By Joseph R. Soraghan
The JOBS (Jumpstart Our Business Startups) Act (the “Act”), was signed into law by the President on April 5, 2012.
The Benefits to Entrepreneurs
Probably, to entrepreneurs, the most important change in the “Act” is the elimination of the ban on “general solicitation”. This elimination in effect allows advertising of small (heretofore “private”) offerings of investments in their businesses. For companies seeking pre-seed, seed and angel investment, this step creates or implements essentially two new types of offerings:
- Accredited investor offerings, in which the investments may be sold only to accredited investors (those who meet significant net worth or income requirements), which offerings are not new, but in which now the issuing company may advertise the offering in mass settings, such as newspapers, broadcast, and most importantly, on the Internet and in social media; and
- “Crowdfunding” offerings, also generally solicited, in which non-accredited investors may purchase the investments, but only (a) up to the lesser of $10,000 and 10% of their annual income; (b) with the assistance to the company of “intermediaries” who must meet certain requirements; and (c) with maximum sales in each offering limited to $1 million in any 12 month period (hereinafter called “crowdfunding”).
It is my belief that perhaps the most beneficial of the above two “new” offerings will be the first, that which simply removes the prohibition on advertising on offerings to accredited purchasers only. The removal of that prohibition will allow an issuer to reach many more possibly interested persons, and therefore many more accredited investors. And although those offerings will not require the use of registered brokers dealers or unregistered intermediaries, the entrepreneur offering companies will now be able to use “intermediaries” (or “portals”) who no longer must be fully registered as broker-dealers, to assist in finding and working with accredited investors. This will be a huge advantage to entrepreneurs seeking capital. And this type offering will place no restrictions on the dollar amount which the purchasers may acquire or the amount which the entrepreneurial business may raise.
It is likely that numerous qualified professional “finders,” i.e., informal investment bankers who are not registered as broker dealers with the securities regulators but with skills and contacts in marketing investments to accredited investors, will develop and become “intermediaries.” Historically, such “finders” have been under severe risk of censure by the SEC and other regulators for carrying out this activity without registration as broker-dealers, a highly illogical and expensive process. When the Act is implemented, intermediaries will not face that risk.
The Need for Caution
However, entrepreneurs using the newly available will need to be cautious. In the early days of use of unregistered “intermediaries” and “portals,” some less than honest, and perhaps more less than skilled, finders calling themselves intermediaries may cause significant problems to issuing companies. And there are other prospective problems with the new “crowdfunding” offering, such as the ability of many smaller, less sophisticated voting shareholders to at least create a significant need for costly investor relations efforts on the company’s part, and at worst, to use their votes to be problematic.
Other problems may cause arise from such shareholders’ rights to inspect the company’s books and records under state law, their right to bring derivative claims on behalf of the company, and their rights under state law against “oppression” by the majority shareholders. And startups will likely have difficulty raising funds in later rounds from angel investor groups and venture capitalists if they have even as few as one hundred unsophisticated shareholders from prior crowdfunding offerings.
Also, such companies with many such unsophisticated shareholders may find it significantly more difficult to attract high value directors and consultants, and director and officer liability insurance coverage may increase significantly.
The ramifications of these new funding methods are mainly conjectural at present. And, because there will be 90 days for SEC rulemaking, 60 to 90 days of comment period, and probably another 60 days for the SEC to draft and adopt the regulations necessary, these methods (the crowdfunding and advertised accredited investor offerings) will not be implemented until early 2013.
Posted by Attorney Joseph R. Soraghan. Soraghan practices in legal matters pertaining to business operations and growth. He guides businesses in financing, contracts, acquisitions, mergers, and sales. Soraghan frequently resolves commercial disputes as an arbitrator or mediator, or through litigation.
05/17/12 3:14 PM
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