The JOBS Act – Small Company Capital Formation

Title IV of the JOBS Act provides for expansion of the “small issue” securities offering registration exemption currently available under Regulation A promulgated under the Securities Act of 1933, as amended (the “Securities Act”).  However, the full scope of the new exemption will not be known until it is implemented by the Securities and Exchange Commission (the “SEC”) through its rulemaking process.  It is not clear at this time when the SEC will formally adopt rules necessary for its implementation.

Current “Small Issue” Exemption under Regulation A

Regulation A provides for an exemption under Section 3(b) of the Securities Act from the registration requirements under the Securities Act for a public offering by a non-reporting issuer of up to $5 million within the 12-month period prior to, and through completion of, such offering. 

An issuer is required to submit to the SEC an Offering Statement on Form 1-A, which contains information about the issuer and the offering, including, but not limited to, a description of its business, management and properties; risk factors; financial information; capitalization; and use of proceeds.  An issuer is not required to provide audited financial statements as part of the Form 1-A unless it prepares audited financial statements for other purposes.   An issuer that completes an offering pursuant to Regulation A will not be subject to the periodic reporting requirements under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), until such time as required by Section 12 of the Exchange Act.

There are no restrictions on the types of investors that may purchase securities in a public offering conducted pursuant to Regulation A, and upon completion of such offering, the securities will be transferable by the investors without restriction. 

New “Small Issue” Exemption under the JOBS Act

Section 401 of the JOBS Act has created a new subsection (2) to Section 3(b) of the Securities Act to allow companies to issue up to $50 million in securities (up from $5 million currently available under Regulation A).  Although the details of certain provisions of the new exemption must be decided by future SEC rulemaking, Section 401 of the JOBS Act does specify several important requirements of the new exemption as follows:

• Offering Limitation.  The new exemption will allow companies to issue up to $50 million in securities (up from $5 million currently available under Regulation A) within the prior 12-month period.  Unlike the $5 million limitation under Regulation A, which has remained in place since 1992, the SEC is required every two years to consider raising the $50 million limitation.
• Unrestricted Resales.  Similar to offerings under Regulation A, securities sold under the new exemption will be freely tradable upon issuance to investors in the offering.
• “Testing the Waters.”  Similar to offerings under Regulation A, issuers that rely on the new exemption may confidentially solicit investor interest prior to filing offering statements with the SEC.  However, the SEC must conduct further rulemaking to determine the terms and conditions placed on such solicitation.
• Audited Financial Statements.  Unlike issuers that conduct offerings under Regulation A, issuers relying on the new exemption must file audited financial statements with the SEC on an annual basis upon completion of the offering.  The SEC must conduct further rulemaking to determine whether audited financial statements should also be required as part of the offering statement. 
• Liability.  The civil liability provisions of Section 12(a)(2) of the Securities Act shall apply to persons offering or selling such securities pursuant to the new exemption.
• Offering Statement.  Companies relying on the new exemption may need to file an offering statement with the SEC.  However, the SEC must conduct further rulemaking to determine the requirements of any such offering statement.
• Periodic SEC Reporting.  Unlike Regulation A, companies relying on the new exemption may be subject to periodic SEC reporting upon completion of the offering.  However, the SEC must conduct further rulemaking to determine specific filing requirements, if any.  Specifically, the SEC must consider requiring periodic disclosure about a company’s business operations, financial condition, corporate governance principles and use of investor funds. 

Practical Considerations

Section 401 of the JOBS Act is designed to provide access to capital for smaller companies and it may signify the return of the smaller IPO market.  The new exemption will allow companies to conduct public offerings in a shorter period of time and with lower associated costs than the more traditional public offerings filed with the SEC under Form S-1 registration statements.

Section 401 of the JOBS Act is viewed by many as a significant step towards reducing the regulatory burden and expense associated with accessing the capital markets.  However, while Section 401 of the JOBS Act will require heightened reporting obligations compared to the existing Regulation A, it may provide fewer investor protections than the more traditional public offerings filed with the SEC under Form S-1 registration statements.  Certain requirements of this new exemption will remain unclear until the SEC completes its rulemaking process. 

Summary of Changes

A summary chart comparing the existing requirements of Regulation A and the requirements of the new Section 3(b)(2) exemption is available here.  For a complete list of requirements, please refer to the full text of Regulation A and Section 401 of the JOBS Act.