PRESIDENT OBAMA SIGNS THE JUMPSTART OUR BUSINESS STARTUPS OR JOBS ACT, BUT A LOT OF WORK AND QUESTIONS REMAIN

People watch as US President Barack Obama signs the JOBS act during a ceremony in the Rose Garden of the White House April 5, 2012 in Washington, DC

WASHINGTON—President Barack Obama signed into law Thursday, April 5, 2012, that eases an array of business regulations, particularly rules for initial public offerings, in what backers hope will help companies raise capital and boost job growth.

Supported by a broad bipartisan coalition in the House and Senate, the law reflects a desire by both parties during an election year to show they are doing all they can to eliminate red tape for start-ups and smaller companies. But regulators, investor groups and a small number of Democrats have warned the bill is unlikely to succeed in dramatically boosting employment and would likely lead to more financial fraud.

 

Mr. Obama said the bill will "help entrepreneurs raise the capital they need to put Americans back to work and create an economy that's built to last."

A provision of the Jumpstart Our Business Startups, or JOBS Act would make it easier for companies to launch IPOs by rolling back corporate governance and accounting rules for as long as five years for firms with as much as $1 billion in annual revenue—a threshold that covers the bulk of recent IPOs.

Under the new law, firms could skip hiring an auditor, wouldn't have to adhere to rules that give shareholders a say on executive compensation and would be excused from new national accounting or auditing standards for up to five years.

Some of the bill's exemptions would apply to companies as large as Groupon Inc., which had under $1 billion in revenue in the year prior to its registration with the Securities and Exchange Commission last year.

The bill also relaxes a number of rules to make it easier for private companies to raise capital without going public, such as by increasing the number of shareholders companies can have before opening their books to 2,000 from 500. The bill wouldn't count stock held by company employees toward those caps.

Many of the bill's provisions go into effect immediately, though the SEC must still write rules in some areas, including crowd-funding, in which entrepreneurs tap thousands of investors who are given very small shares of stock. The SEC must write rules for web sites that function as funding portals for such start-ups.

The changes represent one of the biggest rollbacks of the 2002 Sarbanes-Oxley law, the revamp of accounting rules enacted in response to the Enron and WorldCom scandals, and the first major slackening of securities laws since the Dodd-Frank financial overhaul.

The House signed off on the bill by a vote of 380-41 last month, while the Senate passed the measure by a 73-26 vote.

COMMENTARY:   Finally, President Obama has signed the JOBS Act, and it is finally a law. The full text of his speech at the signing of the JOBS Act is available by clicking HERE.  

So how exactly does the JOBS Act affect startup entrepreneurs?  It makes it easier for them to obtain investors without having to file an Form S-1 Registration Statement with the Securities & Exchange Commission and meet all the stringent SEC disclosure and reporting requirements. However, it is not a free ride in any respect.  

The JOBS Act creates a new category of issuer — an emerging growth company, or EGC. An EGC is a company that has had its first registered sale of securities within its five prior fiscal years and has total annual gross revenues of less than $1 billion (subject to inflationary adjustment by the SEC every five years) and less than $700 million in publicly traded shares. Issuers that had their first registered sale of securities on or before December 8, 2011 are not eligible to be an EGC.

The JOBS Act now allow entrepreneurs to directly solicit investors, something that Regulation D of the SEC forbid, provided that investors are fully-accredited.  It does exempt startups from filing financial disclosures the SEC once they reach 500 individual investors.  The limit has now been raised to 2,000 individual investors, but 1,500 of those investors must be fully-accredited investors as defined by the SEC.  Employees issued stock under employee benefit plan securities (stock options) are excluded from the 2,000 investor limit.

The JOBS Act establishes the new crowdfunding exemption, which is designated as Section 4(6) of the Securities Act, with the following parameters:

• The aggregate proceeds from all investments in the issuer, including amounts sold under the crowdfunding exemption during the preceding 12 months, must be less than $1,000,000.
• The aggregate amount invested by any investor in all issuers pursuant to the crowdfunding exemption must not exceed a limit determined on a sliding scale based on net worth or annual income. The limit is 5% of net worth or annual income that is less than $100,000 (or $2,000, if greater than the 5% calculation), and 10% of net worth or annual income that is $100,000 or more. No investor may invest more than $100,000 in an issuer pursuant to the crowdfunding exemption. Income and net worth are to be calculated in the same fashion as the tests for accredited investors. Accordingly, equity in a principal residence is excluded from net worth.
• The transaction must be conducted through an intermediary that is either a registered broker-dealer or “funding portal.”
• Funding portals are not required to register as broker-dealers, but are subject to SEC registration and must be members of a national securities association, such as FINRA.
• The intermediary must provide disclosures, including disclosures related to risks and other investor education materials (as determined by SEC rules).
• The intermediary must ensure that investors review investor-education information (as determined by SEC rules).
• The intermediary must ensure that investors answer questions demonstrating that they understand the risks of investing in startups, including the risk of loss of the entire investment, and that each investor can afford such loss.
• The intermediary must provide the disclosures to the SEC and to investors at least 21 days prior to accepting any investments.
• The intermediary must take fraud-prevention measures to be determined by SEC rules, including background checks of officers, directors and 20% holders.
• The intermediary must ensure that proceeds are not released to issuers until a set target amount is reached and must allow investors to withdraw their commitment in accordance with SEC rules.
• The intermediary must take steps to be determined by SEC rules to ensure that each investor has not exceeded its crowdfunding limit in a 12-month period, which as noted above applies to all investments in all issuers under the crowdfunding exemption.
• The intermediary must take steps to ensure the privacy of information collected from investors in accordance with SEC rules.
• Intermediaries cannot pay finders fees.
• Directors, officers and partners of the intermediary may not have a financial interest in the issuer.
• The issuer must make the following mandatory disclosures to the SEC, the intermediary and investors:
  • identifying information about the issuer, including its website
  • the names of officers, directors and 20% shareholders
  • a description of the business and the anticipated business plan
  • a description of the financial condition of the issuer, with scaled requirements depending on the target amount of the offering.
    • For offerings of $100,000 or less, the income tax return for the last completed year and financial statements certified by the principal executive officer to be true and correct
    • For offerings of $100,000 to $499,999, financial statements reviewed by an independent public accountant
    • For offerings over $500,000, financial statements audited by an independent public accountant
  • the intended use of proceeds
  • the target offering amount, the deadline to meet the target offering amount, and regular updates regarding the progress of the issuer toward the target
  • the price or the method of determining the price, and if the price is not fixed, a reasonable opportunity for the investor to rescind its commitment once the price is determined
  • detailed information about the capital structure of the issuer, the securities being offered and the risks associated with those securities
  • how the securities being offered are being valued, and how they might be valued in the future in connection with a corporate transaction
• The issuer may not advertise the terms of the offering except for notices which direct investors to the intermediary.
• The issuer may not compensate finders except in accordance with SEC rules that will ensure the recipient clearly discloses such compensation.
• The issuer must file annual reports of results of operations and financial statements with the SEC and provide to investors, in accordance with SEC rules.
• No resales are permitted for one year except to the issuer, an accredited investor, a member of the investor’s family or pursuant to a registered offering.
• The exemption is available only for U.S. issuers that are not investment companies and are not subject to periodic reporting under the Exchange Act.
• The issuer and its directors, partners, principal executive officer, principal financial officers and controller/principal accounting officer will be liable to investors for any material omissions or misstatements unless they can sustain the burden of proof that they did not know, and in the exercise of reasonable care, could not have known, of such untruth or omission.

The JOBS Act creates a new "mini public offering exemption".   Startups may now raise up to a maximum of $50 million without having to file an S-1 Registration Statement. he ability to raise up to $50 million publicly and the potential not to be subject to Exchange Act reporting could make the new Regulation A-type exemption a superior alternative public offering method.   

As you can readily see, the new crowdfunding exemption is not an "automatic" road to funding minerva. One of the biggest issues is insuring that investors who claim to be fully-accredited provide proof they meet the definition of "fully-accredited investor" as defined by the SEC.  A scrupulous licensed broker or dealer or authorized funding portal operator could try to "slide by" by relaxing or even purposely circumventing the "fully-accredited investor" requirements, opening the door to individual investors who are not fully-accredited and might not be financially prepared to carry the risk associated with losing some or all of their investment if the startup goes bellyup.  Verification is going to be the key, and hopefully the SEC will require some kind of income and net worth verification issued by an attorney or CPA. Anything less than this is playing with fire.  

Unlike award-based crowdfunding, investor-based crowdfunding will require significant disclosures.  If you have ever prepared a Private Placement Memorandum under SEC Regulation D, you know what I am talking about.  This means hiring an attorney familiar with SEC regulations and the requirements of the JOBS Act.  This means incurring significant legal expenses to insure that the exempt securities fully disclose all the risks and other financial data needed to make a prudent investment decision by accredited investors.

The crowdfunding regulations are going to make it a virtual requirement to hire a licensed broker or dealer to sell the securities.  They are licensed and have the resources and experience to offer securities and an experienced broker or dealer has the network of investors that meet the SEC requirements of fully-accredited investors.   

The SEC has 270 days to issue the final crowdfunding regulations and rules that exempt startups, investors and licensed brokers  and dealer, and funding portals must comply with.  My guess is that Securities and Exchange Commission will take great care in avoiding confusion and ambiguity when they issue the final crowdfunding regulations, but I don't see this happening until Q4 2012 at the earliest, so they become effective on January 2013. 

The law firm of Sheppard Mullin prepared an excellent summary and interpretation of the JOBS Act and I have listed below:

 

JOBS Act of April 5, 2012 - Summary and Interpretation

View more documents from turk5555. 

 

Courtesy of an article dated April 5, 2012 appearing in The Wall Street Journal Online and April 6, 2012 appearing in Time Business and an article dated April 5, 2012 appearing in Sheppard Mullin's Corporate and Securities Law Blog

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