A lot of ink has been spilled over the Jumpstart Our Business Startups (JOBS) Act, and particularly the provisions that will allow for “Crowdfunding”. You can find a good summary of the capital raising aspects of the JOBS Act by my colleague Ford Ladd at Dimuro Ginsberg PC here. Of course, the devil will be in the details (e.g., the regulations that the SEC will need to generate to implement the JOBS Act), but there are a couple of key takeaways I would like to discuss.
One change that I think will benefit small companies greatly is in Section 201(a)(1) of the JOBS Act, which now allows for Rule 506 private offerings to be generally advertised, so long as the buyers are accredited investors. This will allow companies to utilize a pre-existing and well-understood exemption from SEC registration of private offerings, while removing the largest impediment (the restriction on general solicitations and advertisements). Companies will be limited to only accepting investments by accredited investors, but frankly this is a restriction companies should be happy to accept. I always advise companies raising funds that they try to only accept investments from sophisticated investors who understand the risks of investing and can absorb a loss of their investment, and that generally means accredited investors. And as far ask risk assumption goes, it’s always best to follow a path that’s already been worn.
Speaking of risk assumption, this leads me to the item that is getting the most discussion… Crowdfunding. Many see this as a great way for companies to solicit small investments from non-high net worth investors who have until now been restricted from investing in private companies. I see it as a breeding ground for securities litigation. Title III of the JOBS Act (the portion on Crowdfunding) already takes up 9 pages, and I cannot imagine what the regulations are going to look like. Companies looking to take advantage of Crowdfunding are going to be careful in navigating what I expect to be a very complicated and difficult regulatory framework (and note… state anti-fraud statutes are not preempted).
And even if a company is successful in navigating the regulatory waters of Crowdfunding… where does it end up? It ends up with hundreds of investors with no personal ties to the Company, many of whom are not sophisticated. It does not take much imagination to see the class action lawyers clamoring to get first in line whenever a company makes a misstep (or a savvy lawyer can assert made a misstep). And how does a company with so many investors look to a potential Venture Capital or Private Equity investor when the company grows and is ready to raise institutional funds, or to a strategic buyer looking to acquire the company? Easy answer: Not nearly as attractive as the exact same company with only a handful of investors. Crowdfunding might sound like a great idea, but I don’t see myself advising clients to take that path any time soon.