It doesn’t get much attention outside of crowdfunding and financial circles. No one mentions it in presidential campaigns, either to take credit or disparage it. But it’s hard to understate the importance of the JOBS Act, the landmark securities legislation signed into law on April 5, 2012 by President Obama with broad bipartisan support. As we mark the law’s fourth anniversary, its pieces are finally coming together to form a coherent whole.
It’s not perfect. And it will evolve—indeed, the bill’s original champions in Congress are already working on improvements. But even as Title III—the final and potentially most revolutionary provision that will open up equity crowdfunding to everyone—is set to go into effect next month, this set of laws is already changing the face of finance, providing new capital-raising tools for every stage of business and opening up brand new opportunities for investors.
So on its fourth birthday, we offer a status report and JOBS Act refresher:
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 and reporting. ECGs may also submit draft registrations for confidential, non-public review by the SEC.
Status: Was effective immediately (April 5, 2012). The provision was further modified by the FAST Act, signed into law in December, 2015. FAST simplified disclosure requirements for smaller issuers and clarified rules for secondary selling of these privately issued securities.
Impact: Emerging Growth Companies have accounted for the lion’s share of recent IPOs—86% of IPOs in 2015, according to Citi, and two-thirds of IPOs in 2014, according to another study. Title I has been used, as intended, by fast-growth startups such as Elon Musk’s Solar City. 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 to date. It allows private companies conducting a private placement under Regulation D Rule 506 to publicly market the offering. Before that such marketing was banned. The securities can only be sold to accredited (wealthy) investors.
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) exemption cannot advertise).
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 two years, there have been more than 6,000 offerings conducted under Title II, according to Crowdnetic, with recorded capital commitments of $870 million (there is no way of tracking how much of that capital was successfully raised). That’s still a small portion of Regulation D private offerings, but growing fast.
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 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.
As such, it is also the most controversial piece of the JOBS Acts. Critics argue it will 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 that individuals can invest, so that no one is likely to lose the farm even 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 market to invest, it will open a vast new pool of capital. A bigger issue may be the burdens imposed on funding portals, and making small deal economics work.
The final rules issued by the SEC last fall improved upon the original draft rules—in particular by waiving the need for audited financial for most 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 every 12 months
– 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 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.
These issues will become more clear after Title III goes into effect on May 16. In the meantime, Congress is already working on a bill that would increase the amount that companies can raise and fix some of the flaws in the original law.
Read more about Crowdfunding in Our Education section
Status: Goes into effect on May 16, 2016. Recently, Rep. Patrick McHenry introduced a new bill that would increase the amount that companies are able to raise from $1 million to $5 million, among other changes.
Impact: To be seen! Title III is expected to have a slow ramp up as portals, investors and entrepreneurs get comfortable with the new law. In the meantime, the long wait for Title III has inspired at least 30 states to create their own exemptions allowing investment crowdfunding within their state borders, which may offer some issuers and investors a more attractive option.
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 Reg 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.
Significantly, the SEC preserved the ability for 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 is 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 have listed on the OTC and NASDAQ markets.
Status: Rules went into effect in June, 2015.
Impact: Reg A+ has been the sleeper of the JOBS Act. In less than a year, it 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, crowdfunding platforms and online lenders have used it to extend investment opportunities to unaccredited investors.
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: Allows companies to stay private longer, giving them more autonomy.
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 I 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.
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.