Lexington, KY - Congress passed, and in early April President Barack Obama signed, the Jumpstart Our Business Startups (”JOBS”) Act. This new legislation affects significant changes in federal law regulating how small and emerging companies raise funds. While a detailed review of the new law would long exceed the space available for this article, a few of its provisions are briefly summarized and will be welcomed by entrepreneurs and small businesses seeking additional capital.
Advertising private offerings to affluent investors
As small-business owners who have tried raising capital in the past know, current limitations can prove insurmountable on advertising and soliciting investors in small, private offerings. These limitations include restricting solicitations to prospective investors with whom the small business has existing contacts and prohibiting advertising, both of which greatly limit the universe of investor sources. Thanks to the JOBS Act, in about 90 days, companies will be able to advertise Regulation D offerings under Rule 506 when those offers are made only to “accredited investors” (i.e., investors that have annual incomes in excess of $200,000 or $1,000,000 or higher net worth, excluding the equity in the investor’s home).
This development will greatly expand the range of persons and institutions from which small companies will be able to raise debt and capital. However, it is yet to be seen if the U.S. Securities and Exchange Commission will curtail any of this apparent benefit in implementing the new rules. For example, will the SEC attempt to restrict the content or nature of advertising? Nonetheless, the JOBS Act should help ease the difficulty of small businesses raising funds from affluent investors in Kentucky and other markets. Still, it will remain the burden of the offering company to determine that the purchaser is, in fact, an accredited investor and that all other securities law requirements are met, including disclosing to investors all material information about the company and investment.
Note that, consequent to the Dodd-Frank Act and regulations issued late last year by the SEC, the definition of who is an accredited investor has in effect been restricted by excluding from the wealth calculation equity the primary residence and, in certain instances, other assets acquired by pledging that equity.
Crowdfunding
Spurred in part by the 2009 online attempt through social media to raise millions of dollars from millions of small investors to acquire Pabst Brewing Co., which the SEC ultimately stopped as an unregistered public offering of securities, Congress is now forcing the SEC to permit “crowdfunding” on a limited level. Again, thanks to the JOBS Act, it will now be possible for companies to raise up to $1 million through crowdfunding websites. It is quite likely that this is the provision of the Act that has received the most public press. The final parameters of these new provisions are unknown; the SEC has 270 days in which to adopt its regulations. Generally speaking, small companies will be able to register with CrowdFunding Investor (CFI) website portals and after what is anticipated to be a low level of mandatory disclosure, solicit relatively small individual investments. These investors may be of any income or net-worth level. For persons with a net worth or annual income of $100,000 or more per year, the maximum investment in any individual company through crowdfunding will be 10 percent of the income or net worth, capped at $100,000; the maximum permissible investment by those with net worth or annual income of less than $100,000 per year will be 5 percent of net worth or annual income. The CFIs will be regulated by the SEC.
Crowdfunding has the potential to be a very useful source of start-up funding for entrepreneurs who have great ideas with popular appeal. It may also prove useful to already established businesses that have broad customer or community support and are in need of small amounts of capital. As a word of warning, entrepreneurs and small businesses should enter crowdfunding thoughtfully, and have in place mechanisms and procedures to deal with the dozens, hundreds or even thousands of partial, albeit small, co-owners or lenders that could result from a successful crowdfunding raise.
Limit on state interference
The new federal rules with respect to both advertising of Rule 506 offerings to accredited investors and crowdfunding preempt state law; the individual state security regulators may not enact rules or regulations that limit these opportunities. The state regulators do retain, however, the power to bring enforcement actions in cases of possible fraud.
Emerging growth companies
Under the JOBS Act, many small companies, having gone public, will transition into the full range of regulatory requirements applicable to public companies rather than being subject to all of them immediately. It was estimated after the enactment of the Sarbanes-Oxley Act that the annual compliance cost for small companies having gone public would be in the range of $1 million per year. Under these new rules, newly public companies will over a period of time transition into the full range of compliance and disclosure obligations. In addition, so-called “emerging growth companies,” which may include companies with revenues up to just less than $1 billion, will be exempt from certain of the disclosure obligations, including the requirement of shareholder advisory votes on executive compensation.
Thomas E. Rutledge and Rich Mains are attorneys in the Louisville and Lexington offices of Stoll Keenon Ogden PLLC, respectively.