JOBS Act: Basic Requirements
Last week, I wrote about the JOBS Act, discussing some of the pros and cons of crowdfunding for startup companies. In this post, I’ll go into a bit more detail about the requirements companies have to meet in order to access the world of Internet crowdfunding.
Access for Everyday Investors
The JOBS Act will give companies access to capital from people who are not accredited investors. The SEC’s definition of accredited investors is here – briefly, the term is used to refer to a wealthy, sophisticated investor who has money to lose on risky investments. The SEC and securities laws generally act under the assumption that an accredited investor knows what he or she is doing, so they are given slightly less protection than the average investor.
Under the JOBS Act, companies will be able to sell up to $1 million worth of stock to non-accredited investors, as long as:
(B) the aggregate amount sold to any investor by an issuer…does not exceed–
(i) the greater of $2,000 or 5 percent of the annual income or net worth of such investor, as applicable, if either the annual income or the net worth of the investor is less than $100,000; and
(ii) 10 percent of the annual income or net worth of such investor, as applicable, not to exceed a maximum aggregate amount sold of $100,000, if either the annual income or net worth of the investor is equal to or more than $100,000
So in the first place, we can see that there is an attempt to limit the amount that any individual investor can lose in a transaction conduced under this Act. Congress doesn’t want you putting your annual salary on the line to fund a risky startup over which you may have little or no control.
Requirements for Crowdfunding Intermediaries
Under Section 4A of the JOBS Act, a company acting as an intermediary for crowdfunding – meaning, a company that puts together corporations seeking financing with individual investors – has to do several things, including register with the SEC (as either a broker or a “funding portal”), and ensure that the investors are given a variety of relevant information and demonstrates an understanding of the risks involved.
The intermediaries also have to ensure that they will not release the funding until the target offering amount is reached. For example, let’s say Company A wants to raise $100,000 through crowdfunding. You, an investor, decide to put in $1,000. You need to be sure that the funds won’t reach Company A until the full $100,000 target is reached – otherwise, your $1,000 will most likely go down the tubes, and if Company A folds up, good luck trying to get your money back.
Requirements for Companies Issuing Stock Online
The issuers – meaning, the companies who are seeking crowdsourced funding – have a list of requirements as well. These include, notably, disclosing the names of directors, officers, and anyone holding more than 20% of the shares of the issuer, the purpose and use of the funds, and the target offering amount, deadline, and updates regarding the progress in reaching that amount.
More controversial are the required financial disclosures. Companies seeking $100,000 or less must disclose their most recent income tax returns and financial statements certified by the principal executive officer (usually the CEO). Companies seeking more than $100,000 but less than $500,000 must provide financial statements reviewed by an independent accountant. Companies seeking $500,000 or more must disclose audited financial statements.
Are these requirements reasonable? Ryan Caldbeck, CEO of CircleUp (described as an equity-based crowdfunding website), writing on Forbes.com, stated that the “…proscriptions are out of line with investor expectations in the market today. Find a private company with audited financials that is only raising $500,000. You’ll be searching for a long time.” While Mr. Caldbeck arguably has a personal interest in making the crowdfunding process as streamlined as possible, it’s reasonable to argue at what point the disclosure requirements become so onerous as to place crowdfuding out of the reach of those small companies that most need access to capital. Investing in small companies will always, by definition, be risky. The SEC has until September 29, 2012, to issue rules relating to crowdfunding, and it will be interesting to see how the details of those rules balance some of these competing needs and interests.
Buy-and-Hold, Not Buy-and-Sell
One more interesting point: Section 4A(e) of the JOBS Act restricts the ability of a crowdfunding investor to sell the newly purchased stock for one year, other than (a) to the issuing corporation itself; (b) to an accredited investor; (c) as part of an offering registered with the SEC (i.e., an IPO); or (d) in certain cases, to a family member or in connection with the investor’s death or divorce. So the JOBS Act was not intended to be used for the kind of quick buy-and-sell transactions favored by day traders or large investment houses. Investors are expected to hold on to the stock – the purchase should be made based on a belief in the viability of the company and its product or service offerings.
