It has surprised me that discussion of the JOBS Act has not perpetuated the "investing blog" universe given the ramification of this new legislation. I am hoping this post will be a springboard for institutional investors and writers to begin discussion of the bill and its implications for those in the professional money management business. I'd encourage you to forward this post to those who may be interested. And as always, if you have questions, please send me an email at hunter [at] distressed-debt-investing.com
Introduction to the JOBS Act
While there are quite a number of provisions in the final JOBS act legislation signed into law, the two that I will focus on in this post are:
- The removal of the general solicitation ban: You will now be able to publicly announce, through any medium available (TV, radio, newspaper, Facebook, LinkedIn, blogs) that you are raising capital for anything from a hedge fund, to private equity fund, to a convertible note for a start-up you are thinking about under Rule 506 of Regulation D and under Rule 144A under the Securities Act. This is a complete game changer for capital raising in this country
- Crowdfunding: Companies will now be able to raise up to $1 million dollars a year in small increments from a large pool of investors. Crowdfunding is nothing new: If you have ever heard of Kickstarter or Indiegogo, you know what I am talking about. People have been contributing small amounts of money to many causes over the past few years. But never before were you allowed to offer equity in exchange for the capital received. Crowdfunding in exchange for equity will turn the current channels of crowdfunding and angel investing upside down, and will provide enormous opportunities for professional investors and entrepreneurs alike.
In 90 days from enactment of the legislation, the general solicitation ban will be removed, and in 270 days, crowdfunding in exchange for equity will begin across this country.
I cannot contain my enthusiasm for the JOBS Act. I hope this post will show you why.
Background of the JOBS Act
In the middle of 2010, a friend of mine who is involved in the angel investing community here in New York forwarded me a petition that was being sent to the SEC to allow for small sums of money to be raised in exchange for equity from a large group of investors. At this point, Kickstarter was a raging success and was getting more and more press for the size of deals going through the site. The backers of the petition called it the "Crowdfunding Exemption." Up to this point, the SEC was staunchly against crowdfunding in exchange for equity (and arguably still is). Expert testimony was heard in Congress in the middle of 2011. People really started to take notice in September 2011 when the White House announced the President's Start America Initiative, which would change current regulation to allow for crowdfunding among other things that eventually ended up in the JOBS Act. HR 2930, the "Entrepreneur Access to Capital Act" was passed in November 2011 with bipartisan and White House support. Eventually, and with a real push from Senator Scott Brown in Massachusetts, the Senate, after many revisions, committees, and testimony pushed through version of the crowdfunding bill. The final bill, which stemmed from HR 2930, with amendments from the Senate passed in late March 2012.
General Solicitation
Previously, the SEC has emphasized that there is a pre-existing relationship with potential investors. For anyone that has filled out an accredited investor survey, this is one of the ways in which funds historically have developed this "pre-existing" relationship. Furthermore one of the reasons that 99% of funds out there have password protected sections is to ensure that these funds aren't soliciting investors in violation of Rule 502(c).
Under the new legislation, within 90 days of enactment (so call it in a little less than 80 days), the SEC must change the rules of Rule 506 private placements to allow for general solicitation through any medium. A caveat here is that all ultimate purchasers must be accredited investors. If I wanted to raise a fund, I could take out an ad on CNBC, or put up banner ads across the internet, or take out a ad in the WSJ or New York Times. As long as my ultimate purchasers are accredited, I am good to go. The SEC is also required the eliminate the prohibitions on solicitation for Rule 144a securities.
There are so many implications to this that it would take pages and pages of text. The possibilities and opportunities are endless. Information is going to flow so much more fluidly, which I think is a good thing. While there still may be some reasons to limit general solicitation (i.e. keep your investors small and strategic), a small fund that has amazing results will be able to broadly communicate their success with the public at large. Larger funds with deep marketing teams have historically had the advantage just by owning the channels to the accredited community. Now those channels are being torn wide open.
And the change to operating companies is simply fantastic. This is Shark Tank on steroids (fantastic show). If I have a great business idea, and needed capital, historically I could go to friends and family (pre-existing relationships) or possibly something like AngelList or Gust if I had any idea about the angel investment community. Now the opportunity for possible lucrative investments will not be held in the clutches of those just in the know. Furthermore, if opens up potential "vertically integrated" investments from strategics on Day 1. If I have built an application that is targeted to help retailers sell their product, why not go right to the retailers to raise capital? You might even get acquired right from the get-go.
And you have to think that hedge funds will have public presences on the internet, with letters, performance, and marketing materials for all the world to see.
As one would expect, the key criticism opponents to the bill bring up is the risk of fraud. I have no doubt that "fly by night" schemes will increase. But given that the ultimate purchasers will be accredited and in theory qualified, the positives here massively outweigh the negatives. I do expect an entire new cottage industry to develop that will serve as a combination of forensic as well as private investigator on the fund managers and entrepreneurs to eliminate as much fraud as possible.
Crowdfunding
The second item in the legislation that I am excited about is crowdfunding. By amending Section 4 of the Securities Act, a new registration exemption will emerge in crowdfunding.
In the past, the Kickstarters of the world (there are hundreds) allowed people to raise money from individuals in exchange for everything BUT equity. The JOBS Act does away with this, and now individual investors (they do not have to be accredited) can fund projects and start ups in exchange for equity. As one would expect there are many stipulations in the legislation to protect the general investing public: For example, individuals with incomes or net worth less than $100,000 will only be able to invest a few thousand dollars annually. For other investors, the amount is the lesser of $100,000 or 10% of an investor's annual income. The capital will be raised through what the SEC is calling "funding portals" which will have to register with the SEC in order to facilitate crowdfunding.
There are many more stipulation on the companies raising the money. The max capital that can be raised each year is $1,000,000, and that's only if you have fully audited financials (you can raise $100,000 with the CEO signing off and $500,000 with a CPA signing off). In addition, there are informational disclosure requirements including names of holders of more than 20% of the shares, names of officers and directors, and a description of the business plan. Crowdfunding issuers cannot advertise their offerings except to direct potential investors to the crowdfunding platform for specific terms. This will allow the SEC to maintain a close watch on the crowdfunding market (i.e. through portals versus non registered offerings).
A liability provision has been put in place in the legislation that, in my opinion, is probably the worst piece of the legislation. Any purchaser buying these securities can bring a lawsuit against the company raising capital and will be returned his/her capital if there were material misstatements or omissions in the crowdfunding document offerings. I wish this were changed (i.e. Why wouldn't I always sue in the investment failed?) but I understand the reason it was included.
If you purchase one of these securities (it doesn't just have to be equity), you will be required to hold it for one year, though you will be able to transfer the security back to the issuer or to accredited investors. To me, this means SecondMarket is going to be absolutely killing it - they are the All Stars of trading private companies' equities and I think this will just bolster their offering. Even with SecondMarket, I truly believe there will be MASSIVE amounts of inefficiencies in the secondary market that an astute investor should be able to capitalize on.
Until now, very few people were able to get in at the ground level for lucrative venture investments. I think this opens it up dramatically and benefits both investors and entrepreneurs. Many people in the angel and venture capital community DO NOT like this legislation since it stomps all over their turf / playground. Now skilled investors will have a fair shake and look at many different sorts of investments that they would otherwise never have seen. Some companies will still choose to go the traditional angel / venture capital route as it offers many strategic/advice/mentoring/connection advantages. But I think crowdfunding will turn the angel and venture capital world upside down.
The SEC has a 270 day review period to make sure all the rules / regulations / systems are ready for crowdfunding. I'd expect the first capital raises to begin on January 1st, 2013.
Conclusion
This bill will completely change capital raising in this country. It will allow more entrepreneurs to raise capital and create jobs than every before. It will allow more investors to participate in the upside for start up and high growth companies than ever before. It will create significant inefficiencies in the marketplace that I think discerning value investors can take advantage of.
While I did not get to the other aspects of the bill, after reading them a number of times, they are just as exciting as the two mentioned above. I will probably do a summary post on it in the near future.
I hope the investing blogosphere starts spending more time on the JOBS Act. I am trying to get myself involved in as many ways possible, from advising start-ups, to providing services to companies thinking about crowdfunding, to getting ready to personally invest through the crowdfunding platform, and finally to eventually raise capital through one of these channels. If you'd like to know more about the work I'm doing or want to get involved, please contact me.
I've said this to many people in the past few weeks: This is our gold rush. And I couldn't be more excited.
Previously, the SEC has emphasized that there is a pre-existing relationship with potential investors. For anyone that has filled out an accredited investor survey, this is one of the ways in which funds historically have developed this "pre-existing" relationship. Furthermore one of the reasons that 99% of funds out there have password protected sections is to ensure that these funds aren't soliciting investors in violation of Rule 502(c).
Under the new legislation, within 90 days of enactment (so call it in a little less than 80 days), the SEC must change the rules of Rule 506 private placements to allow for general solicitation through any medium. A caveat here is that all ultimate purchasers must be accredited investors. If I wanted to raise a fund, I could take out an ad on CNBC, or put up banner ads across the internet, or take out a ad in the WSJ or New York Times. As long as my ultimate purchasers are accredited, I am good to go. The SEC is also required the eliminate the prohibitions on solicitation for Rule 144a securities.
There are so many implications to this that it would take pages and pages of text. The possibilities and opportunities are endless. Information is going to flow so much more fluidly, which I think is a good thing. While there still may be some reasons to limit general solicitation (i.e. keep your investors small and strategic), a small fund that has amazing results will be able to broadly communicate their success with the public at large. Larger funds with deep marketing teams have historically had the advantage just by owning the channels to the accredited community. Now those channels are being torn wide open.
And the change to operating companies is simply fantastic. This is Shark Tank on steroids (fantastic show). If I have a great business idea, and needed capital, historically I could go to friends and family (pre-existing relationships) or possibly something like AngelList or Gust if I had any idea about the angel investment community. Now the opportunity for possible lucrative investments will not be held in the clutches of those just in the know. Furthermore, if opens up potential "vertically integrated" investments from strategics on Day 1. If I have built an application that is targeted to help retailers sell their product, why not go right to the retailers to raise capital? You might even get acquired right from the get-go.
And you have to think that hedge funds will have public presences on the internet, with letters, performance, and marketing materials for all the world to see.
As one would expect, the key criticism opponents to the bill bring up is the risk of fraud. I have no doubt that "fly by night" schemes will increase. But given that the ultimate purchasers will be accredited and in theory qualified, the positives here massively outweigh the negatives. I do expect an entire new cottage industry to develop that will serve as a combination of forensic as well as private investigator on the fund managers and entrepreneurs to eliminate as much fraud as possible.
Crowdfunding
The second item in the legislation that I am excited about is crowdfunding. By amending Section 4 of the Securities Act, a new registration exemption will emerge in crowdfunding.
In the past, the Kickstarters of the world (there are hundreds) allowed people to raise money from individuals in exchange for everything BUT equity. The JOBS Act does away with this, and now individual investors (they do not have to be accredited) can fund projects and start ups in exchange for equity. As one would expect there are many stipulations in the legislation to protect the general investing public: For example, individuals with incomes or net worth less than $100,000 will only be able to invest a few thousand dollars annually. For other investors, the amount is the lesser of $100,000 or 10% of an investor's annual income. The capital will be raised through what the SEC is calling "funding portals" which will have to register with the SEC in order to facilitate crowdfunding.
There are many more stipulation on the companies raising the money. The max capital that can be raised each year is $1,000,000, and that's only if you have fully audited financials (you can raise $100,000 with the CEO signing off and $500,000 with a CPA signing off). In addition, there are informational disclosure requirements including names of holders of more than 20% of the shares, names of officers and directors, and a description of the business plan. Crowdfunding issuers cannot advertise their offerings except to direct potential investors to the crowdfunding platform for specific terms. This will allow the SEC to maintain a close watch on the crowdfunding market (i.e. through portals versus non registered offerings).
A liability provision has been put in place in the legislation that, in my opinion, is probably the worst piece of the legislation. Any purchaser buying these securities can bring a lawsuit against the company raising capital and will be returned his/her capital if there were material misstatements or omissions in the crowdfunding document offerings. I wish this were changed (i.e. Why wouldn't I always sue in the investment failed?) but I understand the reason it was included.
If you purchase one of these securities (it doesn't just have to be equity), you will be required to hold it for one year, though you will be able to transfer the security back to the issuer or to accredited investors. To me, this means SecondMarket is going to be absolutely killing it - they are the All Stars of trading private companies' equities and I think this will just bolster their offering. Even with SecondMarket, I truly believe there will be MASSIVE amounts of inefficiencies in the secondary market that an astute investor should be able to capitalize on.
Until now, very few people were able to get in at the ground level for lucrative venture investments. I think this opens it up dramatically and benefits both investors and entrepreneurs. Many people in the angel and venture capital community DO NOT like this legislation since it stomps all over their turf / playground. Now skilled investors will have a fair shake and look at many different sorts of investments that they would otherwise never have seen. Some companies will still choose to go the traditional angel / venture capital route as it offers many strategic/advice/mentoring/connection advantages. But I think crowdfunding will turn the angel and venture capital world upside down.
The SEC has a 270 day review period to make sure all the rules / regulations / systems are ready for crowdfunding. I'd expect the first capital raises to begin on January 1st, 2013.
Conclusion
This bill will completely change capital raising in this country. It will allow more entrepreneurs to raise capital and create jobs than every before. It will allow more investors to participate in the upside for start up and high growth companies than ever before. It will create significant inefficiencies in the marketplace that I think discerning value investors can take advantage of.
While I did not get to the other aspects of the bill, after reading them a number of times, they are just as exciting as the two mentioned above. I will probably do a summary post on it in the near future.
I hope the investing blogosphere starts spending more time on the JOBS Act. I am trying to get myself involved in as many ways possible, from advising start-ups, to providing services to companies thinking about crowdfunding, to getting ready to personally invest through the crowdfunding platform, and finally to eventually raise capital through one of these channels. If you'd like to know more about the work I'm doing or want to get involved, please contact me.
I've said this to many people in the past few weeks: This is our gold rush. And I couldn't be more excited.
Very interesting.
ReplyDelete"It will create significant inefficiencies in the marketplace that I think discerning value investors can take advantage of."
ReplyDeleteIn other words, it opens the door to unscrupulous stock promoters, quasi-legalizes the pump-and-dump and all manner of other boiler room schemes, and practically begs the entrepreneurial community to overstate business prospects in exchange for investment. The act is a travesty rushed through Congress without consideration of the reasons the regulation existed in the first place, not something to be excited about.
Between this and John Hempton's post yesterday on short-selling, we have rather a lot of policeman getting excited at an increase in crime these days. Sure it's an opportunity for value investors but I think the mess will be a bit larger than we can efficiently clean up.
Great article! I could not agree with you more. In fact, please check out www.nowstreetjournal.com as I, too, am writing about the importance of this legislation. I am also hosting an event on Wednesday in NYC about the topic. To see details go to http://cacnyc.eventbrite.com/. If you are in town, I'd be happy to provide you with a complimentary press pass. Email press@thesoholoft.com if you are interested.
ReplyDeleteHere's some more commentary: http://blog.xero.com/2012/04/crowdfunding-bringing-wall-street-to-main-street/
ReplyDeleteIt's been my impression that while this bill might be good for startup funding in a narrow sense, it is more importantly a broad repeal of investor protections, and the bad will vastly outweigh the good.
ReplyDeleteGreed may be a powerful incentive in the middle of a tech bubble like this, but the (further) erosion of trust in the capital markets will stink long after Groupon is a memory.
Any such initiative should be applauded because new jobs are needed now more than ever. But at the same time I have to ask why the government doesn't implement similar measures for those who get practically no protection? I am talking about small farmers who are often discriminated against by the companies holding a monopoly such as Monsanto. As a big fan of organic farming I would welcome some more initiative to protect this particular industry sector which also involves a number of small businesses but their owners are often left with little alternative but to respect the rules set by the bigger players. I think if the right solution were found to this problem it would be more useful for small business than the Jobs Act.
ReplyDeleteGreat review of the jobs act. I agree that people should look more positively on this and try to engage other people in awareness about this bill as well.
ReplyDelete