Scott was a major promoter and early author, for White House staff, of the American Jobs Act SEC revisions. Here is the result of those efforts:
IntroductionWednesday marked a historic milestone in the future of early stage investment and funding for innovation. Roughly 60 days from now, over 200 million Americans will have the option to be angel investors. “If Americans shifted 1% of the $30 Trillion they hold in long-term investments to small businesses, it would amount to more than 10x the venture capital invested in all of 2011.” – Amy Cortese, author of Locavesting This is not just a democratization of capital, but reform that empowers “main street” to have a say over which companies will build our future. Nearly three years since the JOBS Act was passed, we are finally seeing significant progress in the future of equity crowdfunding, Title IV is here.
What is equity crowdfunding?Equity crowdfunding is a new fundraising model that allows private companies to offer securities to a large audience of both accredited investors (annual income over $200k for past two years and/or net worth of $1M+) and non-accredited. This fundraising model is being enabled through evolution in technology, primarily the emergence of online social networks, as well as through regulatory innovations, such as the rules proposed by the Securities and Exchange Commission. Unlike rewards or donation crowdfunding, equity crowdfunding is a financial offering, and therefore falls under the regulation of the Securities and Exchange Commission.
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What is the JOBS Act?In the wake of the financial crisis of 2008 the US government designed a program which sought to promote small and medium business growth by easing regulatory barriers on smaller companies. With sweeping bipartisan support, President Obama enacted the Jumpstart Our Business Startups (JOBS) Act on April 5, 2012. The anticipation built as the SEC pushed back several deadlines before passing the first step in legalizing equity crowdfunding by adopting Title II on July 10, 2013 which allows for the public solicitation of offerings through the amendment of Regulation D rule 506(c). While there are many significant reforms in the act, it is the dream of “main street” investing in the next Facebook or Google that has captivated the public’s imagination. While proponents see this as an opportunity to vastly increase innovation and spread the high returns earned on early stage investments, there is also a pragmatic and cautious opposition concerned about fraud and exploitation. For new and inexperienced investors, having ready access to affordable, trusted legal help will be key to preventing some of the potential harms. Infographic provided by Crowdfunder.com
What is Title IV – Small Company Capital Formation?Title IV known as “Regulation A+” allows private companies to publicly solicit and raise up to $50 million from non-accredited investors. The law is not completely new, rather it is a reformed version of the long-neglected Regulation A. In order to understand the impact of the changes we need a basic understanding of Regulation A and why even SEC Chair Mary Jo White identifies it as “rarely ever used.”
What is Regulation A?Regulation A was an existing way for private companies to be able to raise funds from non-accredited investors. Although it provides the benefit of access to non-accredited investors and a simpler filing process than an IPO, it still possesses two fundamental restrictions which has led to its ongoing lack of popularity. Restrictions:
- Can only raise up to $5 million in any 12-month period (Only $1.5 million can be offered to affiliates or existing investors).
- Under “Blue Sky Laws” the company is required to file the offering and bare the expenses of compliance in every state where they are seeking to offer shares.
What’s new with Regulation A+?Regulation A+ salvages the public offering component of Regulation A but “pre-empts” the individual states, in that federal regulation override each state’s individual regulations on fundraising. The potential rift this might have caused has been addressed by putting into place a two tier solution.
- Tier 1 is the same as Regulation A except that the $5 million cap has been increased to $20 million (with no more than $6 million from existing investors or affiliates of the issuer).
- Tier 2 has several differences which are most easily shown in the chart below, but most crucially this removes the need for state by state registration.
Understanding the choices
Other points of interest regarding Regulation A+
- NASAA and “Blue Sky Laws”: In what looks like a tactful move to pre-empt “Blue Sky Laws” and increase the maximum raise size, the SEC agreed to a “coordinated review process” conducted by the North American Securities Administration Association (NASAA), known as the voice of state and provincial securities regulators.
- Offering Circular Approval Required: The largest potential setback for those that opt to go the Regulation A+ route will be the requirement to file a disclosure document and audited financials with the SEC. These documents will need to be approved by the SEC before any equity sales. This places the company in the position of receiving the same scrutiny as if under a Form S-1 for an IPO, when they may not have the resources to prepare for such a filing.
- Testing the Waters: An issuer can “test the waters” and see if there is interest in the offering prior to spending the time and money to create the Offering Circular. This creates a need, which most equity crowdfunding platforms meet, of allowing investors to confirm interest via a web portal. *NOTE An Offering Circular must be filed at least 48 hours prior to the first equity sale.
- Funds cannot use Regulation A to raise capital.
- Growth stage companies now have a viable new route to raise funding: With the burdensome state filing process removed and the caps increased to amounts more suitable for companies at this stage, equity crowdfunding now provides a legitimate fundraising option to growth stage companies.
- Liquidity for early investors: Early investors now have an alternative exit option with the potential for new secondary markets to be formed.
- “Main street” investors now have access before the IPO: This is often where the highest returns are earned and has historically been reserved for large financial institutions.
- The ball is moving! It may not be Title III (the intended filing for seed stage equity crowdfunding) but all non-accredited US citizens just became eligible investors for equity crowdfunding. This is a significant milestone that should be celebrated as it will promote adoption and accelerated growth for the sector.
Final thoughts:What about Title III? While this is an exciting step in the right direction, Regulation A+ is primarily suited towards later (growth) stage companies and does not fully deliver on the hope of democratized access to early stage capital. What is undeniably exciting is each of the key takeaways above challenges large, well-established industries. We anticipate new relationships between customers-turned-shareholders, evolving secondary markets and completely new opportunities for common investors. It is gratifying to see the SEC take such a bold move. This evolution will not be completed overnight. In the end, though, it is inspiring to see initiatives that can lead to more innovation, particularly from non-traditional sources. I believe this type of democratization in finance will lead to people seeing investment not just as a means to grow personal wealth, but as a power to influence our futures through funding innovation we believe in.
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