Many small businesses and startups look for funding when starting. This funding, often referred to as “capital,” can come from many different sources, including investors. However, funding from investors is regulated by the United States Securities and Exchange Commission (SEC), and there are many laws to comply with.
In 2012, Congress passed the JOBS Act, aimed at making it easier for startups to gain access to capital funding from a wider pool of individual investors by loosening and changing some of the SEC regulations. In this article, we will cover how capital investment funding works, what the JOBS Act entails, and how the revised regulations might apply to your business.
Capital and Securities Explained
One thing many early-stage companies need is money. It costs money to rent an office space, pay for advertising, purchase supplies, and pay employees. Startup expenses are just a fact of life, and the funds used to pay these are often referred to as capital.
There are many ways to obtain capital. You may have your own savings, borrow money from friends and family, or even take out a small business loan. However, an alternative is to find investors. Investors buy securities, a tradable financial asset that gives them a stake of ownership in your business. A common example are shares of a company. By selling these shares of equity, you can create liquid capital funding to grow the business. In return, the shareholders have partial ownership of the company.
If you want to sell shares of equity, there are many rules and regulations surrounding how you may do so, as laid out by the Securities Act of 1933 and other similar acts that followed. The Securities Act of 1933 came about in response to the Great Depression, and rules associated with this act are enforced by the SEC.
What is the SEC?
The SEC is an independent agency created by the U.S. federal government in response to the stock market crash of 1929 and the subsequent Great Depression. The goal of the SEC is to “protect investors; maintain fair, orderly, and efficient markets; and facilitate capital formation,” ultimately with the goal of preventing financial disaster.
As such, the SEC is responsible for enforcing the laws related to the creation and exchange of securities offerings, including the Securities Act of 1933, and the more recent JOBS Act of 2012. Although the rules and regulations enforced by the SEC are for the protection of investors and the market, securities laws can be challenging to navigate. The complexity of maintaining compliance and submitting filings can be cost-prohibitive for startups.
What is the JOBS Act?
In 2012, President Obama signed the Jumpstart Our Business Startups (JOBS) Act into law. The goal of this act was to make it easier for startups and small businesses to raise capital by changing some SEC regulations to allow smaller contributions from individuals.
The JOBS Act is broken down into seven titles, each outlined as follows:
- Title I: “Reopening American Capital Markets to Emerging Growth Companies”: Reduces disclosure rules for emerging growth companies (those with annual gross revenue below $1 billion per year) and provides easier access to capital markets
- Title II: “Access to Capital for Job Creators”: Allows private companies to raise unlimited capital from accredited investors and for public advertisement of investment opportunities, referred to as “general solicitation”
- Title III: “Crowdfunding”: Allows equity crowdfunding opportunities to be made available to non-accredited investors via crowdfunding portals registered with the SEC
- Title IV: “Small Company Capital Formation”: Increased the limits of capital that could be raised by the sale of securities in interstate offerings without SEC registration from $5 million to $50 million (This is often most relevant to real estate investment scenarios.)
- Title V: “Private Company Flexibility and Growth”: Raised the number of shareholders a company can have before it is required to register as a public company from 500 to 2,000, of which 500 can be unaccredited
- Title VI: “Capital Expansion”: Raised the number of shareholders a bank can have from 500 to 2,000
- Title VII: “Outreach on Changes to the Law or Commission”: Requires the SEC to conduct outreach to inform small businesses about these changes in legislation
The most important parts of the JOBS Act for small businesses are Titles II and III.
Title II of the JOBS Act
Prior to the JOBS Act, Regulation D of the Securities Act of 1933 stated that companies were allowed to privately sell securities to accredited investors without registering them with the SEC, but they could not publicly advertise those investment opportunities. An accredited investor is anyone with a net worth of $1 million or more or who has a regular annual income of $200,000 or more ($300,000 or more with a spouse).
If a company or issuer wanted to advertise publicly and gain access to more investors, they had to become a public company, form a board of directors, adhere to SEC listing and reporting requirements, register all shares with the SEC, and complete additional paperwork, including annual reports.
Title II of the JOBS Act changes this and allows for an exemption where companies can engage in “general solicitation” or public advertising of investment opportunities without needing to become a publicly traded company, provided they do the following:
- Take reasonable steps to verify that the investors meet the accreditation standards (such as reviewing financial information on income tax returns or other financial statements).
- File Form D with the SEC within 15 days after selling their first securities.
There is no limit on the number of investors or the amount of money that can be raised under Title II. What this means for small businesses and startups is that they can now use the internet or other resources to seek investors that they wouldn’t have had access to otherwise without going public. They can then raise capital without having to deal with as much red tape.
Title III of the JOBS Act
Title III of the JOBS Act opens up investment to smaller investments under new crowdfunding rules. First, it’s worth noting that there are different types of crowdfunding. You may be most familiar with crowdfunding platforms like Kickstarter or Patreon, which allows users to fund projects in exchange for some type of personal benefit.
The type of crowdfunding offerings referred to in the JOBS Act is a little different and is referred to as equity funding. This means that funders get an equity share, similar to a traditional investor.
Title III crowdfunding opportunities come with the following stipulations:
- Funding must be handled through special online crowdfunding portals registered with the SEC. (Examples: Wefunder and Fundable.)
- Businesses may raise no more than $1 million in a 12-month period this way.
- Investors do not need to be accredited, but there are investment limits:
- For investors with an annual income and net worth below $100,000, they can invest a maximum of $2,000 or 5% of their income, whichever is more.
- For investors with an income or net worth of more than $100,000, they may invest up to 10% of either their annual income or their net worth.
Small businesses and startups now have access to a whole new group of potential investors, and can raise funds from a wider variety of sources. This, coupled with the ability to advertise those investment opportunities, makes it much easier for companies to gain capital without excessive red tape. This is particularly important for smaller ventures and microbusinesses that may have significant difficulty obtaining funding otherwise.
In fact, any small business can go on an SEC-registered crowdfunding site today and set up an account to start soliciting funds. You can share your funding goals far and wide, and everyone who is interested can invest, regardless of their income and if you know them personally.
Find More Small Business Resources with ZenBusiness
The JOBS Act makes it much easier for first-time small businesses and startups to acquire the capital funding they need to get off the ground. If you would like more information and tools to make funding and growing your small business easier to manage, check out the resources and support available at ZenBusiness today.