Since the enactment of the Jumpstart Our Business Startups Act (the “JOBS Act”) in 2012, the Securities and Exchange Commission (“SEC“) has slowly been making its way through the titles to the JOBS Act to promulgate the final regulations for implementation of the act. This is a short synopsis of the various new rules and proposed rules from the SEC regulating the new JOBS Act titles that govern three new capital raising strategies for start-ups, and small to mid-sized businesses.
The JOBS Act is intended, among other things, to reduce barriers to capital formation, particularly for smaller companies, which find it expensive, time consuming and painful to register their securities under the Securities Act of 1933 (the “Securities Act”). The JOBS Act requires the SEC to adopt rules amending existing exemptions from registration under the Securities Act and creating new exemptions that permit issuers of securities to raise capital without SEC registration.
First in line to receive implementing regulations was Title II of the JOBS Act finalized in 2013 (download published regulations). Title II provides a new exemption under Regulation D by adding Rule 506 (c). The real innovation with Rule 506 (c) is allowing a new exemption from registration of securities which involve general solicitation and advertising of private investment opportunities. However, to qualify for this exemption all purchasers of the securities must be “accredited investors” and the issuer must take reasonable steps to verify that the purchasers are accredited investors.
Accredited Investors are basically high net worth or high income investors (generally individuals with a net worth in excess of $1.0 million, excluding home equity, or annual income in excess of $200,000 in each of the two most recent years or a joint income with that person’s spouse of $300,000 in each of the last two years). The full definition with all its nuances is in Section 501(a) of Regulation D. The criticism of this innovation is that it continues to keep a large amount of the investing public on the sidelines – non-accredited investors.
The most recent regulations published by the SEC under the JOBS Act are the rules to implement Title IV, Section 401 of the JOBS Act, the rebirth of Regulation A known as Regulation A+. These regulations breathed life into a near dead exemption to registration which had gone relatively unused in recent years largely because the maximum that could be raised under old Regulation A was $5.0 million.
The maximum amount of capital that can be raised under Regulation A+ is now $50 million over a 12-month period. Regulation A+ creates a two-tiered framework for these offerings. Issuers in Tier 1 may offer and sell up to $20 million of securities over the course of a 12-month period and issuers in Tier 2 may offer and sell up to $50 million during 12 months. There are distinctions between these two tiers that are very important and will be discussed in more detail in later posts. The big breakthrough in Regulation A+ was permitting non-accredited investors to invest in these offerings, subject to a limitation that the non-accredited individual investor in a Tier 2 offering is limited to purchasing no more than 10 percent of the greater of the individual’s annual income or net worth.
New 506 (c) and Regulation A+ are technically not “crowdfunding” under the parlance of the JOBS Act. That label is given to Title III of the JOBS Act, which is a new exemption from registration under Section 4(a)(6) of the Securities Act. This is referred to as the “equity model” of crowdfunding in which providers of the money receive forms of equity, as opposed to rewards-based crowdfunding.
The proposal would provide a framework for the regulation of registered internet “funding portals” and brokers that issuers are required to use as intermediaries in the offer and sale of exempt securities sold pursuant to Section 4(a)(6) of the Securities Act. No endorsements here, but examples of “funding portals” are Crowdfunder, CircleUp, and EquityNet. Fox Business News has a good introduction to these types of equity based crowdfunding sites in an interview with Chance Barnett, the CEO of Crowdfunder.
The amount raised must not exceed $1 million in a 12-month period and individual investments in a 12-month period are limited to the greater of $2,000 or 5 percent of annual income or net worth, if annual income or net worth of the investor is less than $100,000; and 10 percent of annual income or net worth (not to exceed an amount sold of $100,000) if annual income or net worth of the investor is $100,000 or more. The transactions must be conducted through an intermediary that either is registered as a broker or is registered as a “funding portal.” The size lends itself well to the internet funding model and small start-up enterprises. Issuers will have to wait for this innovation since the final rules for this crowdfunding exemption have not yet been published.
Use this link to download the SEC’s proposed regulations for crowdfunding capital raising.
If you have questions about the regulations, our Business Transactions Team attorneys would be glad to speak with you.