The is a 2012 securities reform law targeted at easing the flow of capital to startups and new public companies.
For aspiring tech entrepreneurs, the most relevant provision of the JOBS Act are Titles II and III, which are aimed at loosening restrictions around equity crowdfunding and marketing of securities offerings by new companies. Title II permits startups to advertise investment opportunities broadly through mass media, and Title III allows entrepreneurs to obtain investments through the internet from individuals interested in investing in new companies. These provisions are intended to enable new pathways for startups to seek capital online from large pools of investors and forego some of the costs associated with traditional means of obtaining financing.
Changing the Landscape
It is anticipated that Title III of the JOBS Act will significantly transform the landscape for investment in startups, as crowdfunding sites are banned under current U.S. law.
By allowing startups to leverage the internet to reach potential lay investors, Title III of the JOBS Act would substantially increase the pool of capital available to new companies. Coupled with provisions in Title II that expand the abilities of companies to target sophisticated investors through mass marketing, the JOBS Act has the potential to provide a significant boost to the startup economy in the U.S.
Because of the way the Jobs Act is structured, the SEC was required to make specific rules for Titles II and III before the new provisions can go into effect. Title II went into effect on September 23, 2013 after several months of regulatory delay, and Title III is still pending before the SEC. The SEC issued a proposed ruling on Title III in October of 2013, which is now subject to a 90-day administrative comment period and subsequent review by the SEC before Title III can go into effect. Crowdfunding boosters and entrepreneurs have been anxiously awaiting approval of the new provisions, though observers warn that it could take several more months for Title III to finally kick in. The JOBS Act and related regulations have drawn harsh criticism from watchdog groups who say it will now be easier for unscrupulous stock promoters to target unsophisticated investors, and these groups have promised to fight for robust investor protections in the regulations.
Title II: Mass Marketing of Securities Offerings
The public sale of equity (or ownership interests) in a company is generally considered to be a “securities offering,” which is subject to regulation by the U.S. Securities and Exchange Commission. Securities are documents that represent a legal interest in something else, such as a company. Securities can include things like stocks, bonds, transferable shares, investment contracts or certificates of interest in profit-sharing agreements. Generally speaking, public offerings of securities must be registered with the SEC. Otherwise they must qualify for an exemption from registration requirements. Registration with the SEC entails the filing of documents that describe the company’s product or service, the management team, the nature of the security being offered for sale, and financial information about the company.
There are already significant exemptions from the registration requirements. Title II of the JOBS Act is intended to make it easier for startups to take advantage of one of the most important exemptions, which applies to offerings made to sophisticated investors. Historically, securities offerings have been exempt from registration requirements in cases where the offering was not publicly advertised and investors were high net-worth individuals or qualifying institutions. Such investors are known as “accredited investors.” Title II of the JOBS Act would allow new companies to engage in public advertising of their securities offerings so long as they can demonstrate that they believe and have taken reasonable steps to confirm that purchasers of the securities meet the legal threshold for accredited investors. The upshot of this is that startups will now be able to advertise their securities offerings in online publications, newspapers or social media; but they can only issue securities to individuals they reasonably believe to be accredited investors, such as sophisticated angel investors or venture capital funds.
Title III: Crowdfunding
Title III of the JOBS Act goes further, allowing companies to raise up to $1 million from the public over a 12-month period through “funding portals” or crowdfunding websites. The law imposes annual caps on the amount that any individual can invest. The SEC’s proposed rule allows maximum investments of 10% of income or net worth (whichever is greater) from investors whose annual income is above $100,000. For individuals whose yearly income is below $100,000, annual investments are capped by the SEC at $2,000 or 5% (whichever is greater) of annual income.
Under the proposed rule, companies seeking investment through crowdfunding would be required to file annual reports with the SEC and make certain disclosures to investors. Companies would be required to make disclosures about the company’s finances, management team, use of proceeds, and pricing of securities being offered, among other things. The SEC’s proposed rule also imposes hefty disclosure and “investor education” requirements upon funding portals and other intermediaries that engage in crowdfunding, as well as record-keeping rules and due diligence requirements regarding the ability of investment vehicles to comply with applicable regulations.
Some seasoned investors caution entrepreneurs that obtaining investments through crowdfunding could potentially dampen a startup’s future prospects for obtaining later rounds of funding. Giving away too much equity in the crowdfunding round can limit the appetite of larger investment funds to participate in the venture at later stages, when the company needs additional capital in order to grow. It remains to be seen how these crowdfunded vehicles will operate in practice, and venture capital funds might hesitate to participate in these ventures when later rounds are sought.
On a more positive note, Title III has generated enthusiasm among advocates for the rare disease community, as the new provisions will give them new ways to participate directly in the search for treatments through small investments. The crowdfunding provisions will allow nonaccredited investors who are interested in particular diseases to help fund early-stage biotech companies that could help develop innovative treatments for their family members.
As noted above, Title III of the JOBS Act still faces a difficult administrative comment period before the SEC in which investor protection groups will advocate for tighter restrictions and more protections. But when all is said and done, it is likely that Titles II and III of the JOBS Act will result in some of the most momentous changes in the U.S. investment landscape of the last century.