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What has changed with JOBS ActAfter a flurry of news articles when the JOBS Act became law in April, the news cycle has been non-stop election coverage.  While we all look forward to the end of the political advertisements (especially us Floridians), I wanted to take a moment to bring you up to date on the JOBS Act.  So, where are we now?  What has been enacted and what issues have been identified with the JOBS Act?  I look at each of the provisions of the JOBS Act below:

Title I – Reopening American Capital Markets to Emerging Growth Companies (IPO On-Ramp)

Title I eases the path for companies going public by greatly reducing the regulatory burden for companies with less than $1 billion in revenue.  While I believe that regulatory relief is a great first step, Congress should have made much of the relief permanent for small- and mid-cap public companies.  But, I suppose we should take what we can get. 

One of the most used (maybe universally used) provision of Title I is the ability of an Emerging Growth Company (EGC) to submit its initial registration statement confidentially.  This allows a company that begins the IPO process to stop the process without having released its financial and other confidential information to the public or its competitors.  Beginning in October, the SEC streamlined the confidential submission process by moving from an email submission process to an Edgar submission process. 

One of the biggest complaints with the capital raising process for newly public companies and small- to mid-cap public companies in general is their inability to attract investors and establish a market for their securities.  Several provisions in the JOBS Act enhance the EGC’s ability to market its registered offerings.  For example, investment banks are now expressly permitted to publish or otherwise distribute research reports on an EGC at any time before, during, or after any offering, including an IPO.  Previously, research reports, particularly those by investment banks participating in the offering, had to wait at least 25 days after the offering (40 days if the underwriter served as a manager or co-manager).  Unfortunately, because of the risk of lawsuits, investment banks have not fully embraced this change.  The industry standard that has developed is to wait 25 days after the offering to publish reports.  Despite recent rule changes from FINRA, the investment banks’ regulator, the 25-day waiting period will likely persist for now.

And it was just a matter of time, but
Continue Reading Update on the JOBS Act: Where are we now?

Regulation A+, one of the most overlooked provisions of the JOBS Act, promises to be the best new way for private companies to raise money without the headaches of going public or the restrictions of private offerings.  As part of the JOBS Act, the SEC was tasked with creating a new offering exemption that has been dubbed “Regulation A+” due to its improvement upon the current Regulation A exemption.  The upgrades should take little-used Regulation A and transform it into the primary way for private companies to raise capital in the U.S.  In fact, I believe that Regulation A+ will end up having the opposite effect of the stated intent of the JOBS Act, which is to have more companies go public.  In contrast, Regulation A+ will allow smaller and mid-cap public companies to more easily raise capital without having to going public.  As noted in the recent GAO review of current Regulation A, investment banks that had stayed away from Regulation A offerings in the past because of the small offering maximum will now be attracted to the new exemption.

In the past, Regulation A has suffered from some serious limitations.  Particularly, the exemption only allows for $5 million to be raised in any 12-month period.  This amount is too small for many companies, given the offering costs.  In addition, the securities in Regulation A offerings do not qualify as “covered securities” under the National Securities Markets Improvement Act of 1996, which would have exempted them from state securities laws.  Thus, a Regulation A offering still has to comply with time consuming and expensive state “Blue Sky” law requirements.  Regulation A also requires SEC review of an issuer’s offering materials (generally, a scaled-down version of a full registration statement).  This offering statement, which includes a notification and a fairly extensive offering circular and exhibits, still requires a substantial outlay, despite being less expensive than a full registration statement.

So companies ultimately turn to other exemptions to raise capital.  The main exemption used is SEC Rule 506, which allows an unlimited amount to be raised, but places limits on solicitation, sales to non-accredited investors and resale (elimination of these solicitation limits are subject to current proposed rules).  With the creation of new Regulation A+, however, we should see the SEC throwing out the bad, and keeping the good, parts of Regulation A.  As a result, I believe Regulation A+ will overtake Rule 506
Continue Reading Regulation A+: Raise the capital you need without the hassle or expense

Following up on my post on the subject, I had the opportunity to speak with Colin O’Keefe of LXBN regarding the Facebook/Instagram deal.  In the brief interview, I explain how things have changed since Facebook’s IPO and what, if anything, that meant for the deal’s fairness review with the California Department of Corporations.

Following up on my post on the subject, I had the opportunity to speak with Colin O’Keefe of LXBN regarding the Facebook/Instagram deal.  In the brief interview, I explain how things have changed since Facebook’s IPO and what, if anything, that meant for the deal’s fairness review with the California Department of Corporations.

seed moneyThis is the second part of our Securities Law 101 series.  Because capital raising is such a critical function for emerging start-up companies, we designed this series to introduce their management teams to some of the fundamental concepts in securities law.  We hope that this series will prevent some of the most common mistakes management teams of start-up companies make.  We will periodically publish posts examining different aspects of securities law. 

So your company would like to raise money?  These days it seems like every company is in need of more capital, even banks that are in the business of lending their funds out to others.  Whether your business needs new funding for growth, or more funding to meet regulatory capital requirements, or your company has not been able to secure that loan the business needs, there are a lot of reasons to consider a private placement.  Here, we will explore the use of the private placement to raise funds and the recent changes in securities laws that make this a better alternative than it was before.

We all know that there are many ways to raise money out there (and sales of stock through crowdfunding isn’t one of them yet), but one typical way would be to sell equity in your company to private investors.  All securities offerings must be registered unless an exemption exists.  Therefore, these deals are generally set up as private placements exempt from registration under SEC Rule 506, which allows an unlimited amount of money to be raised from an unlimited number of accredited investors (and up to 35 non-accredited investors).  Accredited investors are those individuals whose joint net worth with their spouse is at least $1 million, excluding the value of any equity in personal residences but including any mortgage debt to the extent it exceeds the fair market value of the residences.  The term also includes individuals with income exceeding $200,000 in each of the two most recent years, or joint income with their spouse exceeding $300,000 in each of those years, plus a reasonable expectation of reaching these income levels in the current year.  There are also other types of accredited investors such as companies with total assets in excess of $5 million.  Consequently, there are several categories of accredited investors out there that can potentially help with funding.

We recommend limiting the offer of securities in a private offering to only accredited investors.  The reason for this is that
Continue Reading Securities Law 101 (Part II): Avoiding the pitfalls in a private placement

JOBS Act

Depending on your perspective, lifting the ban on general solicitation and advertising for private offerings is one of the most anticipated or feared provisions in the JOBS Act.  Consumer protection groups are aghast at the potential of fraud stemming from startup companies hawking their stock to unsophisticated investors.  Pro-business groups are ecstatic that someone finally had listened to their complaints about the trouble entrepreneurs have raising capital once they have exhausted their family and friends.  Well, after today’s Securities and Exchange Commission meeting, it looks like the pro-business groups got a further victory.  Or did they?

This morning, the Commission proposed rules to implement Section 201 of the JOBS Act to remove the prohibition on general solicitation and advertising in private offerings when all purchasers are accredited investors.  While removing a ban seems relatively simple, Congress instructed the Commission to write rules to “require the issuer to take reasonable steps to verify that purchasers of the securities are accredited investors, using such methods as determined by the Commission.”

What constitutes “reasonable steps” is the only difficult interpretation that the SEC had to make. There was some concern that the “reasonable steps” could be as harsh as requiring investors to prove their net worth through bank statements; however, the proposed rulemaking takes a much more flexible approach.  The proposed rules require issuers to make an objective determination based on certain factors:

  • The type of purchaser and the type of accredited investor that the purchaser claims to be;
  • The amount and type of information that the issuer has about the purchaser; and
  • The nature of the offering, including the manner in which the purchaser was solicited to participate in the offering and the terms of the offering such as the minimum investment amount.

The Commission didn’t set forth specific required verification methods because it felt a “one-size-fits-all” approach would be overly burdensome, impractical and ineffective.  At first glance this seems like a very issuer friendly approach. 
Continue Reading Elimination of ban on general solicitation and advertising may leave some questions unanswered

California Department of Corporations, One Sansome Street, San Francisco

We previously blogged about the potential liability for Facebook, Inc. directors if the company paid too much for the social media start-up company Instagram. Recall that in April, Facebook agreed to acquire Instagram for, at the time, approximately $1 billion with the consideration payable 30% in cash and 70% in Facebook common stock (now, due to the decrease in Facebook’s share price from the stipulated price of $30 per share, the deal is only worth about $650 million). A recent NY Times Deal Book article points out that if the deal fixed the total purchase price rather than the number of shares to be issued, Instagram would have gotten a much better deal due to the depressed Facebook share price. Given the declining share price of Facebook stock, is Facebook’s reduced consideration still fair to Instagram’s shareholders? This is exactly the question that will be determined by the California Department of Corporations which will be conducting a fairness review of the acquisition this Wednesday.

The purpose of this fairness hearing is to allow Facebook to take advantage of a lesser-known exemption from registration under the Securities Act of 1933 known as the “3(a)(10) exemption.” Because Facebook is issuing securities in connection with the Instagram acquisition, the 23 million shares to be issued are required to either be registered or they must be exempt from the registration requirements of the Securities Act. The 3(a)(10) exemption allows companies to issue securities in an exchange transaction without registration provided that either a court or designated state agency finds that the transaction is fair to the recipients of the new securities. This exemption was popular during the tech boom and has both advantages and disadvantages when compared with the most common exemption provided by Rule 506 of Regulation D promulgated under the Securities Act. 

Most smaller companies tend to offer and sell securities on an exempt basis because of the substantial costs of conducting a registered offering. There are a laundry list of exemptions but only a few are of much practical use. Most exempt offerings are structured to take advantage
Continue Reading Is Facebook’s acquisition of Instagram fair to Instagram shareholders?

More interesting times have arrived for holders of Facebook stock. The stock, which has been brutally beaten down from its IPO price, faces new challenges as the “lockup” restrictions (which have been in place since the IPO) began to expire on August 16. This means that a significant number of Facebook shareholders are now able to sell their shares in the open market, and significant numbers of Facebook shares will be freed from these restrictions over the next few months. The sale of a substantial number of Facebook shares could obviously drive the stock price down even more. The big questions now:  Who will or won’t sell their stock as these restrictions lapse?

This situation is also a great lesson for entrepreneurs who are contemplating the possibility of taking their companies public. Most observers thought that Facebook’s IPO was a certain success, but so far it’s been a very tough road. One big concern here is that the problems that Facebook has faced with its transition to public company status will divert management’s attention from the company’s business tactics and strategy at a very critical time. 

Facebook went public at a price of $38 per share. Many observers felt that this price was too high, and the market apparently agreed. The stock has not been back to its IPO price since the first day of trading, and its closing price on August 17 was $19.05 per share (a 49.9% decline from the IPO price). The stock price went below $19.00, but has since rebounded to close at $19.44 today. In any case the company has lost almost half of its market value since the IPO. Even at this reduced price the stock is still trading at about 30 times projected next years’ earnings. It’s interesting to note that Google and Apple currently trade at 12 to 13 multiples, so Facebook’s stock is still very highly valued even after its decline.

Lockup restrictions on stock sales by insiders and other parties are normally demanded by underwriters as part of the IPO process. These restrictions help to reduce volatility in the market price of a newly public company’s stock, and they help to ensure that existing shareholders
Continue Reading Significant stock price questions loom as Facebook lockup restrictions begin to lapse

This is the first part of our Securities Law 101 series.   Because capital raising is such a critical function for emerging start-up companies, we designed this series to introduce their management teams to some of the fundamental concepts in securities law.  We hope that this series will prevent some of the most common mistakes management teams of start-up companies make.  We will periodically publish posts examining different aspects of securities law. 

Contrary to popular perceptions, securities law is not just for large corporations and conglomerates.  Too many start-up companies make the mistake of thinking securities law does not apply to them, though there is no de minimis exception to regulation. Practically, this means all entities, big and small, are required to comply with the applicable provisions of the Securities Act of 1933 (“1933 Act”).  Each state has its own securities laws with similar requirements.

The general principle of the 1933 Act is that every offer and sale of securities must be registered with the SEC unless an offering exemption exists.  You should keep in mind that a “security” is not limited to a share of stock either.  In fact, securities also include what are known as “investment contracts.”  Thus, courts have also applied the 1933 Act to interests bearing little resemblance to traditional securities transactions, including chinchillas, payphone packages, rare coins, live beavers, silver foxes, whiskey receipts, diamonds, and religious cults.

How is a beaver a security?  Back in 1946, the U.S. Supreme Court in a case called SEC v. W.J. Howey Co. created this test for an investment contract: (1) an investment of money; (2) with the expectation of profits; (3) in a common enterprise; (4) coming mainly from the efforts of others. Under this test, for example, limited partnerships are securities because investors invest money and expect a profit which comes in part from the efforts of others (here, the general partners exercising essential managerial efforts).

What do we mean by the investment of money?  Cash is not the only item that constitutes “money.” For example,
Continue Reading Securities Law 101 (Part I): Yes, securities law applies to you

New mandated cybersecurity disclosure requirements appear to be imminent. Cybersecurity has become a critical issue for most companies, and almost all companies today face cybersecurity risks due to the substantial increases in the volume of data and information stored online, the rise of multiple platforms for accessing data and the sophistication of criminal hackers. Cyber incidents such as a data breach or an intrusion into a company’s systems can have very negative and expensive results. These risks are considerably higher for any company that stores personal information or that operates in a regulated industry such as financial services or health care. Despite this significant increase in cybersecurity risks and the liabilities associated with such cyber incidents, however, public companies to date have had very little guidance regarding their disclosure obligations in this area.

The primary guidance that the SEC has issued on cybersecurity disclosure to date has been the 2011 CF Disclosure Guidance:  Topic No. 2 (Cybersecurity) (the “Release”) issued by the SEC’s Division of Corporation Finance on October 13, 2011. This Release was helpful in that it gave some indication of the Division of Corporation Finance’s positions on cybersecurity issues and cyber incidents. The Release provided overall guidance, however, and did not provide detailed information or instructions on cyber disclosure. Additionally, the Release did not contain official SEC rules or regulations. Accordingly, companies could use the Release for broad principles but were still left to develop disclosure information about cybersecurity and other similar matters based on their own evaluations of what should be disclosed.

Under the Release, some of the items that public companies are advised to address include:

  1. review the adequacy of their disclosure regarding cybersecurity and cyber incidents on a regular basis;
  2. disclose the risks of cyber incidents in “Risk Factors” if these items are significant risk factors that would make an investment in the company speculative or risky;
  3. disclose known or threatened cyber incidents;
  4. address cybersecurity risks and cyber incidents in the Company’s Management’s Discussion and Analysis if the costs or other consequences associated with such incidents are reasonably likely to have a material effect on the Company’s results of operations, liquidity or financial condition or would cause reported financial information to not be indicative of future operating results or financial condition;
  5. disclose a cyber incident in “Description of Business” if the cyber incident materially affected the company’s products, services, relationships with customers or suppliers or competitive conditions;
    Continue Reading Get ready for increased cybersecurity disclosure requirements