In an effort to stimulate job creation and economic growth by improving access to capital, Congress has taken action in the form of legislative changes that will radically alter the landscape of the securities laws and practices that affect many of our clients—both businesses and investors alike.
The Jumpstart Our Business Startups Act was signed into law last Thursday (April 5, 2012). However, the law did not become effective upon enactment. The law orders the Securities and Exchange Commission (SEC) to promulgate rules for enacting many of its provisions, so the SEC will have significant influence over how the various elements are implemented in practice. The following overview summarizes the significant changes that will occur.
We frequently rely on SEC Rule 506 exemptions to facilitate private fundraising. Currently, no general advertising or general solicitation is permitted under Rule 506 offerings. Within ninety days of enactment of the new law, general advertising and general solicitation will be permitted for securities issued pursuant to Rule 506. However, unlike under the current Rule 506 which permits sales to up to 35 unaccredited investors, all investors must be accredited if the issuer engages in general advertising. Therefore, before selling any securities under Rule 506, the company issuing the securities (the “issuer”) must take reasonable steps to ensure purchasers are accredited. At this time, we do not yet know whether companies currently fundraising under a Rule 506 offering will be permitted to advertise, but we will provide you with that information as soon as it is available. Also, the advertising channels will be subject to additional restrictions that have not been finalized. If you are unsure whether you are currently raising funds under Rule 506 or whether you should consider a Rule 506 round, or if you have additional questions about how this change could apply to you, please do not hesitate to contact us with your specific questions.
Crowdfunding has been generating a buzz in the entrepreneur community for the past couple of years. Various web-based platforms allow startups to raise small amounts of funds in exchange for products, promotional materials, and other schwag. Current securities law, however, prohibits the sale of securities through these channels because of the restrictions on public advertising and registration requirements for securities brokers. Under the new law, within nine months of enactment, issuers will be permitted to sell securities through such web-based platforms, also known as “crowdfunding portals,” provided that the issuers and portals comply with the new law’s specific requirements and procedures.
This following list provides a brief overview of the most significant elements of the crowdfunding legislation:
- The aggregate offering amount cannot exceed $1,000,000 within 12 months
- The aggregate amount sold by a single issuer to any investor during any 12-month period cannot exceed:
- The greater of $2,000 or 5% of the investor’s annual income or net worth if the investor’s annual income or net worth is less than $100,000, or
- 10% of the investor’s annual income or net worth if the investor’s annual income or net worth is greater than $100,000
- $100,000 per investor, regardless of the investor’s total net worth
- The transaction must be conducted through an SEC registered intermediary—a broker or funding portal
- Specific disclosure requirements will be provided by the SEC
- Each investor must review educational information and answer questions showing an understanding of risks in startups, illiquidity, and other matters, per SEC determination
- The intermediary must: conduct a background check on key personnel and investors; provide disclosure information to the SEC; and follow additional, mandatory practices and procedures to protect investors and regulate the offering
- Issuers must: comply with substantial disclosure procedures related to financial condition, organizational structure, and ownership; comply with advertising restrictions; file annual reports with the SEC and comply with additional restrictions
- Current securities laws regarding liability for material misrepresentations and omissions will still apply to issuers, officers, and key personnel
- The securities must be held by the purchaser for at least one year unless transferred to: the issuer, an accredited investor, as part of a registered offering, or a family member of the purchaser in connection with death, divorce, or similar circumstances
- The issuer must be organized under state law, and cannot be a reporting/registered company, and cannot be an investment company as defined under the Investment Company Act, including exempt investment companies (i.e. VCs and angel group cannot rely on the exemption)
- Income and net worth rules carry over from the accredited investor rules (e.g. value of an investor’s primary residence is excluded from net worth)
- Other restrictions apply and additional guidance will be provided by the SEC
Both issuers and portals must comply with significant registration and compliance procedures, and heavy penalties remain in place for securities law violators. Accordingly, because of administrative expense, crowdfunding will not be appropriate for many early stage startups. As the law moves towards implementation, Immix Law Group will be closely monitoring SEC releases pertaining to crowdfunding legislation, and we can assist you in determining whether crowdfunding would be appropriate for your company, or whether more traditional fundraising methods may be more cost-effective. We are ready to advise you regarding securities compliance as you prepare to either fundraise through crowdfunding channels or register your crowdfunding portal.
Under current law, any issuer with more than $1,000,000 in assets and any class of equity held by more than 750 investors must register (“go public”). This law will be amended so that registration will not be required until an issuer has more than $10,000,000 in assets and a class of equity security held by either (1) more than 2,000 persons or (2) more than 500 unaccredited investors. Securities held by employees and issued pursuant to an employee compensation plan will not count against the threshold. Also, securities sold under the crowdfunding exemption will not count against the threshold. This change will permit many young companies to consider additional rounds of fundraising, and potentially accept smaller investments from a larger number of investors. If you have any questions related to your current cap table, or how this change will impact your current or future fundraising rounds, please email Robert Scott with your questions.