In an effort to jump-start the US economy and create more jobs, both the House and Senate passed the Jumpstart Our Business Startups (JOBS) Act, and President Obama signed the act into law April 8, 2012. With bipartisan support, the bill is designed to make it easier for small businesses, start-ups, and entrepreneurs to raise capital by decreasing government oversight and federal regulations.
Now the intrigue begins. Many questions arise from this new legislation. What kind of impact will the JOBS Act have on small businesses, start-ups, and the economy in general? Will the JOBS Act open the door for new IPOs? Or will it provide more incentive for companies to stay private? What impact will the JOBS Act have on investors who rely on full disclosure when reviewing the filings of IPOs?
These open-ended questions have answers that vary depending on who you are asking – the opponents or proponents. Those in favor of the JOBS Act see it as an opportunity for growth; while those against it worry that loosened regulations may lead to investor fraud and abuse. Whether for or against the legislation, the JOBS Act will:
Create emerging growth companies. One provision of the JOBS Act essentially creates a new category of public companies. Businesses that have under $1 billion in annual revenue during its most recent fiscal year would qualify “emerging growth companies” (EGCs) and would not be required to comply with certain Securities and Exchange Commission (SEC) reporting regulations for up to five years; less than five years if the company reaches $1 billion in gross revenue, $700 million in public float, or issues more than $1 billion in non-convertible debt in the previous three years. Companies that complete or have completed an IPO after December 8, 2011, will be eligible to qualify as an EGC. Through this legislation, EGCs would be exempt for their first five years on the public market from the compliance burdens of Sarbanes-Oxley (SOX) Section 404(b), such as requiring an auditor’s attestation report on internal controls over financial reporting. The JOBS Act will also allow pre-IPO EGCs to confidentially submit a draft registration statement for SEC review. Other reporting requirements will be “phased in” over the initial five-year period. These relaxed regulations will allow smaller companies to go public sooner.
Allow equity-based “crowdfunding.” New businesses will be able to raise up to $1 million in equity capital from unaccredited investors. This provision facilitates the utilization of online trading portals, a mechanism used to solicit a large number of smaller investors. The Senate version of the JOBS Act created a number of restrictions aimed at protecting investors. Among those restrictions are limiting individual investments to (1) the greater of $2,000 or 5 percent of the investor’s annual income or net worth if either annual income or net worth is less than $100,000; and (2) 10 percent of the investor’s annual income or net worth, not to exceed $100,000, if annual income or net worth is greater than $100,000 and also requiring registration by intermediary platforms and issuers with the SEC. Federal law would preempt state regulations, meaning that issuers could raise funds from across the United States. The SEC will have 180 days after the bill’s enactment to publish rules for crowdfunding.
Remove prohibitions on general solicitation of Regulation D offerings. The JOBS Act allows for advertising of Regulation D 506 offerings, as long as advertisements are focused on accredited investors. Affluent individuals who provide capital for a business start-up, also known as “angels,” should especially note the McHenry Amendment, which clarifies that angel and incubator platforms that do not charge a fee connected to the purchase or sale of securities would be exempt from broker-dealer registration. This exemption from registration will be helpful for Internet platforms, such as AngelList or Gust and venture forums aimed at accredited investors, and also for some angel groups.
Increase the threshold for Regulation A “mini-public offerings.” Regulation A currently allows companies to go public and be exempted from SEC registration for offerings up to $5 million. The JOBS Act will increase the offering threshold for this little-used exemption to $50 million, perhaps making it a more useful option for angel-backed companies.
Raise the cap on private shareholders from 500 to 2,000. Many private companies are forced by regulations to file as a public company once they exceed 500 shareholders and $10 million in assets. The bill will increase the shareholder limit to 2,000 accredited investors or 500 unaccredited investors. The increased limit will give some flexibility to companies like Facebook in deciding whether to stay private or go public, and it could also benefit secondary market platforms that can offer a more robust market for the shares of private companies.
From the above analysis of the bill, it is clear how the JOBS Act will help small businesses, start-ups and entrepreneurs raise capital, but the question that remains is how will the bill create jobs? Here are a couple of thoughts: (1) the $1 billion ceiling on regulation will spur job growth since it will provide an incentive for companies to go public instead of selling, and (2) the cost savings for new IPOs will allow them to spend more money on growing their businesses and hiring personnel instead of regulatory compliance.
Despite the apparent benefits of the bill, the legislation still has its detractors. Critics fear that the JOBS Act will lead to massive fraud due to a lack of regulation and oversight. Investors will not see the “full picture” when making their investments. For example, the online coupon company, Groupon (that who went public in 2011 and had over $1 billion in revenue at the time), was faced with major SEC scrutiny over its accounting methods during its IPO. The company suffered a significant market capitalization reduction when going public due to reported questionable accounting methods and the loss of investor confidence. Had the JOBS Act been in effect prior to its IPO, Groupon could have gone public before it reached the $1 billion mark and not dealt with the intense scrutiny that resulted in its reduction in market capitalization. Conversely, the investing public would not have been aware of the apparent “red flags” had the reporting regulations been relaxed.
To address these concerns, the Senate attached an amendment to the bill, requiring the business to warn investors that there are risks when it comes to investments. The amended bill requires that a business “takes reasonable measures to reduce the risk of fraud with respect to such transactions” and gives the investor its company address and website, which must be kept up-to-date. The JOBs Act also requires the SEC to implement various actions on a tight time line from as little as 90 days after enactment of certain aspects of the law, while up to 270 days for other portions.
The President and Congress are hoping the JOBS Act will generate as much economic growth as it did bipartisan support. It originally passed the House by a vote of 390 to 23, and then passed the Senate 73 to 26. However, only time will tell.