The Jumpstart Our Business Startups Act, or JOBS Act, was signed into law on April 5th, 2012. The legislation was designed to make it easier for small businesses in the U.S. to raise capital through a number of changes in the securities law. Some of these changes were already in effect, including a streamlining of the IPO process and an increase in the investor threshold forcing companies to go public (see Facebook). On September 23rd, 2013, Title II went into effect (EDIT: About a week after Title II went into effect, the SEC reopened its comment period for 30 days to discuss these rules. So currently these changes are proposed and are not set in stone. October 23rd is the new deadline for changes.) This provision lifts the ban on “general solicitation” and gives private companies the ability to publicly advertise that they are fundraising. The new law will undoubtedly affect startups and the early VC landscape. Here at LaunchCapital, we’ve had some time now to digest, reflect, and discuss the new law and how it will affect our world. We’ll break this post up into two parts. Part 1 will provide a detailed overview of the new law and the changes that are taking place. In Part 2, we’ll lay out our thoughts on how these changes might have an effect on the startup world.
So What Exactly is Changing?
Officially, Title II of the JOBS Act makes changes to Rule 506 of Regulation D in the Securities Act. Rule 506 was considered a “safe harbor” for private offering of securities. This allowed companies to raise an unlimited amount of money through accredited investors (and up to 35 non-accredited investors) while being exempt from registering and filing financial reports with the SEC. In order to receive this exemption, companies had to file “Form D” 15 days after they had raised money. Form D is a generally brief notice that included names and addresses of shareholders, but little other information on the company itself. Also, private companies could act on “good faith” that an investor who said they were accredited, were actually accredited. In order to receive this exemption, however, companies were not allowed to use general solicitation and advertise publicly that they were fundraising.
The new law creates Rule 506 (c) which allows companies to generally solicit their fundraise. There are some strings attached, however:
- Instead of acting on good faith, companies must take “reasonable steps” to verify that purchasers of securities are accredited investors; companies may solicit to everyone, however.
- The SEC does not provide exclusive steps that companies must take to verify accreditation, but it does give examples that would qualify as “reasonable”.
- IRS forms reporting investor income for the past 2 years
- Recent financial documents – such as bank statements, brokerage statements, appraisal reports and credit reports – along with a written representation that all liabilities have been disclosed.
- Written confirmation from a registered broker-dealer, SEC-registered investment adviser, licensed attorney or certified public accountant that they’ve checked their client’s accreditation in the past 3 months.
- Accredited investors that have previously invested in a private company prior to the law change, counts toward “reasonable steps”.
- Form D must be filed 15 days prior to general solicitation. Previously you had to file 15 days after funds were raised.
- Once you generally solicit, you must follow these rules and can’t revert back to a private placement.
- Companies have to determine that there are no “bad actors” that are shareholders or officers in the company. Essentially these are people with prior felonies or run-ins with the SEC.
As you can imagine, these additional steps necessary to generally solicit will most likely result in increased legal costs and liability for the company. To avoid these additional complications, companies can choose to fundraise under the old rules. This provision is now called Rule 506 (b).
Lastly, there are changes to Form D itself. In addition to filing 15 days prior to solicitation, companies choosing to solicit will need to provide additional information on the exemption form. This additional information includes, types of investors in the offering, use of proceeds, methods to verify accreditation, types of general solicitation used, among other general information about the company itself. Companies that fail to comply with all these changes will be disqualified from fundraising for one year. There is a 30-day grace period, however, to provide updates to Form D.
As you might imagine the JOBS Act creates some new opportunities for crowdfunding platforms like AngelList and may create some additional issues/headaches for companies who solicit. In Part 2 of this post, we’ll discuss all these changes and how it affects our world.
UPDATE: According to Bloomberg, on October 18th the SEC has issued a crowdfunding proposal that would ease the investor verification process for startups. Many of the verification challenges discussed above could be changed next week. October 23rd is the current deadline for any changes. I’m going to hold off on Part 2 until the requirements are more set in stone.