On July 17, 2018, the U.S. House of Representatives passed a near-unanimous bill (406-4) to update the Jumpstart Our Business Startups Act of 2012 (the “JOBS Act”). The JOBS Act, passed with much fanfare in 2012, was designed to help small businesses, entrepreneurs, and investors by updating and modernizing, in a number of respects, the way that capital is formed for these stakeholders. Unfortunately, in the six years since its passage, many of those constituencies have for the JOBS Act wanted in crucial ways, and have viewed its work as unfinished. Accordingly, calls for an overhaul have been steady and growing.
Which brings us to the present, and the passage of an overwhelmingly bipartisan bill from the House of Representatives, titled the JOBS and Investor Confidence Act of 2018 (the “Act”), which seeks to further reform regulations which have been viewed as holding back investments in small businesses and start-ups.
Major Takeaways for Investors and Startups
Update to “accredited investor” definition: The $1 Million ‘net worth test’ as part of the definition of “accredited investor” in the Securities Act of 1933 is amended to be adjusted for inflation every five (5) years using the Consumer Price Index for all Urban Consumers.
The Act also expands the definition of accredited investor beyond simply the net worth and income tests to include registered brokers and investment advisers as well as natural persons who have “professional knowledge” of a subject related to a particular investment, and whose education or job experience is verified by the Financial Industry Regulatory Authority (“FINRA”) or an equivalent self-regulatory organization (“SRO”).
Reg D Modification: The Act requires the SEC, within six (6) months after the Act is enacted, to amend Reg D to exclude presentations made to angel investor groups and others from the definition of ‘general solicitation’.
Special Purpose Crowdfunding Vehicles: Crowdfunding investors can now form “crowdfunding vehicles” advised by investment advisors to invest as a group rather than as disparate, individual shareholders.
Analysis / Impact
These changes would be significant steps forward for the startup space (Note: the Act must, of course, still be passed by the Senate, signed into law and implemented). With fast-moving and highly technical investment opportunities like cryptocurrency, the definition of “professional knowledge” is changing. It is nice to see a shift toward an understanding that professional knowledge is inherently valuable and can give well-informed individuals access to early investments into start-ups, and businesses at all stages of the capital formation life cycle.
The Reg D modification seems to be an extension of the shifting view in securities regulation away from focusing on ‘offers’ and, instead, focusing on ‘sales’. The clarification that activities such as demo days and pitch events do not constitute general solicitation under Reg D would seem to be a recognition of a reality that already exists in those environments and brings lower level ‘testing the waters’ activities into the sunshine. The new exemption is provided so long as: the event advertising does not reference or specify offerings of securities and the event sponsor is not offering investment advice to event participants nor is engaging in investment negotiations, charging fees, or receiving certain compensation; and the information provided does not extend beyond the type and amount of securities being offered, the amount of securities already subscribed for, and the issuer’s intended use of the securities offering proceeds. With the growth of incubators and accelerator programs, the ambiguity between general solicitation and pitches has been questioned numerous times. The clarity offered in the Act finally adds some guardrails to that grey area.
Finally, the Special Purpose Crowdfunding Vehicle seeks to address one of the most significant issues with equity offerings under Reg CF (although, from the author’s perspective, many more still exist!). Currently, using crowdfunding platforms like Angelist, accredited investor groups often form a special purpose vehicle using Reg D to invest jointly in a company. The obvious benefit to the issue is that there is only one shareholder on the cap table rather than thousands. The cost and difficulty in getting shareholder approval from thousands of disparate investors every time shareholder consent is required has kept many companies from utilizing Reg CF.
With respect to non-accredited investors, the Act addresses this issue by allowing small investors to form a special purpose vehicle guided by a sophisticated investor who, additionally, has a fiduciary duty to represent their interests and negotiate on the small investor groups’ behalf. Similarly to accredited investors forming special purpose vehicles under Reg D, a special purpose vehicle for crowdfunding would represent one shareholder on the issuing company’s cap table. Although it seems to be a hopeful aspect that qualified intermediaries will actually find it lucrative to act in this capacity and will wish to do so (which will remain to be seen), nevertheless, this addition provided by the Act may allow companies that are shying away from Reg CF to use it more going forward.
We will be following this Act closely as we continue advising our start-up and investor clients on these and other developments in unlocking innovation and growth in small businesses.
Commentary by Stan Sater & Jeffrey Bekiares, Esq. Jeff is a securities lawyer with over 8+ years of experience, and is co-founder at both Founders Legal and SparkMarket. He can be reached at [email protected]