Each spring, we mark the anniversary of the Jumpstart Our Business Startups (JOBS) Act with an in-depth update. So, six years after the landmark legislation was signed into law, is it living up to its promise of channeling more capital to the nation’s job creators and revitalizing the capital markets?
For impatient types, progress may seem slow. Adoption has been uneven, in part because of the staggered rollout of the law—Regulation Crowdfunding (aka Title III) did not go into effect until May 2016, for example. And public awareness of the new laws is still abysmally low.
That said, the evidence suggests the JOBS Act is helping a diverse range of entrepreneurs and business owners get the capital they need to grow—whether mom & pops or emerging growth companies. Women, minorities and others that have historically struggled to raise funds are benefiting. Women, in particular, are outperforming their male peers when it comes to crowdfunding investment capital.
The JOBS Act encountered some headwinds in 2017. In particular, Initial Coin Offerings (ICOs) sucked some of wind out of its sails. Buoyed by the Bitcoin frenzy and a hands-off regulatory stance, issuers raised $5.6 billion via ICOs last year. Now that regulators have made it clear that crypto-offerings must be treated like securities, ICOs are being brought into the fold of the JOBS Act.
Meanwhile, long-promised fixes to the JOBS Act have failed to materialize. Several bills have been floated in Congress, but despite a deregulatory environment, none have yet made it through the legislative gauntlet.
The SEC has extended some JOBS Act features, such as confidential IPO filings (allowed for emerging growth companies under Title I) to all companies. And it is reportedly considering allowing more companies to “test the waters” (as allowed under Title IV) by talking to potential investors before committing to a public offering.
Below is a title by title progress report for the JOBS Act as it turns the ripe old age of six.
Title I – Reopening American Capital Markets to Emerging Growth Companies
In a Nutshell: Relaxed regulatory requirements for smaller companies as a “nudge” to go public.
Background: Title I created a new category of issuers called emerging growth companies (ECGs), defined as an issuer with total annual gross revenues of less than $1.07 billion during its most recently completed fiscal year (the SEC raised the revenue cap last year from its original $1 billion).
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 (the SEC last year extended that benefit to all companies considering an IPO).
Effective since: April 5, 2012
Impact: The number of IPOs has risen since hitting record lows in 2008 and 2009. In 2017, 160 companies with market caps over $50 million went public. EGCs have accounted for 80% and 90% of IPOs over the past few years.
Title I has been used, as intended, by fast-growth startups such as Elon Musk’s Solar City, Snap and DropBox. It’s also been a magnet for foreign firms, especially from China.
Challenges: Lower disclosure may come with a cost. One recent study suggested that the shares of ECGs are priced lower and face greater post-IPO volatility than non-ECGs. The authors attributed those effects to a “risk premium” imposed by investors.
What’s ahead: The honeymoon may be over for the first crop of ECGs. That’s because ECG’s lose their status after five years if their revenues or the value of their public securities are greater than $1 billion, among other thresholds.
Title II – Access to Capital for Job Creators (“accredited investor” crowdfunding)
In a Nutshell: Made it possible for companies to advertise their private placements to potential investors (as long as they are only sold to accredited investors).
Background: Title II was the first form of crowdfunding under the JOBS Act to go into effect. 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. And there is no limit on how much can be raised. Reg D also preempts state securities laws, and gives issuers the ability to group investors into a single entity.
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.
Effective since: Sept. 23, 2013
Impact: Fast out of the gate, and finding its niche. From September 2013 to December 2016, 5,474 Rule 506(c) offerings have been filed, raising slightly more than $100 billion. But that pales in comparison to the $2.1 trillion raised under the 506(b) during the same period, according to the SEC. And the average raise for a 506(c) offering is $13 million, much smaller than the $26 million average for 506(b).
One reason for the lower usage of 506(c) could be that crowdfunding portals are required to verify the accredited status of investors, which means investors have to hand over sensitive financial documents—something they don’t have to do with traditional private placements.
A bright spot has been the combo of Reg CF and 506(c) parallel or “side by side” offerings. Platforms such as SeedInvest have been successful with these hybrid offerings. For issuers, they provide the benefits of Reg CF (engaging new investors/customers with small dollar investments) with the higher limits of Reg D and its deeper-pocketed accredited investors.
Going forward, Title II’s combination of public advertising and no financial limits is likely to make it a popular option for regulated token sales. Telegram, a blockchain-based network, raised $1.7 billion in February and March though through Title II.
Title III – The Capital Raising Online While Deterring Fraud and Unethical Non-Disclosure Act of 2012 (aka the ‘CROWDFUND Act’)
In a Nutshell: A brand new exemption that paved the way for mainstream investment crowdfunding.
Background: Title III—also known as Regulation Crowdfunding— 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. Instead of getting a t-shirt, you get a financial stake in the business.
It’s also the most controversial piece of the JOBS Acts. Critics argue (still) it will expose naive and vulnerable investors to fraud and undue risk. Others believe that attitude is patronizing, anti-free market and that individual investors can make informed decisions.
The fact is, the law limits the amounts companies can raise and individuals can invest, so no one is likely to lose the farm even if a deal goes bust. And by allowing the 95% or so of Americans who have been cut out of the private markets to invest, it opens up a vast new pool of capital.
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 waived the need for audited financials for most issuers and allowed more leeway for funding portals in selecting deals and taking a stake in them.
One final note: It is often referred to as “equity” crowdfunding, but that’s a misnomer. Businesses may choose to offer loans, revenue-sharing agreements and other forms of debt as well as shares of stock.
Regulation Crowdfunding Basics:
– Companies can raise up to $1.07M 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
Challenges: Reg CF does not allow investors to be grouped into a single entity, which makes for messy “cap tables” that can hinder follow-on funding. 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 has been mulling a bill that would increase the amount that companies can raise, allows SPVs and fix some of the flaws in the original law. Aside from these fixes, by far the biggest challenge remains the limited public awareness of crowdinvesting and the need to educate investors and entrepreneurs about how to make use of the new law.
Read more about Crowdfunding in Our Education section
Effective since: May 16, 2016.
Impact: Slow, steady—and diverse. As of April 4, 2018, there have been 849 Reg CF campaigns. About two-thirds have successfully hit their minimum funding targets (which is required for them to keep the money). The average amount raised is slightly over $404,000.
There are now 38 approved crowdfunding portals, with more in the wings.
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, are represented in the mix. And companies based in more than 40 states have participated to date.
A bright spot is the success women are finding with Reg CF. In one study, women-only led campaigns were successful 87.5% of the time, compared to 41% for male-only campaigns. Minority-led campaigns had a 46% success rate.
The investor base is growing, too. More than 114,000 individuals have invested in Reg CF campaigns to date, according to Crowdfund Capital Advisors. These investors have collectively committed over $113 million in capital, a more than three-fold increase from a year ago. (About half of that has been successfully invested).
The real measure of success, however, will be how well investors fare. To date there have been no big crowdfunding “exits.” But a number of debt and revenue-sharing deals have begun to pay investors back, on platforms such as NextSeed and others.
Finally, there is a ripple effect on communities. As one business owner who successfully raised money from local investors said: “There is a community empowerment component to crowdinvesting. Instead of just telling someone what is going to be on their street corner, this is a chance for them to make money while being involved with the active development of their neighborhood.”
Title IV – Small Company Capital Formation (aka Regulation A+)
In a Nutshell: Revised the little-used Regulation A to create a “mini-IPO” option for growing companies.
Background: 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 SEC for approval. Tier 1 preserves the need for state-by-state “Blue Sky” registration and review, which is costly and time consuming. Tier 2 pre-empts state laws, but requires audited financials and ongoing reporting, much like the reporting requirements of a public company.
Effective since: June, 2015.
Impact: Hitting its stride. In 2017, there were 122 Reg A offerings qualified by the SEC, according to a report by law firm Stradling. The lion’s share of them used Tier II. The average raise reported by issuers was $18 million, and legal fees averaged $93,000.
A separate tally by CrowdCheck put the cumulative number of Reg A+ filings since June 2015 at 310 (not including withdrawn filings) seeking an average of $21.6 million.
Who’s using it? In its first few years, the new Regulation 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 investment trusts (REITs) and online lenders have used it to extend investment opportunities to unaccredited investors.
Reg A has also attracted some duds. But overall, the quality of companies making use of the exemption is rising, notes Sara Hanks of CrowdCheck.
A bigger concern has been the lackluster performance of Reg A offerings that have listed on exchanges such as Nasdaq and OTC. Some companies, such as Chicken Soup for the Soul Entertainment (CSSE), Adomani (ADOM) and YogaWorks (YOGA), have seen their share price sink after promising debuts.
An SEC analysis notes that Reg A issuers are relatively small companies that are not covered by research analysts, and that this “information asymmetry” as well as concerns about adverse selection could be hampering their performance.
What’s ahead: The US House of Representatives has passed legislation that would raise the cap from $50 million to $75 million.
Title V – Private Company Flexibility and Growth
In a Nutshell: Allows private companies to have more shareholders to avoid pushing them into going public before they are ready.
Background: 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 (including employees with stock), 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.
Effective since: 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
In a Nutshell: Bumped up the number of shareholders a bank or bank holding company can have before certain securities regulations are triggered.
Background: Title VI is 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.
Effective since: April 5, 2012
Impact: More than 100 community banks have jumped at the chance to de-register, and no longer have to file reports with the SEC. That cuts down on red tape. But it has not stemmed a general decline in community banks and consolidation of market share among a small number of mega-banks.