The JOBS Act dramatically changes the regulatory requirements and limitations governing the offer and sale of securities by early- and mid-stage businesses by, among other things, permitting "crowd funding," whereby a large number of individuals make small individual contributions to provide an early-stage business with capital. Below, we discuss briefly the provisions of the JOBS Act related to crowd funding.
The crowd funding provisions of the JOBS Act are both novel and controversial. Crowd funding involves large numbers of relatively unsophisticated investors making small contributions to early-stage businesses, essentially creating a large pool of venture capital investors. Given the excitement surrounding crowd funding in many circles, the SEC has issued a special notice reminding the public that the crowd funding exemption does not become available until the SEC issues appropriate rules required by the JOBS Act.
A. Limitations on Amounts and Information Requirements. An issuer using crowd funding cannot raise more than $1 million in any rolling twelve month period, though at the beginning of its offering it must set a target amount it seeks to raise in a given offering. An issuer must file certain information with the SEC and provide such information to investors and the crowd funding portal (described below) used to offer investments, including:
1. the name, legal form, physical address and website of the issuer,
2. the names of the directors and officers (or persons acting in a similar status),
3. a description of the issuer and its current and anticipated business,
4. a description of the financial condition of the issuer (potentially including financial statements and other information), the scope and nature of which depends upon the target amount sought,
5. a description of the intended use of the proceeds of the offering,
6. the target amount, the deadline for reaching the target amount, and regular updates regarding the progress of the issuer in meeting the target amount,
7. the price of the securities being offered and the method for determining the price, and
8. a description of the ownership and capital structure of the issuer, including the names of certain large shareholders, the terms of any securities.
In addition to this initial information the issuer must provide the SEC and investors with annual reports including, among other things, the a report of the results of operations and the issuer's financial statements with such content as the SEC deems appropriate by rule. Notably, the SEC may require that an issuer provide additional initial or ongoing information in its rules implementing the crowd funding exemption and may dictate the required content of any such filings and reports.
B. Crowd Funding Portals. Under the JOBS Act, a crowd funding portal (a type of matching service created by the JOBS Act) must act as an intermediary in a crowd funding transaction. An issuer using crowd funding cannot advertise its offering except to direct interested parties to the relevant portal site.
A crowd funding portal would generally list businesses and give subscribers access to information about the businesses, including the information required above. Prior to the JOBS Act, these entities operated outside the U.S. or catered only to extremely sophisticated investors to avoid pursuit by the Securities and Exchange Commission (the "SEC"). Although the JOBS Act imposes a number of responsibilities on crowd funding portals, many of the details of the crowd funding regulatory framework and regulation of crowd funding portals will be developed by the SEC through rulemaking which must be issued within 270 days of the JOBS Act's April 5, 2012 passage. As a result, companies interested in providing crowd funding portals are lobbying the SEC and seeking to form a trade association to assuage the doubts of state and federal officials who are concerned about the potential for fraud in crowd funding.
C. Limitations on Amounts Investors Can Purchase. The JOBS Act places a limit on the amount of crowd-funded securities that can be sold to an investor in any 12-month period. An investor with annual income or net worth of less than $100,000 can invest the greater of either (1) $2,000 or (2) 5% of his or her annual income or net worth. An investor with annual income or net worth greater than $100,000 can invest up to 10% of their income or net worth, up to a maximum of $100,000. The JOBS Act provides for the manner of calculating annual income and net worth. It is unclear whether a crowd funding portal or issuer can rely on a mere representation from an investor or if it must seek to obtain some documentation related to annual income or net worth. For instance, it would be difficult for a portal or issuer to track crowd-funded securities purchased on another portal in assessing the investor under the above thresholds.
D. Resale of Crowd Funding Securities. Crowd funding securities can be freely resold by the holder one year after their purchase. This could create a form of minor secondary market for small and emerging business's shares or debt.
E. State Law. Securities purchase pursuant to the crowd-funding exemption are exempt from state registration. This is an extremely important feature of the crowd funding provisions of the JOBS Act, and was strongly opposed by state regulators and their representative body, the North American Securities Administrators Association (or "NASAA"). An issuer is still subject to the anti-fraud provisions of state law, but is not require to go through a state-by-state process of registration and oversight.
No one is certain whether crowd funding will be successful in helping small and emerging businesses raise capital. The utility of the exemption will largely turn on the implementing rules issued by the SEC and the additional requirements or limitations those rules impose. Regardless of how widespread the use of crowd funding becomes, it is a laudable step toward improving small and emerging business's access to a new, broader source of capital. This update is not intended as legal advice. The rules governing the offer and sale of securities under state and federal law are extremely complicated. Prior to raising capital, you should consult with counsel.