How the JOBS Act Helps Your Business Access Capital
November 17, 2014
The Jumpstart Our Business Startups (“JOBS”) Act passed both houses of Congress with bipartisan support and was signed into law on April 5, 2012. The JOBS Act has seven titles but is known chiefly for the titles dealing with access to capital (“Title II”) and crowdfunding (“Title III”). Titles II & III of the JOBS Act give small businesses a greater chance to access capital and ease restrictions on securities funding for smaller private entities through differing methods.
Title II- The JOBS Act Increases Access to Capital
Title II of the JOBS Act improves the access to capital available to a small business. For more than 80 years Regulation D Rule 506(c) forbid the advertisement of a private offering to investors ahead of the offering. The Securities and Exchange Commission (“SEC”) green-lit Title II into law effectively lifting the ban on advertisement of private securities offering so long as the issuer of the securities takes “reasonable steps to verify” that all of the purchasing investors are accredited.
Now you, dear prospective 506 issuer, might be wondering: what does the SEC determine as “reasonable steps to verify” an accredited investor or even what is an “accredited investor?” Luckily we have got you covered.
Reasonable Steps to Verify
This has been a huge gray area for businesses and investors trying to set up these private sells of securities using the exemption provided by the JOBS Act. The SEC allows the use of four non-exclusive verification methods including:
1. verification based on income, by reviewing copies of any Internal Revenue Service form that reports income, such as Form W-2, Form 1099, Schedule K-1 of Form 1065, and a filed Form 1040;
2. verification on net worth, by reviewing specific types of documentation dated within the prior three months, such as bank statements, brokerage statements, certificates of deposit, tax assessments and a credit report from at least one of the nationwide consumer reporting agencies, and obtaining a written representation from the investor;
3. a written confirmation from a registered broker-dealer, an SEC-registered investment adviser, a licensed attorney or a certified public accountant stating that such person or entity has taken reasonable steps to verify that the purchaser is an accredited investor within the last three months and has determined that such purchaser is an accredited investor; and
4. a method for verifying the accredited investor status of persons who had invested in the issuer’s Rule 506(b) offering as an accredited investor before September 23, 2013 and remain investors of the issuer.
Title II of the JOBS Act also allows a principles-based approach to verification which the SEC Financial Division Director Keith F. Higgins describes as a “method in which the issuer would look at the particular facts and circumstances to determine the steps that would be reasonable to verify that someone is indeed an accredited investor. Although the verification method must be objectively reasonable, the principles-based method is intended to provide issuers with significant flexibility in deciding the steps needed to verify a person’s accredited investor status and to avoid a “one size fits all” approach.” (Keynote Address at the 2014 Angel Capital Association Summit in Washington DC on March 28, 2014. A full transcript is available here.)
Director Higgins states that prior information, the way the investor found the offering, or the terms of the offering can used to verify and adjust information needed about the accredited investors. This approach gives issuers flexibility to structure the verification in such a way that it does not unduly inconvenience either party.
Now that the SEC’s standards for verification under the JOBS Act are better established we venture on to define the accredited investor in the eyes of SEC. 17 C.F.R. §230.215 states the following are accredited investors:
(a) Any savings and loan association or other institution specified in section 3(a)(5)(A) of the Act whether acting in its individual or fiduciary capacity; any broker or dealer registered pursuant to section 15 of the Securities Exchange Act of 1934; any plan established and maintained by a state, its political subdivisions, or any agency or instrumentality of a state or its political subdivisions, for the benefit of its employees, if such plan has total assets in excess of $5,000,000; any employee benefit plan within the meaning of Table I of the Employee Retirement Income Security Act of 1974, if the investment decision is made by a plan fiduciary, as defined in section 3(21) of such Act, which is a savings and loan association, or if the employee benefit plan has total assets in excess of $5,000,000 or, if a self-directed plan, with investment decisions made solely by persons that are accredited investors;
(b) Any private business development company as defined in section 202(a)(22) of the Investment Advisers Act of 1940;
(c) Any organization described in section 501(c)(3) of the Internal Revenue Code, corporation, Massachusetts or similar business trust, or partnership, not formed for the specific purpose of acquiring the securities offered, with total assets in excess of $5,000,000;
(d) Any director, executive officer, or general partner of the issuer of the securities being offered or sold, or any director, executive officer, or general partner of a general partner of that issuer;
(e) Any natural person whose individual net worth, or joint net worth with that person’s spouse, exceeds $1,000,000.
(1) Except as provided in paragraph (e)(2) of this section, for purposes of calculating net worth under this paragraph (e):
(i) The person’s primary residence shall not be included as an asset;
(ii) Indebtedness that is secured by the person’s primary residence, up to the estimated fair market value of the primary residence at the time of the sale of securities, shall not be included as a liability (except that if the amount of such indebtedness outstanding at the time of the sale of securities exceeds the amount outstanding 60 days before such time, other than as a result of the acquisition of the primary residence, the amount of such excess shall be included as a liability); and
(iii) Indebtedness that is secured by the person’s primary residence in excess of the estimated fair market value of the primary residence shall be included as a liability.
(2) Paragraph (e)(1) of this section will not apply to any calculation of a person’s net worth made in connection with a purchase of securities in accordance with a right to purchase such securities, provided that:
(i) Such right was held by the person on July 20, 2010;
(ii) The person qualified as an accredited investor on the basis of net worth at the time the person acquired such right; and
(iii) The person held securities of the same issuer, other than such right, on July 20, 2010.
(f) Any natural person who had an individual income in excess of $200,000 in each of the two most recent years or joint income with that person’s spouse in excess of $300,000 in each of those years and has a reasonable expectation of reaching the same income level in the current year;
(g) Any trust, with total assets in excess of $5,000,000, not formed for the specific purpose of acquiring the securities offered, whose purchase is directed by a sophisticated person as described in §230.506(b)(2)(ii); and
(h) Any entity in which all of the equity owners are accredited investors.
Title III – Crowdfunding with the JOBS Act
The JOBS Act allows for crowdfunding within Title III, but unfortunately the SEC has not yet established rules for its implementation. The SEC wrote a proposed rule set that well exceed 500 pages in length (I wish I was joking). As of this writing there has been little movement from the SEC regarding the implementation of Title III.
Meanwhile individually states have not waited on clarification on the JOBS Act and moved ahead with intrastate crowdfunding exemptions. Georgia passed Rule § 590-4-2-.08 better known as the “Invest in Georgia Exemption” which allows for Georgia Businesses to be funded by investors who are Georgia residents subject to certain restrictions. Tennessee has a similar bill SB 1481 that passed both houses in Tennessee and was signed by Tennessee governor Bill Haslam on May 19, 2014 and goes into effect on January 1, 2015. The bill will revise Tennessee Code § 48-1-103 to include the exemption for intrastate crowdfunding.
If you have any further questions or concerns relating to the JOBS Act, intrastate crowdfunding or your business, please give us a call. Executive Legal Professionals offers no-obligation initial consultations, and we can assist you and your company in access the capital you desire to get your business up and running. You can reach a licensed attorney at (678) 824-2969 . We look forward to speaking with you.
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