There has been a lot of ink spilled about the JOBS Act, especially its “crowdfunding for securities” provisions. The JOBS Act is an exciting piece of legislation for the startup community. What is my favorite part of the Act? Section 201 (quoted below).
Why is Section 201 my favorite section and not Section 301 (the crowdfunding exemption), or Sections 101-108 (the IPO on-ramp provisions)? Because Section 201 will dramatically change the playing field for the investment rounds that I am most actively involved in–all accredited investor Rule 506 offerings under the 1933 Securities Act.
Crowdfunding has promise, but currently 95% of all private securities offerings are done via Rule 506 of Regulation D. In other words, Reg D Rule 506 is where the game is played. In my opinion, startup companies will continue to predominantly rely on Rule 506 offerings to raise capital due to limits on crowdfunding contained in the JOBS Act. Unfortunately, the crowdfunding provisions in the JOBS Act are not what advocates hoped for (see my previous critiques here). Regardless, let’s look at the bright side for a minute with respect to Section 201.
What will Section 201 do for 506 offerings?
- It will allow companies to advertise to the public that they are engaged in securities offerings, without costing them the 506 exemption. This is a dramatic and astounding change from the previous ban on general solicitation. Companies could run ads in the NYTimes or the WSJ if they wanted to, for example.
- Even if they don’t advertise, companies will no longer have to be silent when they raise capital. Companies could not only advertise to the public, but they can talk to the press about their offerings. This has been a regulatory “gotcha” for companies for a long time. So many startups have unwittingly been caught in the following scenario: First, you file a Form D within 15 days of the first sale of securities (as required by the SEC), then after seeing the public filing, the press calls, and you inadvertently talk about your offering and blow your 506 exemption by violating the ban on general solicitation.
- Companies will be able to post on their web sites that they are raising capital. Rule 506 offerings may not be as democratizing as crowdfunding, but they may come close as old barriers about how companies can connect to investors melt away. Companies no longer will have to rely only on word of mouth or people with whom the company had preexisting relationships to reach out to investors. Web sites indexing and rating offerings by private companies will probably spring up. Look for Angel List to become even more significant.
- Companies will no longer have to worry about blowing their Rule 506 exemption by pitching at seminars or meetings where “attendees have been invited by any general solicitation or general advertising” (quoted from the current version of the rules). Under the current rules, this was a real risk (albeit one not too many companies concerned themselves with).
These are all, in my opinion, very welcome and positive developments for the startup community.
What To Look Forward To
The SEC must act within 90 days of the enactment of the JOBS Act to revise the current rules to “provide that the prohibition against general solicitation or general advertising” not apply to Rule 506 offerings, provided that all purchasers of the securities are accredited investors.
What Could Go Wrong?
Not to be cynical, but we will have to wait and see if the SEC’s proposed regulations actually carry out the intent of the JOBS Act. For instance, Section 201 states that the new rules are going to “require the issuer to take reasonable steps to verify that purchasers of the securities are accredited investors, using such methods as determined by the Commission.”
Let’s hope the SEC does not impose burdensome information gathering and disclosure requirements on companies. We have already seen how the “bad actor” provisions spun out of control in the regulatory process: In the bad actor case, the SEC proposed an onerous “did not know, and in the exercise of reasonable care could not have known” standard of diligence for companies identifying potential bad actors.
Let’s hope the SEC does not take the same tact with these new regulations.
TITLE II—ACCESS TO CAPITAL FOR JOB CREATORS
SEC. 201. MODIFICATION OF EXEMPTION
(a) MODIFICATION OF RULES.— (1) Not later than 90 days after the date of the enactment of this Act, the Securities and Exchange Commission shall revise its rules issued in section 230.506 of title 17, Code of Federal Regulations, to provide that the prohibition against general solicitation or general advertising contained in section 230.502(c) of such title shall not apply to offers and sales of securities made pursuant to section 230.506, provided that all purchasers of the securities are accredited investors. Such rules shall require the issuer to take reasonable steps to verify that purchasers of the securities are accredited investors, using such methods as determined by the Commission. Section 230.506 of title 17, Code of Federal Regulations, as revised pursuant to this section, shall continue to be treated as a regulation issued under section 4(2) of the Securities Act of 1933 (15 U.S.C. 77d(2)).