JOBS ACT 2012 – Elimination of General Solicitation Ban for Startups and Small Businesses
“ by Arushi Bhandari , Technical Accounting Manager.”
Jumpstart Our Business Startups Act of 2012 (JOBS Act of 2012) was passed by Congress and signed into law by President Obama in April 2012. It is designed to ease small business and startup funding by easing the federal regulations.
Currently exempt offerings are only offered to accredited investors and limited non-accredited investors. After this law, businesses will be able to accept small investments up to $1 million annually from non-accredited investors, or the general public, and offer equity in return. These private individuals are also called crowd investors. Thus, it gives regular people a chance to become investors in small businesses and startups and allows entrepreneurs easy access to capital.
Amendments and New Regulations by SEC
SEC has amended Rule 506 to add a new rule called Rule 506(c) to reflect the legislative act and has mandated two different set of private offering exemption rules:
Ø Traditional/Old 506(b) - where general solicitation will not be permitted and purchase of securities can be made by up-to 35 non-accredited investors and unlimited accredited investors.
Ø New Rule 506(c) - where general solicitation will be permitted, issuer can solicit general public but only accredited investors can purchase private equity.
Amendments to Rule 506 per Section 201(a) of JOBS Act – Elimination of General Solicitation Ban for Startups and Small Businesses
Rule 506 of Reg D is considered safe harbor for private offering exemption if the company adheres to certain rules and regulations. It is the most widely used rule by startups and other small businesses. One of the conditions pursuant to Rule 506 was that the company cannot use general solicitation or advertising such as newspaper, magazines, radio, television and internet to market its securities.
Per the passage of the final rules relating to Section 201(a) of the Jumpstart Our Business Startups Act of 2012 (JOBS Act 2012) by the US Securities and Exchange Commission in July 2013, the ban on general solicitation has been lifted. However, this amendment to Rule 506 (referred to as Rule 506(c)) under JOBS Act 2012 make it mandatory for issuers to verify and take reasonable steps to ensure that all purchasers are accredited investors. In other words, the issuer can solicit anyone but issuer’s securities can only be purchased by accredited investors.
The ‘accredited status’ of a purchaser eventually is an objective assessment made by the issuer depending upon specific facts and circumstances, nonetheless the SEC has identified four steps which can be regarded as ‘reasonable steps’ and be used to verify accredited investor status. They are :
i. Reviewing IRS form copies which report the income of the purchaser and obtain written representation that the purchaser will continue to earn that in future years or
ii. Obtaining a written statement from registered- broker, licensed attorney, SEC registered investment-adviser, or CPA who have taken reasonable steps to verify the accredited status of the purchaser or
iii. If purchaser is being regarded as accredited investor based on ‘net worth’ review copies of documents dated within the past three months, showing the assets and liabilities of the purchaser or
iv. Relying on a certification confirming ‘accredited investor’ status of purchaser from an existing accredited investor who previously purchased issuer’s securities under old 506 rules.
To enable investor protection in addition to the above rules the SEC proposed adherence to additional rules like filing Form D within 15 days before use of general solicitation, expanded and additional disclosures on Form D especially regarding general solicitation methods and methods used to verify accredited investor status etc.
Recent changes to Rule 506 per both Section 201(a) of the JOBS Act 2012 and Section 926 of the Dodd-Frank Act change the private security offerings scenario dramatically. Startups that do not adhere to these rules and guidelines will be in violation of both federal and state securities laws and the officers involved in the offering(s) could face criminal and/or civil penalties. This could increase the legal costs and make the due-diligence process more time-consuming and complex.