Jumpstarting Your Investment Opportunities With JOBS Act Investment Offerings
Welcome to a new world of potential investors and businesses vying for their trust. This new world of investment opportunity began in 2012 when President Barack Obama signed the bipartisan Jumpstart Our Business Startups Act, or the JOBS Act for short.
WHY IS THE JOBS ACT A GAME CHANGER?
Before the JOBS Act, private companies seeking to raise capital from external sources could only take investments from accredited investors. Start-ups were also prohibited from the general solicitation of investors. Since accredited investors account for only the wealthiest Americans, businesses’ options were limited. But the JOBS Act created new investing options to include crowdfunding from non-accredited investors. The JOBS Act created three new forms of investing via online broker-dealers:
- Title III of the JOBS Act created Regulation CF investing, or equity crowdfunding. This type of investing, which went into effect on May 16, 2016, allows private companies to raise up to $5 million from both accredited and non-accredited investors.
- The JOBS Act also amended Rule 506 of Regulation D. While the previous version of this regulation still exists as Rule 506(b), the JOBS Act requires the Securities and Exchange Commission (SEC) to allow general solicitation of offerings under Rule 506 while also removing the cap on potential investors. This form of investment offer is limited to accredited investors.
- Lastly, Title IV of the JOBS Act created Regulation A+. Similar to the change mentioned with Regulation CF crowdfunding, Regulation A+ allows companies to offer shares to the general public, not just accredited investors. A Regulation A+ offering operates as an Initial Public Offering, or IPO, and allows private companies to raise either up to $20 million in the first tier or up to $75 million from the public in the second tier.
Why are these changes important, and how does investing via a broker-dealer differ from other online crowdfunding campaigns? Investors get shares in the company in which they invest, which allows private businesses more options for raising external capital. This newly acquired capital allows companies to grow more quickly and with less risk, benefiting the economy and creating jobs.
Before discussing the benefits and drawbacks of each new type of investment offering a disclaimer: this article exists purely for informational purposes and is not meant as investment advice or legal advice.
An accredited investor is:
- A bank, insurance company, registered investment company, business development company, or a small business investment company
- An employee benefit plan if one of the above makes the investment decisions or if the plan has over $5 million in assets
- A tax-exempt charitable organization or corporation with assets in excess of $5 million
- A director, executive officer, or general partner of the company selling the security
- An enterprise where all the equity owners are also accredited investors
- An individual with a net worth of at least $1 million, not including the value of their primary residence
- An individual with income exceeding $200,000 in each of the two most recent years, or a joint income with a spouse exceeding $300,000
- A trust with at least $5 million in assets, so long as the trust wasn’t formed solely for the purpose of acquiring the securities and so long as investments are directed by someone meeting the legal standard of knowledge and experience in such financial matters
Regulation crowdfunding, also known as Regulation CF or equity crowdfunding is a type of offering that provides investment opportunities to non-accredited investors. Reg CF creates the possibility of a company raising as much as $5 million from accredited and non-accredited investors in a 12 month period.
Should My Company Offer Investments Through Regulation Crowdfunding?
Your business should consider using a Regulation CF offering if you are a private company with a loyal and impassioned customer base. These companies usually have existing relations with their customer bases. These companies are also usually past the seed stage of their funding processes.
How Does It Work?
If your business wants to offer securities through regulation crowdfunding, you must complete Form C and file it with the Securities and Exchange Commission (SEC). This form simply provides the SEC with basic information, but the SEC does not review or approve the form.
Reg CF offerings also must be made through an SEC-registered third party. These third-party intermediaries can offer more specific information about what Form C requires, as well as what the SEC requires for annual reports.
What about investors? Limitations exist for the amount of money each investor can commit. These limitations are based on an investor’s individual annual income and net worth. Investors should also be notified of any material changes to an offering and must reconfirm their investments within five business days. If investors fail to reconfirm, their investments are canceled. Investors are also prohibited from selling their securities for one year.
The SEC also has specific rules regarding the closing of a fundraising round. The requirement to use a registered intermediary, therefore, becomes a benefit, as a broker-dealer can guide you through a closing process legally. Users should know that bad actor disqualifications apply to these offerings. Bad actor provisions disqualify an offering if its issuer, or some other covered person such as a director, partner, or beneficial owners, experience a disqualifying event, such as certain criminal convictions, court injunctions, or other disciplinary actions. Waivers are available if an issuer can demonstrate the performance of due diligence and could not reasonably know that a person involved with the offering ever took part in a disqualifying event.
The JOBS Act changed Rule 506 of Regulation D, creating more investment opportunities. The change kept the previous rule, now known as rule 506(b). The new rule, rule 506(c), allows businesses to make general solicitations to accredited investors, a previously disallowed provision.
Investors who are familiar with the previous Rule 506 will find a lot of similarities. As with the previous rule, investors must be accredited, and issuers must file Form D with the SEC within 15 days of the first sale. And as with the previous regulation, bad actor disqualifications apply.
The main differences between 506(b) and 506(c) offerings are 506(c)’s removal of the 35 person cap that previously existed and its allowance of general solicitation from potential accredited investors. Issuers must take reasonable steps to verify an investor’s accredited investor status.
Purchasers of these securities get restricted securities, which aren’t freely tradable. Restricted securities are detailed in Securities Act Rule 144. These securities can generally only be traded with a registration statement for resale, and only if other conditions are met, such as holding the securities for a minimum amount of time.
Although the Securities Act preempts state law, states can still require notice filings and can collect fees, so anyone considering a Regulation D offering should be aware of any state requirements.
The best candidates to offer securities under Regulation D are early-stage startups in the seed funding stage of investing.
Section 402 of the JOBS Act added Regulation A+ to Regulation A. This offering opens investment to non-accredited investors, allowing companies to raise capital up to a certain limit. There are two tiers, each with their own caps. In tier 1 anyone can invest, and a company can raise up to $20 million in a 12-month period. Under tier 2, anyone can invest, but there are investment limits. Companies here can raise up to $75 million over a 12 month offering period.
Both tier 1 and tier 2 have reporting requirements, with tier 2’s requirements being more stringent than those of tier 1. Regulation A+ offerings are a miniaturized version of an IPO allowing a company to raise revenue without going public.
A Reg A+ offering is far less expensive than an IPO. The more difficult decision for a startup is between Regulation A+ and Regulation D offerings. Under Reg A+, the SEC must review and qualify the offerings, which can take time and can be costly in the form of legal fees. Rather than waiting for a qualifying statement, some companies decide to use a Regulation D offering instead. Additionally, issuers of securities under tier 1 have to file state review and qualification. Tier 2, however, is not subject to state review.
As with the other offering types, bad-actor restrictions exist, although, waivers are available if the issuer did their due diligence, but couldn’t reasonably know that someone involved with the offering had a qualifying event. Regulation A funding has been extremely underutilized because of its high costs. For A+ funding to be more successful, costs would need to become more reasonable. Preempting state requirements could assist in reducing these costs. Tier 2 exempts state sources, but that benefit is offset by additional reporting costs, which may lead some to choose Regulation D instead.
What types of companies should be taking advantage of Reg A+ offerings? The best candidate companies are similar to those best suited for Regulation D. But because of the costs associated with the process, many early start-ups will use Regulation D instead, while companies with large customer bases willing to actively invest might benefit from a Regulation A+ offering.
- Regulation crowdfunding, also known as Regulation CF funding, allows companies to raise $5 million over a 12 period from both accredited and non-accredited investors. Issuers must file Form C with the SEC prior to making an offering, which must be made through an SEC-registered intermediary. There are limits on individual investments.
- Regulation D offerings remove the 35 investor cap that existed in the prior rule now known as rule 506(b). As with its predecessor, there is no cap to the amount of capital an issuer can raise, but issuers can now make general solicitations. Investors purchasing securities under Regulation D must be accredited investors. Issuers must file Form D with the SEC within 15 days of the first sale.
- Regulation A+ offerings act likes an IPO, except issuing companies aren’t going public. Reg A+ has two different tiers. The SEC must review and qualify the offering in both cases. Investors can be accredited or non-accredited investors under both categories. Companies can raise up to $20 million under the first tier but may face additional qualification requirements from state regulators. The second tier allows companies to raise up to $75 million and avoid state qualification requirements, but there are additional reporting requirements and limitations on what individual investors can offer.
- Regulation CF and Regulation D offerings are restricted securities, meaning securities sold can’t be traded within a specific time frame. There are no resale restrictions under either tier of Regulation A+.
- Bad-actor disqualifications are disqualifications related to covered persons involved in an issuance who have taken part in a qualifying event such as an SEC disciplinary or criminal action. This disqualification applies to each of the offerings discussed here, but the issuer can apply for a waiver in some cases.
*1 SEC Frequently Asked Questions About Exempt Offerings; Available at https://www.sec.gov/
*2 SEC Regulation Crowdfunding; Available at https://www.sec.gov/smallbusiness/
*3 SEC General Solicitation - Rule 506(c); Available at https://www.sec.gov/smallbusiness/exemptofferings/
*4 SEC Regulation A; https://www.sec.gov/smallbusiness/exemptofferings/rega
*5 Rutherford B Campbell, Jr., Regulation A, and the JOBS Act: A Failure to Resuscitate, 7 Ohio Entrepreneurial Bus. L. J. 317 (2012).