The JOBS Act: Economic Solution or Investor Nightmare?
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By Taryn M. Bostjancic, CPA, and Robert W. Van Arnum, CPA
In an effort to jump-start the US economy and create more jobs, both the House and Senate passed the Jumpstart Our Business Startups (JOBS) Act, and President Obama signed the act into law April 8, 2012. With bipartisan support, the bill is designed to make it easier for small businesses, start-ups, and entrepreneurs to raise capital by decreasing government oversight and federal regulations.
Now the intrigue begins. Many questions arise from this new legislation. What kind of impact will the JOBS Act have on small businesses, start-ups, and the economy in general? Will the JOBS Act open the door for new IPOs? Or will it provide more incentive for companies to stay private? What impact will the JOBS Act have on investors who rely on full disclosure when reviewing the filings of IPOs?
These open-ended questions have answers that vary depending on who you are asking – the opponents or proponents. Those in favor of the JOBS Act see it as an opportunity for growth; while those against it worry that loosened regulations may lead to investor fraud and abuse. Whether for or against the legislation, the JOBS Act will:
- The crowdfunding provision now allows start-ups to raise up to $1 million annually in small-dollar contributions. Individuals with annual income or net worth of less than $100,000 can invest the greater of 5 percent of their yearly income or $2,000. Start-ups may need to increase their infrastructure to account for these small equity investments received from investors.
- The "general solicitation" ban lift means start-ups can advertise themselves and their products and build up hype while they are raising money. This also means they cannot use this as an excuse to keep their financials confidential. Some companies would say, "We cannot reveal details about revenue or user growth because it is against the law to hype our company while we are raising a round." Companies will need to be educated on the differences between facts and hype or exaggerations.
- Instead of registering when companies have 500 investors, companies can now wait until they have 2,000 investors total (less if there are more than 500 unaccredited investors) and employees do not count in that number. Facebook and Twitter started to create specialty funds that would collect money from dozens of investors to invest. The idea was that one specialty fund only counts as one investor. If twenty-four people wanted to invest in Facebook, then it was twenty-four closer to the 500 investor limit, and thus closer to being forced to release its financial performance. If this 2,000 rule had been in effect, Facebook's IPO might have come later. Clients may need additional legal assistance or resources to understand how to apply these new rules.
- Companies with less than $1 billion in annual revenue can “go public” without following strict disclosure regulations for the first five years. While they will not have to follow all Sarbanes-Oxley regulations initially, this could prove to be risky for initial investors because they may not have the full picture. Individuals will have to exercise more due diligence before they make investments because the transparency is less.
- Although companies are not required to follow all Sarbanes-Oxley regulations, they can still be sued. Companies that neglect bookkeeping could face regulatory action and investor lawsuits. Companies and investors will have to recognize that risks remain anytime you raise money from the public.
- With the increased access to the angel investor, companies may enter into various funding arrangements that typically have complex accounting treatment. Companies will need to be able to appropriately account for these transactions and may not have the technical expertise in house and, therefore, may need to engage consultants to assist in them.
- How will the relaxed regulations affect investor demand for EGCs? While companies hope that the demand will increase, investors may need to perform greater due diligence or engage business advisors to assist them in evaluating EGC investments.
Create emerging growth companies.One provision of the JOBS Act essentially creates a new category of public companies. Businesses that have under $1 billion in annual revenue during its most recent fiscal year would qualify "emerging growth companies" (EGCs) and would not be required to comply with certain Securities and Exchange Commission (SEC) reporting regulations for up to five years; less than five years if the company reaches $1 billion in gross revenue, $700 million in public float, or issues more than $1 billion in non-convertible debt in the previous three years. Companies that complete or have completed an IPO after December 8, 2011, will be eligible to qualify as an EGC. Through this legislation, EGCs would be exempt for their first five years on the public market from the compliance burdens of Sarbanes-Oxley (SOX) Section 404(b), such as requiring an auditor's attestation report on internal controls over financial reporting. The JOBS Act will also allow pre-IPO EGCs to confidentially submit a draft registration statement for SEC review. Other reporting requirements will be "phased in" over the initial five-year period. These relaxed regulations will allow smaller companies to go public sooner.
Allow equity-based "crowdfunding." New businesses will be able to raise up to $1 million in equity capital from unaccredited investors. This provision facilitates the utilization of online trading portals, a mechanism used to solicit a large number of smaller investors. The Senate version of the JOBS Act created a number of restrictions aimed at protecting investors. Among those restrictions are limiting individual investments to (1) the greater of $2,000 or 5 percent of the investor's annual income or net worth if either annual income or net worth is less than $100,000; and (2) 10 percent of the investor's annual income or net worth, not to exceed $100,000, if annual income or net worth is greater than $100,000 and also requiring registration by intermediary platforms and issuers with the SEC. Federal law would preempt state regulations, meaning that issuers could raise funds from across the United States. The SEC will have 180 days after the bill's enactment to publish rules for crowdfunding.
Remove prohibitions on general solicitation of Regulation D offerings. The JOBS Act allows for advertising of Regulation D 506 offerings, as long as advertisements are focused on accredited investors. Affluent individuals who provide capital for a business start-up, also known as "angels," should especially note the McHenry Amendment, which clarifies that angel and incubator platforms that do not charge a fee connected to the purchase or sale of securities would be exempt from broker-dealer registration. This exemption from registration will be helpful for Internet platforms, such as AngelList or Gust and venture forums aimed at accredited investors, and also for some angel groups.
Increase the threshold for Regulation A "mini-public offerings." Regulation A currently allows companies to go public and be exempted from SEC registration for offerings up to $5 million. The JOBS Act will increase the offering threshold for this little-used exemption to $50 million, perhaps making it a more useful option for angel-backed companies.
Raise the cap on private shareholders from 500 to 2,000. Many private companies are forced by regulations to file as a public company once they exceed 500 shareholders and $10 million in assets. The bill will increase the shareholder limit to 2,000 accredited investors or 500 unaccredited investors. The increased limit will give some flexibility to companies like Facebook in deciding whether to stay private or go public, and it could also benefit secondary market platforms that can offer a more robust market for the shares of private companies.
From the above analysis of the bill, it is clear how the JOBS Act will help small businesses, start-ups and entrepreneurs raise capital, but the question that remains is how will the bill create jobs? Here are a couple of thoughts: (1) the $1 billion ceiling on regulation will spur job growth since it will provide an incentive for companies to go public instead of selling, and (2) the cost savings for new IPOs will allow them to spend more money on growing their businesses and hiring personnel instead of regulatory compliance.
Despite the apparent benefits of the bill, the legislation still has its detractors. Critics fear that the JOBS Act will lead to massive fraud due to a lack of regulation and oversight. Investors will not see the "full picture" when making their investments. For example, the online coupon company, Groupon (that who went public in 2011 and had over $1 billion in revenue at the time), was faced with major SEC scrutiny over its accounting methods during its IPO. The company suffered a significant market capitalization reduction when going public due to reported questionable accounting methods and the loss of investor confidence. Had the JOBS Act been in effect prior to its IPO, Groupon could have gone public before it reached the $1 billion mark and not dealt with the intense scrutiny that resulted in its reduction in market capitalization. Conversely, the investing public would not have been aware of the apparent "red flags" had the reporting regulations been relaxed.
To address these concerns, the Senate attached an amendment to the bill, requiring the business to warn investors that there are risks when it comes to investments. The amended bill requires that a business "takes reasonable measures to reduce the risk of fraud with respect to such transactions" and gives the investor its company address and website, which must be kept up-to-date. The JOBs Act also requires the SEC to implement various actions on a tight time line from as little as 90 days after enactment of certain aspects of the law, while up to 270 days for other portions.
The President and Congress are hoping the JOBS Act will generate as much economic growth as it did bipartisan support. It originally passed the House by a vote of 390 to 23, and then passed the Senate 73 to 26. However, only time will tell.
About the authors
Taryn M. Bostjancic, CPA, is a partner based in WithumSmith+Brown's New Brunswick, New Jersey, office with over eighteen years of public accounting experience. She is a certified public accountant in the states of New Jersey and Michigan and holds practice privileges in California. Taryn specializes in accounting, auditing, and consulting services for clients in the life science, pharmaceutical, manufacturing, software, technology, and service industries. In addition, Taryn provides both consulting and auditing services to the firm's SEC clients and serves as the firm's Team Leader for the SEC Compliance and Reporting niche. Taryn can be reached at firstname.lastname@example.org.
Robert W. Van Arnum, CPA, is a partner based in WithumSmith+Brown's Princeton, New Jersey, office. Bob has over twenty years of experience in private and public accounting. He is a certified public accountant in the state of New Jersey and serves as the firm's Practice Leader for the accounting and auditing niche. Bob oversees and administers various activities in WS+B's Quality Control Department and assists many of the firm's largest clients on technical accounting projects, such as FASB implementations, acquisition accounting, and equity transactions. In addition, he directs and coordinates the accounting, auditing, and reporting activities related to the firm's publicly held clients. Bob can be reached at email@example.com.
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