In last week’s column, I dissected the “crowdfunding” provisions of the new federal “Jumpstart Our Business Startups Act” (J.O.B.S. for short). The new law, which was signed by President Obama last week, changes the federal securities laws so as to enable startups and other privately-owned companies to raise capital from strangers on the Internet (known as “crowdfunding” and up to now illegal).
While the “crowdfunding” provisions of the J.O.B.S. Act (sections 301 to 305) are getting all the press and media, I don’t think those provisions will enable “crowdfunding” – at least in the short run – the way many entrepreneurs hope. As I pointed out last week, the Act requires “crowdfunding” to take place via Internet “portals” that will have to comply with Securities and Exchange Commission (S.E.C.) regulations that are months, if not years, away from being drafted. Also, companies that avail themselves of “crowdfunding” will have to jump through many of the hoops companies launching initial public offerings (IPOs) have to go through today – including the drafting of a mini-prospectus and the filing of annual reports with the S.E.C.
All in all, you aren’t going to see a lot of “crowdfunding” under these provisions for quite some time, and there’s a real danger startup companies – absorbing the media “hoopla” and thinking it’s now permissible to sell stock on the Internet – will launch stock offers online that remain illegal despite the J.O.B.S. Act.
However . . .
There is another provision of the J.O.B.S. Act that I think will have a huge impact on early-stage companies looking to raise capital in a difficult market.
Since the 1930s, it has been illegal to use “general solicitation or general advertising” to raise capital without registering an IPO. Section 201(a) of the J.O.B.S. Act removes that requirement for companies seeking capital online as long as all of the “purchasers” of the company’s securities – as opposed to people who receive only “offers” to buy the securities – are “accredited investors” within the meaning of the federal securities laws. Currently, that means institutional investors and certain very wealthy individuals (people having a net worth of more than $1 million or annual income of more than $200,000).
Under Section 201(a), a company can post an offer to sell securities on its website or on other websites (yet to be created) designed to facilitate such sales – heck, they can even take out full-page ads in The New York Times or The Wall Street Journal – as long as actual sales happen only to “accredited investors”.
Here’s how this would work:
- when posting the ad, the company would indicate that the securities are being offered to “accredited investors” only;
- people responding to the ad would be sent an investor questionnaire much like private companies use now when raising capital;
- prospective buyers would complete the questionnaire and send it to the company along with supporting documentation showing that they are “accredited investors”;
- if the company is satisfied with the prospective buyer’s paperwork, the sale would be completed and the buyer would become a shareholder or part-owner of the company.
I believe it is this section of the J.O.B.S. Act – as opposed to the “crowdfunding” provisions – that will actually facilitate “crowdfunding,” at least by the more “seasoned” early-stage private companies that tend to attract “accredited investors”.
But there are a couple of “gotchas” in the New J.O.B.S. Act.
First, the Act leaves intact the “general solicitation and general advertising” prohibition for offerings which include ANY “nonaccredited” investors such as employees, product developers and other people contributing “sweat equity” for their shares – these people would have to be brought on board as “founders” (and their number would be strictly limited as under previous law) well before a company offers securities under section 201.
Second, and more importantly, is the fact that while the J.O.B.S. Act expressly overrules state securities laws (called “blue-sky laws”) that might otherwise prevent or restrict an offering under the “crowdfunding” provisions of the Act (sections 301 to 305), the Act DOES NOT overrule conflicting state “blue-sky laws” that would prevent or restrict an offering under section 201(a). Many states have such laws, and a company offering securities under section 201(a) must continue to comply with them to avoid regulatory action at the state level.
So, for example, Connecticut requires a company to register its stock with the state’s securities regulators if more than 10 people buy the stock, whether they are “accredited investors” or not. As I read the J.O.B.S. Act, a company seeking to raise capital under section 201(a) would have to reject investors from Connecticut (even “accredited investors”), or register the offering in Connecticut, if the company expects to sell securities to more than 10 purchasers overall.
Generally, the J.O.B.S. Act is a step in the right direction. But anyone thinking they can offer shares in a startup company freely on the Internet will need to talk to a competent securities lawyer before they start soliciting investors online.
Cliff Ennico (www.succeedinginyourbusiness.com), a leading expert on small business law and taxes, is the author of “Small Business Survival Guide,” “The eBay Seller’s Tax and Legal Answer Book” and 15 other books.