2012 JOBS ACT
As you may have seen in the press last month, the Jumpstart Our Business Startups Act (“JOBS Act”) was signed into law. This is the first piece of legislation in recent history to specifically improve access to capital for startups, small, and medium sized businesses.
The JOBS Act is targeted toward “emerging growth companies” - those firms with less than $1 billion in annual revenues - to allow them to raise capital more freely while concurrently reducing the compliance requirements of disclosure and accounting regulations. The Act features substantial changes to Pre and Post IPO funding activities that will help emerging companies gain access to, and comply with, the various procedures of raising capital.
Pre-IPO Funding Opportunities
One of the JOBS Act’s most intriguing features includes a new exemption from securities registration for private companies raising capital via “crowdfunding” - or private financing through the aggregation of a number of small investors. While prior regulations restricted the offering of un-registered securities to accredited investors only, private companies may now issue up to $1 million of non-registered securities to the general public during any twelve month period.
Further enabling investment by the general public, investors no longer need to meet the standard of being an accredited investor. Instead, the JOBS Act simplified guidelines to allow individuals to make investments during any 12 month period equal to the greater of:
- $2,000 or
- 5% of annual income or net worth if annual income or net worth is less than $100,000 or
- 10% of annual income or net worth, up to $100,000, if annual income or net worth exceeds $100,000
In addition to expanding the pool of potential investors, the disclosure requirements for these types of investments has been reduced to:
- The names of directors, officers and stockholders with a greater than 20% equity share
- A business plan
- The target offering amount
- Financial statements
- A description of the use of proceeds
- The final offering price
- Description of current ownership and capital structure
Of particular note is the relaxation of the requirement that companies have audited financial statements. A company that is issuing less than $100,000 of securities will only need to have its financial statements certified by its Chief Executive Officer. For security offerings greater than $100,000, financial statements will need to be either reviewed, or audited by, an external accounting firm:
Up to $100,000
CEO Certified Financial Statements
$100,000 - $500,000
Reviewed Financial Statements
Audited Financial Statements
In order to provide some structure to the investment process, the JOBS Act requires that all crowdfunding offerings be conducted via a broker or funding website specifically designed to handle these types of offerings. These third-party intermediaries – who themselves will be required to be registered with the Securities and Exchange Commission – will be required to implement “know your investor” procedures to ensure that potential investors are sufficiently knowledgeable to participate in a crowdfunding offering.
Postponing the Requirement to Go Public – another pre-IPO attribute of the JOBS Act is a reprieve from the requirement that companies must go public if they take on more than 500 investors (which under the old standard included employees who owned company stock). Under the new Act, organizations may hold off on going public until they have 2,000 investors - and employee owners are specifically excluded from the definition of investors.
As a result of this change, companies will be allowed to stay private for longer periods provided that they have access to capital other than public equity. This delay should provide companies with more flexibility to choose when and how they enter public markets as well as improving the quality of companies that eventually go public.
Post IPO Relief
For companies that choose to go public, the JOBS Act modified a number previously restricted activities related to the pre and post IPO process:
Lifting of the General Solicitation Ban
Following the passing of the JOBS Act, organizations are no longer required to follow the “general solicitation” ban for investments – meaning they can advertise that they are raising funds during the very early stages of their formation, even before having a product. This advertising can help to establish brand awareness for the company, build interest for an investment, and when ready, use that enthusiasm to help raise investment funds.
As a firm readies its formal registration statement, the company will be able to measure investor sentiment by communicating with qualified institutional buyers and accredited investors before the registration statement is filed with the SEC. This “pre-listing” feedback can greatly strengthen the success of the company’s IPO by allowing the firm to adjust the terms of its offering in accordance with the sentiment received by would-be investors.
Lifting of Research Restrictions
The JOBS Act also lifted restrictions on the publication of equity research and now provides for reports to be released before, during and immediately after an IPO. Research analysts will also be able to participate in meetings with an emerging growth company alongside investment banking personnel – a practice that was prohibited following legislation enacted in 2003.
Reduction of Sarbanes Oxley Paperwork
One of the most anticipated aspects of the JOBS Act is the creation of an IPO “on-ramp” that allows companies with less than $1 billion in revenues to gradually come up to speed with Sarbanes Oxley (SOX) compliance and disclosure requirements. For the first five years following its IPO, an emerging growth company will not have to comply with many of the SOX requirements including:
- obtaining an auditor’s certification on internal control over financial reporting required by section 404(b) of the Sarbanes-Oxley Act of 2002
- disclosing details of executive compensation
- complying with requirements to rotate audit firms
- disclosing sensitive information or trade secrets
This post-IPO “on-ramp” period should help emerging growth companies prepare for SOX requirements while postponing the expense and administrative burden required to become SOX compliant.
Pitfalls of the JOBS ACT
While the JOBS Act will increase the opportunity for small companies to raise capital and decrease compliance effort and expense, there are potential pitfalls that companies and investors should be aware of. Specifically:
· Corporate Officers Could Be Exposed to Personal Liability - Companies that accept crowdfunding expose their officers to personal liability and those officers may be sued for their personal assets. As a result, many of the protections afforded to entrepreneurs by the corporate veil will be lost – thereby significantly reducing the attractiveness of crowdfunding as a source of new capital.
· An inability to rank funding opportunities – Crowdfunding websites are prohibited from providing investors with recommendations on potential investments. As a result, it may be difficult for would-be investors to assess and rank individual opportunities without some form of professional investment advice.
· People will lose money – the JOBS Act expands the pool of would-be investors by lowering the income and net worth thresholds to provide for a larger investing audience. Unfortunately, many of these new investors have no experience investing in small businesses and are unlikely to be fully cognizant that many startups fail. As a result, these investors will likely lose money and could, over time, deter other would-be investors in participating in crowdfunding opportunities.
· The JOBS Act is a work in process – following the passage of the JOBS Act, the Securities and Exchange Commission was provided 270 days to draft the regulations that will govern the implementation of the new law. As a result, the practical use of the JOBS Act is still a work in process and the implementation of the law may be more restrictive than originally anticipated. Furthermore, due to the compressed time frame in which to enact the regulations, it may be impossible to foresee all of the pitfalls that are created by this new funding opportunity.
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If you would like more information about the 2012 JOBS Act, or need help preparing your business for strategic growth or fundraising, please contact us at 415-944-8215 or at email@example.com