JOBS Act - Tech Startups

Authored by Bryan Springmeyer Bryan Springmeyer is a California corporate attorney who represents startup companies and investors. The information on this page should not be construed as legal advice.

The startup space has been pretty excited about the JOBS Act since it was first enacted.  Indeed, many prominent figures from the space were lobbying before its passage.  As the SEC rules get promulgated, enabling the various portions of the JOBS Act to go into effect, I'm excited to see what evolutions come to startup investing. As I explain below, I think Reg A+ has the capacity to change startup investing, but 506(c) will almost surely be a game-changer.

TITLE III – Crowdfunding

Summary: Title III will allow companies to raise up to $1 million online.  Companies will be restricted to raising the money through registered funding portals.  Additionally, companies will have to disclose financial statements pursuant to the offering.  Audited financial statements will be required for offerings in excess of $500,000.

Status: As of now (March 2015), the SEC has not finalized rules or processes for funding portals registration.

Thoughts: This was perhaps the type of offering that had the most buzz in the early stages of the JOBS Act.  I think there are many industries that will benefit from this type of offering; however, I’m skeptical that the tech startup industry will be one of them.  Angel investment activity has grown pretty significantly over the past few years, micro-VCs have become more prevalent, and even traditional VCs have begun investing in seed rounds under $1 million.  It seems to me that any startup with a broad enough public appeal to raise $1 million through crowdfunding could raise $1 million through angels, micro-VCs, and VCs without having to prepare (audited) financial statements and go through the Title III offering process.

Reg A+

Summary: The JOBS Act instructed the SEC to promulgate rules for the amendment of Regulation A, which would lift the $5 million maximum annual sales to $50 million.  The SEC promulgated rules that create two tiers of Regulation A offerings.  Tier 1 is relatively unamended Reg A language, but lifts the $5 million maximum to $20 million.  Tier 2 lifts the maximum to $50 million, restricts unaccredited investors to investing 10% of their annual income (or 10% of net assets or revenue for a business entity investors), has certain reporting obligations (audited financial statements, semiannual reports), and preempts state laws.

Status: The final rules were promulgated yesterday (March 25, 2015) and are set to go into effect 60 days after their publication.

Thoughts: Regulation A has been an extremely underutilized securities exemption.  This is because, although the rule itself is very flexible and allows public solicitations and sales to unaccredited investors, it did not preempt state securities laws (“Blue Sky Laws”).  This meant that a company could make a public offering under Reg A, but needed to qualify the securities in each state for which it did so.  This type of offering, direct public offering (DPO), has never been widely used because the expensive state qualification process was somewhat prohibitive for offerings capped at $5 million.  The $20 million cap alters the cost benefit analysis a bit, but I still don’t think there will be many tech startups that utilize these Reg A+ Tier 1 offerings.

Tier 2 Reg A offerings have the potential to change the game.   Reg A, Tier 2 preempts state laws, eliminating the expensive qualification process.  The major tradeoff is the SEC reporting requirement.  Although the compliance and reporting costs have yet to be determined, I imagine a lot of startups will find appeal for two reasons: (1) early liquidity – founders can sell portions of their equity as of the first offering; and (2) the diversified investment pool limits investor leverage in negotiating terms.

506(c)

Summary: 506(c) allows unlimited sales with public solicitations to accredited investors.  The securities may be sold by an intermediary – either a registered broker-dealer or a funding portal.  The rule preempts state securities laws.

Status: 506(c) has been implemented, but the SEC rules for funding portals have not been finalized.

Thoughts: This type of offering will be a game changer.  It will be appealing to startups because the broad investor pool gives startups more leverage in the terms of the offering, with no cap on the amount of money the company can raise.  Because these offerings can be solicited through public solicitations, the breadth of accredited investors will be high, which will help with aggregating larger investments.  I think even larger investors may look for investment opportunities directly through 506(c) offerings, in lieu of paying a 2% per year service fee and 20% profit share with venture capital firms.

Another significant portion of the Act will be the relaxed public company reporting requirements that may reduce the compliance requirements and make IPOs a more viable exit option.