Before getting into Title III of the JOBS Act, first, let’s understand the Act. JOBS Act emerged as the Securities Act of 1933 showed limitations for startups & entrepreneurs with changing market situations due to Post 1929 market crash.
In the wake of spurring Economic Growth & finding ways for restoring the economy, President Barack Obama signed the Act into law on April 5, 2012.
Why & How JOBS Act Started?
Congress enacted the U.S. federal securities law – The Securities Act 1933 to prevent such market crashes in the future. It entails individuals registering all the offers and sale of securities with the U.S. Securities and Exchange Commission (SEC).
The act’s one of the most used exemption is Rule 506 of Regulation D, promulgated under Section 4(a)(2). It allowed issuers to raise an unlimited amount of capital from an unlimited number of accredited investors and up to 35 sophisticated non-accredited investors.
But the act restricts engagement with any type of general solicitation or general advertising. Thus, resulting in only solicit investments from potential investors with which the issuer has a pre-existing relationship. Thus, limiting the pool of investments.
Understanding JOBS Act:
When Jumpstart Our Business Startups Act (JOBS Act) emerged in 2012, it eased out the securities regulations & opened opportunities for private funding for startups & small businesses.
JOBS act made three important changes in the startup & business world. This includes:
- Opening up of public markets for smaller business companies, wanting to publicize by subsiding the regulatory requirements associated with it.
- Expansion of private capital markets to facilitate opportunities for entrepreneurs, companies, private equity funds, venture capital funds, hedge funds, and any other issuer of securities to easily reach out to potential investors & raise funds.
- Elimination of the restriction on general solicitation and advertising of private offerings under Rule 506.
- JOBS Act proved to be an extraordinary piece of legislation for businesses. The Act took less than 4 months from introduction to enactment to pass through both the House and Senate & finally made it to the final sign-off in April 2012.
Understanding Title III of JOBS Act:
Title III of the JOBS Act is a masterstroke for founders. As it opened gates for entrepreneurs to raise equity crowdfunding through non-accredited individuals that invest in small private firms through online portals.
As previously, only wealthier institutions and accredited investors had the permit. It controverted the past rules. However, the funding portals & broker-dealers need to be registered under SEC and FINRA for the crowdfunding transaction on behalf of Issuers.
Title III of the JOBS Act proved to be a game-changer for new startups seeking capital by increasing access to the capital pool. Market Individuals termed it Title III Crowdfunding, Regulation Crowdfunding, or just Equity Crowdfunding.
The Title III of the JOBS Act has the following provisions for both Issuer & Investors:
Title III Provisions for Issuers:
Only US private firms are the beneficiary of the Regulation. Investment companies, mutual funds or private equity funds company is not permittable to raise capital through crowdfunding portals.
Title III of the JOBS Act has the following additional provisions for issuers:
- An issuer can raise $1,070,000 through equity crowd financing portals in 12 months. The amount is adjustable with inflation at least once for 5 years.
- An issuer has to dispense accurate and true information. It includes Company name, legal status, physical address, website URL, Names of officers, directors, and shareholders owning 20 percent or more of total equity; business description, business plan, capital & financial structure, the offering amount, proceedings & deadline for raising the amount, securities price or method used to determine the price.
- Issuers looking to raise less than or equal to $107,000 must disclose certain information. This includes financial statements, total income, taxable income, and total tax as mentioned in the issuer’s federal income tax returns, and a certification from the principal executive officer. The issuer can replace these documents with, financial statements that are reviewed or audited by an independent public accountant.
- Issuers looking for more than $535,000 and up to $1,070,000 through Regulation CF must provide the financial statement either reviewed or audited by an independent public accountant. However, audited financial statements are more preferred than the reviewed statements by an independent public accountant.
- The offer of the sale of securities is open to unlimited investors but at a deal within the limit of $1,070,000.
- Issuers are allowed for publishing a notice advertising terms of the offering, communicating & directing investors to the crowdfunding portal. Issuers can also participate in Reg D, Rule 506(c) general solicitation offerings along with equity crowdfunding offerings. These are referred to as concurrent offerings.
- In case of fraudulent or intentionally misleading statements, or material omissions in connection with offerings, issuers will be held liable under both federal and state law & had to reimburse investors for their purchase of securities along with interest.
Title III Provisions for Investors:
For preventing big losses, Congress set the limits or the amount of money that an investor can put into crowdfunding through Title III of the JOBS Act. The provisions are:
- Individuals with an annual income or net worth of $107,000 or more, excluding primary residence, can invest up to 10% of the lesser of the net worth or annual income, provided it doesn’t exclude $107,000 per year.
- Individuals with an annual income or net worth of $107,000 or less, excluding primary residence, can invest up to 5% of the lesser or greater of the $2,2000 of the net worth or annual income. Together, an individual can invest at least $2,200 in equity crowdfunding every year.
- Every investor while registering on the funding portal, must review the materials & should positively agree to the fact that they understand the risk of loss of their investment & are ready to bear future, unforeseen loss.
- Investors are required to hold the shares for at least one year. This is while purchasing them via equity crowdfunding with certain exemptions. This includes – Sell of shares back to the issuer or an accredited investor, or to a family member, in connection with death or divorce.
- An issuer has the full right to sue or file a lawsuit against an issuer for revocation of funds or in case of material misstatements or omissions in connection with the offering.
The ultimate purpose of the title was to infuse capital into small businesses. Although Title III gave out few good benefits to entrepreneurs & founders. It also had certain limitations. First, it led to limitations of the total amount to be raised. & Second, the cost associated with it was too high, as a fundraising campaign cost around $50-$100K.
The SEC regulations require the issuer to go through a lengthy procedure & compliance, which costs huge for a new startup & 100 work hours while filing the documents with various in-house or outsourced accountants and lawyers. Additionally, the startup also has to incur fee costs associated with crowdfunding portals and broker-dealers.
Ultimately, this section of the act fell short considering the cost & the hours along with numerous regulatory obstacles. Considering, the equity barriers, top-tier startups won’t opt for equity crowdfunding for fundraising for their startups.
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