Published in the Portsmouth Herald
The Jumpstart Our Business Startups (JOBS) Act was signed into law in April of last year with a great deal of fanfare as the first major reform of federal securities laws in nearly 80 years. Since it was enacted, the JOBS Act has generated an intense amount of interest from the business community, and has been the subject of numerous articles and blogs.
While the cornerstone of the JOBS Act is the so-called “IPO On-Ramp,” a series of changes in the laws designed to encourage smaller companies to enter the public markets by easing disclosure burdens, and allowing small companies to test the waters before committing to an IPO, arguably the provisions of the JOBS Act relating to new rules for private placements will have greater impact for a larger number of companies looking to access the capital markets. The best-known of these new rules for raising private capital is called “crowdfunding.” As the name suggests, crowdfunding involves raising capital in small amounts from large numbers of ordinary investors.
The SEC is in the process of writing regulations which will determine, in large part, whether crowdfunding in particular, and the JOBS Act in general, will live up to its promise of making it easier for small companies to raise capital. Unfortunately, the rulemaking process has dragged on for a number of months, and while we optimistically hoped the SEC would issue regulations on crowdfunding by as early as the second quarter of this year, there are ominous rumblings that perhaps the Commissioners of the SEC are having second thoughts, and it is likely that the crowdfunding regulations will not be issued until as late as the third quarter of this year, or even the first quarter of 2014.
While many in the traditional investment community view crowdfunding as a sideshow to some of the other reforms of the JOBS Act, there is no denying its appeal, particularly to the entrepreneurial community. Other countries like the United Kingdom, Finland, Sweden, Norway and Australia have already implemented crowdfunding alternatives. Moreover, there are a number of influential players in the United States working with regulators to implement crowdfunding. Crowdfunding is an innovative method for small companies to raise capital – but to succeed, it will have to be implemented in a way that balances investor protection with reasonable and understandable disclosure requirements for companies.
Here are the major elements of crowdfunding, as outlined in Title III of the JOBS Act:
•Companies may raise up to $1 million through crowdfunding transactions during any 12 month period.
•Investors will be limited in the amount they can invest based on their income and/or net worth.
•Companies must use intermediaries registered with the SEC or funding portals to reach prospective investors and to facilitate crowdfunding transactions.
•Companies must make fairly robust written disclosures to prospective investors.
It is important to note that crowdfunding is not yet legal. Until the SEC issues the regulations mandated by the JOBS Act, it will remain only a possible future option for companies. In the meantime, companies contemplating crowdfunding or other type of capital raise should take steps today to prepare. If the SEC delivers on the promise of the JOBS Act, companies will need to think strategically about raising capital and what makes the most sense for them. Among other matters, companies should consider:
•How much capital must be raised and what purposes will the capital proceeds serve?
•Is the company’s corporate infrastructure robust enough to deal with the added responsibility of having outside investors?
•Is the company’s capital structure appropriate for having outside investors?
•Is crowdfunding necessarily a better option than traditional sources of capital, given the company’s business plans?
When it is finally implemented, it is likely that early users of crowdfunding will be under greater scrutiny until the SEC and the public have some experience with it. Moreover, given the SEC’s historical focus on investor protection and disclosure, crowdfunding will probably not be a “do it yourself” option for raising capital, and companies seeking to use crowdfunding when it becomes legal should be well prepared and professionally advised in connection with this process.
Michael Tule is of counsel to the Corporate Department at the law firm of McLane, Graf, Raulerson & Middleton, Professional Association. He is licensed to practice in New Hampshire, Vermont and Massachusetts and can be reached at [email protected] or (603) 628-1290. The McLane Law Firm is the largest full-service law firm in the state of New Hampshire, with offices in Concord, Manchester and Portsmouth as well as Woburn, Massachusetts.