JOBS Act, Accredited Investors, and Flaming Hoops

I’ve heard it multiple times now, from angel investors and entrepreneurs alike, that the JOBS Act changed the definition of accredited investorin order to make it easier to be one.  (Remember, Dodd-Frank made it harder.) It’s as if President Obama and the Congress had with the JOBS Act done away with the many flaming hoops that investors and companies have had to jump through for decades in order to raise capital in compliance with the securities laws.

In fact, I’ve heard it stated that the JOBS Act reduced the income or net worth requirement to $100,000.

I’ve always responded to these assertions with: ”No. It didn’t.”

But the last time this type of encounter occurred I was upbraided. “Yes, it did!” my conversant declared.

He proceeded to whip out the statute to show me. As I watched him thumb through the pages, I wondered what he would find. He finally found what he was looking for, it said:

“B)   the aggregate amount sold to any investor by an issuer, including any amount sold in reliance on the exemption provided under this paragraph during the 12-month period preceding the date of such transaction, does not exceed—

  1. the greater of $2,000 or 5 percent of the annual income or net worth of such investor, as applicable, if either the annual income or the net worth of the investor is less than $100,000, and;
  2. 10 percent of the annual income or net worth of such investor, as applicable, not to exceed a maximum aggregate amount sold of $100,000, if either the annual income or net worth of the investor is equal to or more than $100,000.”

“There!” my inquisitor said.

I had to explain to him that the above definition has nothing to do with the definition of “accredited investor.”

“Accredited investor” offerings under Rule 506 are completely different from what will be “crowdfunding” offerings under the JOBS Act, when the rules for crowdfunding offerings are finally done and crowdfunding is actually legal (it is not legal yet).

The best way to think of it is this way: Rule 506 “all accredited investor” offerings are on a completely different planet from crowdfunded offerings. Definitions helpful in one world don’t necessarily have any meaning in the other. The below table shows some of the differences between the two offerings. As you can see, they are dramatically different. Two different worlds.

Below is a table comparing the current most commonly used federal exemption from the registration requirements for early stage equity financing of emerging businesses and the new equity crowdfunding exemption, which I hope you will find helpful.

Rule 506Crowdfunding
Limitation on Offering SizeNone$1M during any 12 month period (including amounts raised in any other private securities offering in the same period).
Limitation on number of investorsNot if all investors are accredited.Not technically, but there is a some outside limit by virtue of the the offering size limit.
Advertising allowedYes – once the rules are final.No, companies cannot advertise; they can only refer people to portals.
Specific Disclosure RequirementsNone required by the rules; but subject to anti-fraud requirements.Yes, very specific, detailed disclosure requirements, the complete details of which have yet to be finally determined. Also subject to anti-fraud requirements.
Third party intermediary requiredNoYes; companies have to go through a broker-dealer or registered funding portal.
Ongoing SEC reportingNoYes, but exactly what is required here is not yet defined.
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  • Brian Lebrecht

    Great topic, Joe. I am in favor of raising capital and small businesses as much, if not more, than the next guy. But crowdfunding scares me, and your example is one of the reasons why. There is such a thing as money that you should reject, because it comes with too much liability, headache, or the investor can’t really put it at risk. It will be intereresting…..

    • joewallin

      Brian, definitely from the company’s perspective, crowdfunding is something to be approached with a lot of caution.

  • http://twitter.com/CrowdMason CrowdMason

    The crowdfunding laws are definitely confusing. Very excited about the changes to the general solicitation rules and hopeful that they will be finalized shortly. Once general solicitation is allowed the way equity is raised will change (for the good). I am particularly excited for the implications to the real estate space.
    Do you have any thoughts or have you come across any studies on why such a small percentage of accredited investors participate in private placements???

    • joewallin

      I am not aware of any such studies, but maybe the Kauffman Foundation would have something…or the Angel Capital Association.

  • willywater88

    One of the best explanation I have seen thus far. However, I am still unclear on the following.

    For a regular person making $50K a year, does this person have to go through a broker, set up a company or simply write a check?

    Is the limit of $2K or 5% per investment? Or can there be investments in multiple startups totaling more than 5% of the persons $50K salary?

    • http://startuplawblog.com/joewallin Joe Wallin

      For the investor, you will be able to invest individually.

      “the transaction is conducted through a broker or funding portal that complies with the requirements of section 4A(a).”

      See this for caps.

      ‘(B) the aggregate amount sold to any investor by an issuer, including any amount sold in reliance on the exemption provided under this paragraph during the 12-month period preceding the date of such transaction, does not exceed–

      ‘(i) the greater of $2,000 or 5 percent of the annual income or net worth of such investor, as applicable, if either the annual income or the net worth of the investor is less than $100,000; and

      ‘(ii) 10 percent of the annual income or net worth of such investor, as applicable, not to exceed a maximum aggregate amount sold of $100,000, if either the annual income or net worth of the investor is equal to or more than $100,000;

      See here for link: http://www.govtrack.us/congress/bills/112/hr3606/text

      • willywater88

        Ok got it. So the cap is set per investment. I can technically invest my entire salary or worth as long as they are in different companies then.

        • http://startuplawblog.com/joewallin Joe Wallin

          There is also this limit imposed on the funding portals: “(8) make such efforts as the Commission determines appropriate, by rule, to ensure that no investor in a 12-month period has purchased securities offered pursuant to section 4(6) that, in the aggregate, from all issuers, exceed the investment limits set forth in section 4(6)(B);”

  • JR Nash

    I am reading here http://questira.com/not-an-accredited-investor-investing-in-a-private-company-is-still-possible-with-your-self-directed-ira/ that a non-accred can invest in private placements through an IRA, thus it seems it would circumvent the 35 non-accredited investor rule in a Reg D 506?

    • http://startuplawblog.com/joewallin Joe Wallin

      Perhaps they are referring to offerings where the issuer chooses not to rely on the safe harbor afforded by Rule 506. Most issuers want the safe harbor, but there are situations where issuers will proceed with it.

 
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