BY:Daniel M. Wasser
The JOBS Act, also known as the Jumpstart Our Business Startups Act, was signed in to law by President Obama on April 5, 2012 and is designed to make it easier for business startups — including entertainment projects like plays and films — to raise capital. Three elements of the JOBS Act are most relevant:
Entrepreneurs are just beginning to contemplate the degree of flexibility these innovations may provide, but much will depend on how the SEC interprets them. The JOBS Act is subject to SEC rulemaking, and the new law cannot be relied on until the rules are out.
Advertising and Solicitation
The elimination of the prohibitions on general advertising and solicitation in connection with certain Rule 506 offerings will have a major impact on how entrepreneurs raise capital. A Rule 506 offering is a private offering of securities involving sales to accredited investors and up to thirty-five financially sophisticated unaccredited investors. Accredited investors include well established companies and people with significant financial means. In practice, to avoid substantially heightened disclosure requirements, most Rule 506 offerings are made solely to accredited investors, and offerings of that sort account for the vast bulk of all capital raised in private film and theatrical financings. The new law addresses itself to Rule 506 offerings that involve purchasers limited to accredited investors.
Consistent with the view that a Rule 506 offering is a private rather than public offering, Rule 502(c) has prohibited issuers from using general advertising and solicitation to make sales of securities. With the passage of the JOBS Act, that prohibition is being eliminated for Rule 506 offerings involving sales solely to accredited investors. This means that a theater producer could seek investors through an advertisement placed in Playbill, and that a film producer could solicit investors in the trailer of a current film. Most significantly, the new law unleashes the power of the internet as a way to reach potential investors. In each instance, however, eager investors who are not accredited would have to be turned away.
These changes may very well give the JOBS Act its broadest impact and they are receiving the most immediate attention by the SEC. It is expected to issue new rules by the end of June, 2012 although delays are possible.
Many people who hear the term “crowdfunding” think of Kickstarter and similar companies that provide online platforms for entrepreneurs and charities to solicit contributions to fund projects. People who make contributions to private companies through Kickstarter do not get a tax deduction and do not obtain an investment interest in the company they contribute to (although, for example, if they contribute toward the funding of a movie, they might receive an invitation to a screening or a DVD copy for home use). In the JOBS Act, “crowdfunding” is used to refer to investments in companies that occur generally in small amounts, commensurate with an investor’s financial wherewithal, and in a total amount that is limited to $1 million per year for the company raising funds.
The JOBS Act does not allow issuers to offer crowdfunding investment opportunities directly to investors. Rather, sales will need to be made by registered broker dealers or through “funding portals” that register with the SEC. It seems likely that funding portals will share some of the features of Kickstarter, but just what they will look like awaits SEC rulemaking. There also will be rules regarding filings to be made with the SEC and disclosures to be made to investors. As a result, it remains to be seen whether protective regulations can cost-effectively co-exist with offerings limited to $1 million.
The effectiveness of the crowdfunding law will not become evident until the SEC issues implementing rules, which probably will not happen earlier than the end of 2012.
Simplified Public Offerings
Last month, The New York Times ran an article about Ken Davenport (an FWRV client) and his innovative use of a crowdfunding model to finance the Broadway revival of Godspell. That offering was facilitated by a seldom used public offering approach known as Regulation A. Once an offering is registered under Regulation A, the pool of potential investors no longer is limited to the echelons of high net worth investors required for Rule 506 offerings. Regulation A is not used more frequently because offerings are limited to $5 million, the offering documents undergo SEC scrutiny, and sales are regulated by the states.
The JOBS Act expands the amount that can be raised to $50 million, but filing of offering papers and perhaps additional periodic filings, with the SEC will be required. Disappointingly, this new federal law does not supersede state regulation (unlike Rule 506 offerings to accredited investors), and if federal exemptions are not made available through the SEC’s rulemaking process, state securities regulators will be able to condition, limit or even prohibit sales of securities issued under the new law.
The usefulness of this new sort of public offering will be highly dependent on the rules to be issued by the SEC, but when they will be issued remains to be seen as Congress did not specify a timetable.
(Note: this article is intended as an overview and should not be relied on as legal advice respecting interpretation or application of the JOBS Act.)