As expected, last week President Obama signed the Jumpstart Our Business Startups (JOBS) Act, which, as I reported, is intended to create jobs by facilitating the initiation and growth of entrepreneurial companies. The Act’s primary way of promoting growth is by facilitating capital-raising activities. The improvement of secondary (resale) markets would support capital-raising by increasing liquidity. Let’s consider the extent to which the JOBS Act promotes these objectives.
Among other things, the JOBS Act is designed to make it easier for companies at different stages of development to raise capital. The crowdfunding provisions permit an early-stage company to obtain up to $1 million through small investments from non-accredited investors, through portals. The JOBS Act also improves the ability of companies (often, later stage) to engage in Reg D private placements by removing the prohibition on general solicitation and general advertising, provided that all purchasers of the securities are accredited investors.
The JOBS Act also increases the number of shareholders that a company can have without having to register as a public company from 500 to 2,000. This change can be helpful not only in offerings but also in facilitating resales.
However, there remains some question as to how much the Act will benefit secondary markets for restricted securities. In recent years, there has been a notable increase in activity on secondary markets, with the emergence of online sites such as Sharespost.com, SecondMarket.com and StartupExchange.com, which provide markets for private company equities that otherwise could not be easily traded. This increase is not surprising in light of the relative lack of liquidity for privately-held companies. As market cap requirements have increased, it has been difficult for a smaller company to go public. Moreover, the cost and administrative burdens of being public have made staying private more attractive.
Is the JOBS Act likely to be as beneficial to secondary markets as it will be on private placements? In a crowdfunding, the issuer can sell securities to an unlimited number of non-accredited investors in the offering, subject to restrictions as to how much each non-accredited can invest. On the other hand, securities purchased in a crowdfunding transaction may not be resold for 12 months, except to the issuer or to an accredited investor.
Also, the changes to Rule 506 will benefit issuers in Reg D offerings, but may not have as much an effect on resales. The removal of the prohibition on general solicitation and general advertising applies to offerings, but in many cases it does not apply to resales of restricted securities that originally were sold in a Reg D offering. (The Act does relax restrictions on the offer of securities under Rule 144A ($500,000 minimum) to offerees that are not Qualified Institutional Buyers (that is, institutions with assets of at least $100 million), including by general solicitation or general advertising.)
The JOBS Act does support the continuing development of secondary markets of restricted securities, but is not likely to have as much of an effect on secondary markets as it will have on primary issuances.