Update: The JOBS Act is now law. Read how the JOBS Act could affect crowdfunding in your business.
The U. S. Senate has just approved a bill that reduces regulatory burdens for early-stage companies and small businesses in their capital formation efforts. President Obama had already issued a statement in support of the bill when it was first introduced in the House.
Informally called the “Jumpstart Our Business Startups (JOBS) Act,” H.R. 3606 relaxes the death-grip on capital formation imposed generally on emerging businesses by the investor and reporting requirements of the Securities and Exchange Commission (“SEC”) and the super-audit requirements of Sarbanes-Oxley (SOX). For too long, SEC rules and SOX have favored large-capitalization companies. The JOBS Act could be a game-changer for startups and small-cap companies.
Under current law, early-stage companies are limited to attracting private investment from accredited investors, and any company that desires to offer shares of stock on a public exchange must first register those offerings with the SEC. The JOBS Act makes several important changes to SEC registration requirements and SOX compliance, specifically by:
- Revising upward from 500 to 2,000 the number of shareholders triggering registration requirements, provided that at least 1,500 of these shareholders are accredited investors (income of $200,000 or a net worth of $1 Million);
- Exempting from the 2,000 shareholder threshold any shareholders employed by the company;
- Permitting general solicitation of accredited investors in direct public offerings, broadening the potential investor pool (and, by implication, removing the general rule prohibiting solicitation by brokers of anyone with whom they do not have an existing or prior relationship);
- Allowing use of “crowd-funding,” including promotion of private investment opportunities via the Internet, to raise up to $1 million, on the condition that no one individual invests more than $10,000;
- Exempting emerging growth companies from enhanced audit requirements for five years from the date they first enter the public markets; and
- Relaxing current regulatory requirements for an IPO by, for example, requiring only two years of audited financial reports, instead of three years, for offerings by small companies
These revisions now allow emerging businesses to attract investment from 500 unaccredited investors and use the time-honored tradition of stock awards to not only attract top talent but to further incentivize employees without being penalized by exceeding the old threshold when employees become shareholders. And, the revisions may spur the number of initial public offerings by placing access to capital markets for small companies on a faster track.
Some observers have quickly sounded the alarm over fears of rampant investor fraud. One commentator seems to suggest that Congress has codified the opportunity to steal. See Jobs, Capital and Policy Folly. Others (Harvard scholars John Coates and Robert Pozen, for instance) have more reasonably suggested that the JOBS Act simply casts too wide a net, exempting nearly 2/3rds of all public companies from public reporting requirements. See Bill to Help Businesses Raise Capital Goes Too Far.
The new standards do not provide an automatic “on ramp” to job creation as has been suggested by some proponents. Emerging companies have never created the number of jobs that their founders have suggested they would, and the JOBS Act won’t change that dynamic. Ultimately, the issue is one of public policy; namely, whether government should legislate the decision as to who qualifies as a sophisticated investor. See, e.g., Deciding Who’s Rich (or Smart) Enough to Invest.
With its steroidal approach to consumer protection, the Dodd-Frank Act asserts that we are all vulnerable to financial schemes and manipulation. The JOBS Act recognizes that many potential investors are savvy enough to conduct basic due diligence — by requiring written business plans and accurate management profiles, for example — before investing in early-stage or small-cap companies. While Coates and Pozen have asserted several compelling objections to the JOBS Act, Congress has in my view only made modest revisions to extreme reporting and disclosure requirements that are not likely to open new floodgates of financial deception in the capital markets.