For most startups and emerging companies, fundraising continues to be challenging. With the passage of the Jumpstart Our Business Startups Act of 2012 (the “JOBS Act”), Congress tasked the Securities and Exchange Commission (the “SEC”) with revamping federal securities laws to make fundraising more accessible for small companies in attempt to help create jobs. Recently, the SEC has implemented and proposed new and revised securities laws to achieve this mandate. While not all of these rule changes make life easier for small companies seeking to raise capital, some of the rules do potentially provide new fundraising alternatives for small companies. Companies and investors should also be aware that certain new rules impact established practices and, predictably, there are new pitfalls to avoid. This post briefly introduces some of the recent developments in unregistered offerings and provides some key takeaways for companies and investors to consider.
Background: The JOBS Act
As a reference point, the JOBS Act consists of the following five parts or Titles: Title I is the so-called “on-ramp” to the initial public offering (“IPO”) process for emerging growth companies that introduced certain relaxed disclosure and audit requirements (this topic is not covered in this post); Title II tasked the SEC to promulgate rules to lift the ban on general solicitation in effect under existing private placement exemptions; Title III created an exemption for crowdfunding offerings; Title IV tasked the SEC with improving the Regulation A offering exemption; and Title V increased the limit on the number of shareholders a company may have before it triggers public reporting requirements.
Traditional Regulation D Private Placements
Companies seeking to raise capital through the offer and sale of securities must either register the securities offered with the SEC under the Securities Act of 1933 (the “Securities Act”) or rely on an exemption from registration. Historically, when small companies raised funds from private investors in unregistered offerings, such offerings were generally conducted as private placements exempt from registration under Rule 506 of Regulation D under the Securities Act, which allows an unlimited amount of capital to be raised from an unlimited number of accredited investors (and up to 35 sophisticated non-accredited investors).(1) One of the requirements of former Rule 506, now revised Rule 506(b), is that a company cannot engage in general solicitation or advertising in connection with the offering.