Tweaks to JOBS Act Should Create Jobs, Spur Growth; Worth Waiting For
[ Sorin is Chair of the Venture Capital and Emerging Growth Company Practices at McCarter & English.]
A potential overnight sensation that was years in the making, the body of new SEC rules regarding equity crowdfunding is intended to greatly expand the pool of people eligible to invest in fledgling companies while markedly reducing the costs of capital formation.
From our vantage point – representing hundreds of early-stage and emerging growth companies as well as investors looking to back the next big winner – we say “huzzah” and “it’s about time,” with equal parts optimism and caution.
By tapping the collective investable funds of previously ineligible would-be investors, reducing transactional costs for issuing companies, and increasing demand for equity participation in startups and emerging growth companies, the SEC crowdfunding rules seem to:
* Provide much-needed fuel to our nation’s economy to spark innovation and job-creation, which, after all, are primary goals of the JOBS Act;
* Democratize an investment landscape that previously was open only to the few, those so-called accredited investors whose position, defined by high levels of earnings or net worth, provided access and opportunity. Historical rules, intended to protect less affluent or less sophisticated investors, deprived too many people of the opportunity to participate in the high-risk, high-reward equity positions that can contribute mightily to wealth creation, and denied issuing companies’ access to a large group of highly motivated potential investors;
* Maintain sufficient and responsible standards that generally protect investors as well as the integrity and reliability of the equity investment/capital markets; and
* Broaden access of early-stage companies to the thing they need most: working capital.
All that in only four “short” years, which were replete with toe-tapping and deep sighs on the part of issuing companies, would-be investors and counsel to both, as well as disappointment and missteps. But I digress ….
So what does the landscape look like for companies and investors now that the SEC has adopted new rules under Title III of the JOBS Act?
Unlike the initial equity crowdfunding proposal that the SEC proffered in 2013, which required audited financial statements of companies seeking to raise more than $500,000 through crowdfunding, the new rules eliminate that chilling requirement, replacing it with the far less costly reviewed-financial statements mandate.
The new rules allow companies to raise up to $1 million of capital through crowdfunding in any 12-month period, without audited financial statements. The biggest bonus, however, is that the aggregate million dollars can come from accredited and unaccredited investors alike – a crucial sea-change in capital formation transactions.
In liberalizing the rules and democratizing the investment landscape, the SEC hardly abdicated its long-standing role as protector of investors. The new rules include limitations and obligations, including issuer disclosure and financial-statement obligations on the part of issuing companies, and caps on investment dollars that may be used in crowdfunding transactions.
Also, all crowdfunding must be conducted online through a broker or funding portal, with relevant financial information and details relating to the distribution plan. Less affluent and less sophisticated investors – commonly referred to as widows and orphans – are hardly flying on their own, with the SEC seeking to preserve the integrity and reliability of the capital-raising markets, even as it liberalizes access rules.
Also, in a departure from Reg A+ offerings, under Title III, shares issued in a crowdfunding transaction must be held by investors for at least a year before they can be resold. So as to liquidity and tradability, there are lingering issues that may – or may not – be revisited once the SEC and both sides of the capital-raising community have a chance to measure the efficacy and protections of the new rules.
Not every early-stage company will garner “Uber” investor interest or grow like an “Apple” and most will not become solid as the “Rock,” any time soon, if at all. So, it would appear that the SEC took balanced, nuanced, laudable, logical steps toward crowdfunding while protecting investors – primarily unaccredited ones – from acting on irrational exuberance, implementing sliding investment restrictions based on net worth and annual income of prospective investors:
* People whose income or net worth is less than $100,000 may invest, in the aggregate, a maximum of the greater of $2,000 or 5 percent of their annual income or net worth (whichever is less).
* People with income or net worth greater than $100,000 may invest up to 10 percent of their annual income or net worth – whichever is less – with an annual ceiling of $100,000 in aggregate crowdfunding equity investment.
Are the new rules perfect? Of course not, with both issuers and investors wishing for more. Are they well-intentioned and logical? Absolutely, and continue a tradition of governmental protection of the uninformed and the less sophisticated. Will they be effective? Only time will tell, but we believe that they are far better than the prior status quo. Can they be tweaked along the way? Of course, and that will be done with the benefit of some hindsight.
For now, we’ll view the new SEC rules as one significant step in the realm of capital formation, which could be one giant step for our economy. We will all stay tuned. After all, the one constant in the world of capital raising transactions is change. And, there surely is more change to come.