including requirements for financial disclosure, reporting and other measures required under Sarbanes-Oxley regulations. ECGs may also file a confidential draft register with the SEC, protecting their privacy until they are ready to commit to a public offering.
Status: Was effective immediately (April 5, 2012).
Impact: Emerging Growth Companies have accounted for the lion’s share of recent IPOs—110 out of a total 128 IPOs in 2016. The percentage was similar in 2015. Title I has been used, as intended, by fast-growth startups such as Elon Musk’s Solar City, as well as a large number of biotech companies. But it’s also been a magnet for long established companies, such as the century-old British soccer team Manchester United, and foreign firms, especially from China.
Title II – Access to Capital for Job Creators (“accredited investor” crowdfunding)
Title II was the first form of crowdfunding under the JOBS Act to go into effect, and arguably one of the most successful. It allows private companies conducting a private placement under Regulation D Rule 506 to publicly market the offering. Before that, public marketing was banned. However, the securities can only be sold to accredited (wealthy) investors (earning it the nickname of ‘rich man’s crowdfunding’)
Specifically, the JOBS Act amended Reg D Rule 506—a widely used securities exemption for private companies raising money from accredited investors—to include a new sub-rule, Reg D 506(c) that eliminates the ban on general solicitation and advertising. Companies issuing securities under the new 506(c) exemption can now openly talk about and advertise the fact they are raising money. (Companies opting to use the traditional Reg D 506(b) cannot).
As before, issuers are not required to produce audited financials or ongoing disclosure.
In practical terms, Title II improves the existing private placement process, allowing companies to reach out to more accredited investors, but it does not represent a major new funding avenue.
Status: Rules went into effect Sept. 23, 2013
Impact: In its first three years, there have been more than 6,600 offerings conducted under Title II, according to Crowdnetic, with close to $1.5 billion in capital commitments (there is no way of tracking how much of that capital was successfully raised).
But the pattern has been mixed: the volume of Title II deals has plummeted, from 4,712 in Year 1 to 550 in Year 3. However, the average deal size has increased, from $405,295 to $731,222 in Year 3. The success rate of companies using Title II to raise money has also increased, from 20% of offerings in Year 1 to 30% in Year 3.
Crowdnetic views this as the maturation of the industry: “As Title II ages and begins to gain a foothold, it is able to attract larger, more successful, or slightly later-stage issuers, as opposed to numerous smaller seed-stage companies in the earlier years that might have been testing out the new capital formation tool.”
Some companies are finding Title II a convenient tool to handle overflow demand from Regulation Crowdfunding (Title III) offerings, which are capped at $1 million. And others are crafting dual Title II-Title III offerings from the get-go.
Title III – The Capital Raising Online While Deterring Fraud and Unethical Non-Disclosure Act of 2012 (aka the ‘CROWDFUND Act’)
Title III was viewed as the most revolutionary provision of the JOBS Act, and rightly so: it allows any American, regardless of wealth, to easily invest in small, private companies for the first time in more than 80 years. This public investment crowdfunding must take place on SEC-sanctioned funding portals—think of it like Kickstarter, but for investing.
The provision had its detractors: Critics argued it would expose naive and vulnerable investors to fraud and undue risk. (Others believe that attitude is patronizing, and that individual investors can make informed decisions.)
The fact is, the law limits the amounts that companies can raise and individuals can invest, so no one is likely to lose the farm if a deal goes awry. And for better or worse, by allowing the 95 or so percent of Americans who have been cut out of the private markets to invest, it will open up a vast new pool of capital for the nation’s small businesses, and allow everyday investors to capture some of the upside that has mostly flowed to wealthy, well-connected investors.
A bigger issue may be the burdens imposed on funding portals and the challenges of making small deal economics work.
The final rules issued by the SEC in 2015 improved upon the original draft rules—in particular by waiving the need for audited financial for most (but not all) issuers and allowing more leeway for funding portals in selecting deals and taking a stake in them. But other challenges remain.
Title III Basics:
– Companies can raise up to $1M in a 12-month period
– Investors are limited in what they can invest each year (to $2,000 or 5% of net worth or income if net worth or annual income is less than $100,000; or 10% of net worth or annual income (whichever is the lesser) if those measures are $100,000 or greater. More here).
– Offering must be conducted via an SEC-sanctioned intermediary, either a funding portal or a broker/dealer platform
– Communications between issuers and potential investors must primarily take place on the funding platform
– Issuers must be based in the US and cannot be an investment company, a public reporting company or a “bad actor”
– Issuers must file Form C with the SEC at least 21 days prior to launching an offering
– Once the offering is complete, companies must update shareholders on an annual basis
Bonus: Companies can run a Title III crowdfunding campaign alongside a larger Title II (accredited investor) or Reg A+ raise.
Challenges: Title III does not allow investors to be grouped into a single entity, which makes for messy “cap tables” that can hinder follow-on funding. (In contrast, under Title II, individual investors can be combined into a Special Purpose Vehicle that allows them to be counted and managed as a single shareholder, streamlining communications, voting, etc.) In addition, if a company has over 500 unaccredited shareholders and over $25 million in assets, it is required to become a public company.
Congress is working on a bill that would increase the amount that companies can raise, allows SPVs and fix some of the flaws in the original law.
Read more about Crowdfunding in Our Education section
Status: Went into effect on May 16, 2016. The Fix Crowdfunding Act introduced by Rep. Patrick McHenry would increase the amount that companies are able to raise from $1 million to $5 million, among other changes. Fix Crowdfunding and related bills are expected to move to the front burner in 2017.
Impact: Off to a respectable start. By the end of 2016, after just a little more than 7 months, 186 companies had launched “Reg CF” campaigns, attracting $19 million in capital commitments. Successful campaigns raised an average of $226,000. And investor demand is growing rapidly. As of publication date (May 16, 2017) investor commitments reached $35 million—an increase of $16 million, almost as much as was committed in all of 2016.
Of completed campaigns, roughly half have succeeded in reaching their minimum funding targets, which is required for them to keep the money.
Who’s using the exemption? Food, beverage, wine and spirits companies lead the field in sheer number of deals, but technology and transportation companies—everything from electric bikes, cars and even jetpacks—have attracted significant amounts of investor capital. Women and minority-led ventures as well as B Corps were modestly represented in the mix. And companies based in 28 states have participated to date.
Crowdfund Capital Advisors (CCA) estimates that 2.2 jobs are created by companies within the first 90 days after a successful with Regulation CF campaign.
The number of funding portals grew as well, from 15 to more than 25 today (one was shut down by regulators).
Jason Best of CCA sums up Reg CF’s progress this way: “You’ve got a new asset class, new investors, a new investment channel, new regulation and new issuers, which means we’re looking at early adopters in this space.” In 2017, CCA expects to see 500 to 700 new campaigns—about 50 a month—that will raise up to $70 million in total.
Title IV – Small Company Capital Formation (aka Regulation A+)
Title IV of the JOBS Act required the SEC to boost the offering amount allowed under Regulation A from $5 million and fix some of its drawbacks, namely the need to register with both federal and state regulatory authorities. The new Regulation A+ rules create two tiers of offerings: Tier 1 allows issuers to raise up to $20 million in a 12-month period; Tier II, up to $50 million.
The SEC allowed unaccredited as well as accredited investors to participate in Reg A+ offerings, making it a true public offering. And it added a valuable tool: the ability for companies to “test the waters” with potential investors before committing to an offering.
This is a capital-raising tool for high-growth companies with large capital needs. And it’s not inexpensive. Issuers need to file a thick offering document (Form 1-A) with the S.E.C. for approval. Tier 1 preserves the need for state by state “Blue Sky” registration and review, which is costly and time consuming. And Tier 2 imposes on companies an ongoing reporting burden, including audited financials, much like the reporting requirements of a public company.
In addition, an open issue is how these mini-IPOs will be traded and supported in the after-market after their restriction periods. To date, some Reg A+ issuers have opted to list on the OTC and NASDAQ markets.
Status: Rules went into effect in June, 2015.
Impact: In its less than two-year existence, Reg A+ has attracted bold and innovative entrepreneurial ventures that might have lacked suitable funding in the past. Examples include next generation electric cars, sci-fi aircraft, media and medical marijuana ventures. In addition, real estate crowdfunding platforms and online lenders have used it to extend investment opportunities to unaccredited investors. However, companies seem to be struggling to raise large amounts of money that would live up to “mini IPO” potential.
As of October 31, 2016, 147 companies have filed offering statements for Regulation A+ offerings, seeking up to $2.6 billion in financing, according to the SEC.
Of those, 81, or a little over half, have qualified by the SEC to go ahead with their offerings. The average issuer was seeking to raise $18 million.
A more updated estimate puts the total at year-end 2016 at 165 filers and 94 qualified offerings.
That’s approaching the total number of annual stock market IPOs (albeit in a sluggish IPO environment).
SEC qualification can take months and Reg A+ campaigns typically last for a year, so there are relatively few offerings that have been completed. The most high profile is Elio Motors, the maker of an electric three-wheeled vehicle. Elio raised $17 million through Reg A+ from 6,600 investors—many of whom also pre-ordered the vehicles. Elio listed on the OTCQX market, but it’s shares have languished in the face of delays and financial concerns.
One of the ballyhooed features of Reg A+ is the ability for companies to ‘test the waters’ – or gauge interest from investors before committing to the expense of an offering. But according to some estimates, only 3% to 7% of investors who indicate interest follow through with an investment. One explanation might be the long time lapse between the TTW campaign and an actual offering, which can take several months to get SEC qualification.
Title V – Private Company Flexibility and Growth
Title V of the JOBS Act addressed a problem familiar to many fast-growing startups that use equity shares to attract and retain employees. Under former rules, once a company reached 500 shareholders, it was considered a public company and subject to ongoing reporting and disclosure requirements. In the most high profile case, Facebook was forced to go public before it wanted to because it amassed too many shareholders.
Title V raises the number of shareholders a company can have before it is considered publicly held from the current 500-shareholder threshold to 2,000 shareholders (as long as the number of unaccredited investors remains under 500). It also excludes employees who receive shares as compensation from counting toward the new threshold.
Status: Was effective immediately (April 5, 2012)
Impact: A good thing for companies that want to stay private longer and maintain their autonomy. However, as some observers have noted, Title V undermines the stated regulatory goal of revitalizing the languishing IPO market.
Title VI – Capital Expansion
Title VI was similar to Title V but aimed at community banks. The intent was to help small banks raise capital without triggering securities regulations. Specifically, Title VI increased the 500-shareholder threshold for banks and bank holding companies to 2,000 shareholders (with no limit on unaccredited investors). It also removed registration and reporting obligations for banks with fewer than 1,200 shareholders.
The SEC updated the rules in 2016 to exclude individuals who received stock as part of an employee compensation plan from the “holder of record” definition, among other amendments.
Status: Was effective immediately (April 5, 2012)
Impact: Unclear. But it has not stemmed a general decline in community banks and consolidation of market share among a small number of mega-banks. That said, regulators have recently signaled a willingness to grant more bank charters, so Title VI may help attract newcomers.