Three New Ways for Startups to Raise Money in the JOBS Act – An Interview with Jeremy Glaser from Mintz Levin
“The problem with socialism is that you eventually run out of other peoples’ money.” – Margaret Thatcher
In this interview with Jeremy Glaser from Mintz Levin, we discuss the JOBS Act (Jumpstart Our Business Statups Act). Jeremy explains why the JOBS Act is important and gives his opinions about the most relevant parts about the legislation and regulatory implementation by the US Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA). This is a piece of legislation that intended to facilitate funding of small businesses in the US by easing various securities regulations. It was passed by congress with bipartisan support, and signed into law by President Obama in April 2012. When most people think of JOBS Act, they think about Title II and Title III. However, Title IV may be the most interesting and exciting part of the legislation. Title IV is also known as Regulation A Plus. Title II and Reg A+ are already in effect, and Title III regarding equity Crowdfunding goes into effect in May 2016.
All of these offer new ways for startups to raise money.
Title II deals with a general solicitation for investors, but only accredited investors can participate in a financing. Validation that the investors are accredited must be confirmed by the startup in order for them to have “Safe Harbor”.
Title III deals with equity Crowdfunding at the $500,000 and $1,000,000 levels. This may be far more costly from a legal standpoint than traditional convertible debt financing or preferred stock offering, so it is not clear yet how widely this may be used. Time will tell.
Equity Crowdfunding is not to be confused with Pre-Sales Crowdfunding on sites like Kickstarter. This new form of equity financing is spawning a new set of “FinTech” companies that will be interesting to watch. See the article in Inc. Magazine, Why Fintech is One of the Most Promising Industries of 2015 and The Rise of Fintech.
Regulation A+ allows for a general solicitation of a much larger financing (e.g., $20,000,000 or $50,000,000), but it is a private financing round with costs much lower that going public. Legal fees alone in a public offering could be over $1,000,000. In Reg A+ filings to-date, legal costs have ranged from $20,000 to $300,000.
I always recommend getting legal advice from a competent attorney like Jeremy Glaser from Mintz Levin before pursuing a financing for your startup. I hope you find this interview informative and helpful.
Patrick: Hi, this is Patrick Henry, the CEO of QuestFusion with the Real Deal…What Matters. I’m here today with Jeremy Glaser who is a partner at the law firm of Mintz Levin.
Jeremy also serves as the co-chair of the firm’s venture capital and emerging companies practice. I’ve known Jeremy for many years. He’s a wonderful guy and an incredible attorney. He is highly recognized in the US as one of the top venture capital lawyers in the country. Welcome to the show, Jeremy.
Jeremy: Thank you, Patrick.
Patrick: Today we’re going to be talking about the JOBS Act. This is a piece of legislation that I think President Obama signed a few years ago. It’s highly complicated. There are a couple of key parts of it called Title II and Tittle III that are especially relevant to entrepreneurs in terms of getting financing done.
Title II deals with traditional startup financing. Title III deals with crowdfunding. Jeremy is an expert on these things, I’m not. I don’t even know what the JOBS acronym means. But I’m sure that Jeremy will explain that as well as many other useful things for the entrepreneurs out there.
Jeremy: Thanks, Patrick. The JOBS Act stands for Jumpstart Our Businesses Act. It’s an acronym that Congress came up with when the economy was not doing very well. They were trying to put things into place to create more jobs. The belief was that, if we opened up financing for early-stage companies, that would help them grow. Perhaps they could hire more people and create more jobs.
How is this relevant to entrepreneurs? It’s relevant to entrepreneurs because we now have three new ways to raise money for startups that we didn’t have before.
There are different titles. Title II is what we call the general solicitation financing. What does that mean? Traditionally, companies raised money in a private placement that had very strict rules about how you could contact your investors. One of those rules was that you couldn’t put an ad in the newspaper. You couldn’t go out and start calling people on the phone randomly that you didn’t know. You couldn’t put the fact that you were trying to raise money on the internet, on a website or on Twitter.
Those rules were obviously becoming a little bit difficult to police in this new world where everyone was on social media. Everyone had websites. People were talking about their companies, including their financing rounds. The good news is, Congress and the FCC recognized this. They said, “Let’s change the rule. Let’s go ahead and create the ability for companies to raise money.”
They use what they call a general solicitation, which is a legalistic term. It basically means that you can now do the things that I said you couldn’t do. Now you can do your offering and present it on your website or put it on an internet portal like AngelList and make it widely available.
There’s a catch, because there always is. There are some restrictions that you have to follow in order to do a general solicitation. The key one is that you have to do some very special due diligence on the investors to determine that, in fact, they are accredited investors.
There are things to do before you try to go down the road of doing an offering, whether it’s a regular private placement where you’re not going to be putting it out on an open internet portal or website, or if you’re going to do a general solicitation offering to accredited investors only, which is what Title II allows. You had better make sure you’re talking to an attorney.
You’d better make sure you have the right documentation. If you don’t, you have some very serious legal issues that could cause you to give the money back. You don’t ever want to be in that position. Still, it’s a very valuable option. It definitely gives companies a much broader ability to reach out to potential accredited investors to fund their businesses. The part that got more attention, but is not even effective yet, is Title III.
Patrick: That’s the crowdfunding stuff. I have a couple of questions about Title II before we get there. I remember when we took Entropic public. We also did private rounds of financing. There is something called Regulation A. When we did the IPO, we did more of a general solicitation. We used investment bankers. There were a lot of things that we had to do in terms of the prospectus and the proxy statement. Do those things go away in this new form of general solicitation in a private stock offering? How does that work?
Jeremy: It’s a great question. I’ve referred to these general solicitation offerings as a private public offering. That’s sort of what they are. The beauty of it is, you don’t have to do a registration statement. You don’t have to file it with the FCC. You don’t have to go through that approval process that you talked about.
You’re limiting your sales only to people who are certified in this procedure as accredited investors. It’s a little different than the public offering that you went through, where you went through that FCC process. You were able to offer those securities to anyone, not just accredited investors.
Patrick: For instance, I am an angel investor. I’m very selective about what I invest in. Do I need to go through a process of being an accredited investor? What does that look like? Do I show my certificate to the entrepreneur and say, “Hey, I’m good to go?” Do they have to go through some type of screening process to identify me and I don’t have to do anything myself?
Jeremy: This is the sticking point with these new accredited investor public offerings. There is a process that the company has to go through to confirm that you are an accredited investor, meaning that you meet the requirements of $1 million net worth or $200,000 of income individually.
Patrick: There is a checklist that they have to go through.
Jeremy: You have to get certified. There is a litany of ways that the FCC laid out in their regulations. It’s what we call a safe harbor. If you do these things, we’re going to say that you’ve met the requirement. It can include things like seeing your tax returns or getting a certification from your accountant, investment banker or financial advisor.
There needs to be more than, “Hi, I am accredited.” You have to actually provide some independent evidence of the fact that you meet these requirements.
There are some services that have popped up that will do this. You talked about showing up with a certificate. That can work if you provide all of that information to these services. Then they do that checking. They confirm that, in fact, you meet those tests.
Patrick: But that isn’t required if you’re doing the traditional private financing, where I’m an angel investor. You’re not doing a general solicitation. If I want to put $50,000 or $100,000 into a deal and it’s not under these general solicitation requirements, it’s the way that it used to work.
Jeremy: Exactly. Those rules are still in place. Whenever you do one of those investments, you have to sign a document that says you’re an accredited investor. You usually have to check a box stating that your net worth is more than $1 million with income more than $200,000 per year. You still have to do that. That hasn’t changed. That’s what you have to do if the company has not used general solicitation in raising that private round.
Patrick: On the general solicitation part, part of the benefit of the public offering process is that you do have to disclose a lot of information. For example, there are the risk factors. A lot of these are corner case things, but if you have good attorneys, they are going to put every single possible corner case in there.
If you read the full disclosures in these proxy statements and these S-1s, you would never invest in anything. What level of disclosure is required? Is there any level of disclosure required other than a pitch deck for a startup when they do this modified version of a general solicitation?
Jeremy: There are two different ways to look at this. From the perspective of the public offering, the FCC has very specific rules about what has to be in a disclosure document to make a company public. When you look at a private placement, whether you’re using general solicitation or not, because those are limited to accredited investors, if the only investors in that financing are accredited, there are no specific disclosure rules. There is this rule called 10b-5. This says that anyone who sells a security cannot misstate or omit material information.
You still have to meet that standard. The reality is that you do a disclosure document. If you want to be smart, you disclose the relevant risks of the business so that your investors are knowledgeable and you can feel comfortable that they’re not going to come back later and say, “Hey, you violated Rule 10b-5 because you didn’t disclose all the material facts about your business.”
Patrick: As a safeguard, if you are an entrepreneur or a startup CEO, it’s prudent to do a mini S-1. But you’re not filing that with the FCC. This is a document that you’re handing to these accredited investors before they invest so that you’re covered by safe harbor by doing that.
Jeremy: Exactly. I advise all companies to do some sort of a disclosure document. It can vary. It depends upon the size of the offering, the number of the investors that you’re going to reach out to, the way you’re going to reach out to the investors and the relationship that you had before. That will all drive decisions.
There is not any one-size-fits-all. You need to address this with someone who does this a lot to guide you so that you’re not over-spending on the disclosure. You also don’t want to under-disclose and create potential liability for yourself.
Patrick: That’s Title II. Title III hasn’t gone into effect. I guess it goes into effect May of this year?
Jeremy: It is 180 days, post when the rules came out. I don’t have the exact date. The rules are out finally. We waited a long time for the FCC to come out with rules about what we call crowdfunding. I know that people are very excited about it. Those rules have been released but are not yet effective. They will be effective in the coming months.
Patrick: When I think of crowdfunding, I think of Kickstarter and things like that. It’s more pre-sales of a product. I need to raise some money. I’m going to go out to the general public. I’m not offering an equity financing. I’m just doing pre-sales of my latest gadget.
I bought something called the thingCHARGER. It’s something that you stick into your wall outlet. You can charge your phones on it. It was a crowdfunding campaign. It was a pre-sales campaign. I was hoping to have my thingCHARGER as stocking stuffers for the Christmas holidays but I just got them a couple of days ago. That’s different than the crowdfunding that you’re talking about, which is going to the general public to raise equity.
Jeremy: The thing you did with Kickstarter, we refer to that a crowdsourcing as opposed to crowdfunding. There is that distinction between when you’re pre-purchasing a product versus investing in equity. The pre-purchasing of a product was okay because you were not selling securities.
When the FCC gets involved is when you’re selling securities. That’s crowdfunding. That’s now what we’re about to have available. I know that a lot of entrepreneurs were excited about having this. People thought it was going to be a big deal so I don’t want to downplay it. Yes, it is wonderful that companies will be able to go out and sell up to $1 million of securities in any 12-month period of time to pretty much anyone.
It’s not going to be limited only to accredited investors, like we were just talking about. It will be like your public offering when you went out with Entropic. You can sell to everyone. However, there are a lot of limitations. There is a form that has to get filed with the FCC, just like your public offering. It’s smaller with less disclosure. It’s less complicated.
There is an approval time and a process. You have to only sell these securities through approved portals. There are a lot of restrictions that most attorneys, including myself, believe that this is not going to get used that much. There is a cost to doing these $500,000 or $1 million fundraisings.
It is probably not going to make sense for most companies because of the cost involved to raise such a small amount of money. Now, $500,000 or $1 million today is usually being raised in angel rounds with convertible notes, basic preferred stock financings and private placements. Those can be done very inexpensively.
You don’t have the regulatory overlay. That’s why most of us think that crowdfunding, in the way of Title III, is probably not going to be used in any significant way by tech companies that have traditionally gone down the angel route and the venture capital route.
That said, I think it’s interesting from the perspective of loyalty programs. For example, you might have a favorite restaurant. My guess is that you might view your relationship with that restaurant differently if you owned some of it. You might go more often.
You might refer your friends there more often. There might be a real advantage to smaller retail operations that can benefit from consumer loyalty to go down this route and use that to sell some equity to their customers, to build that brand loyalty. I think that’s an interesting opportunity.
Patrick: When you talk about the cost being prohibitive, that’s what was resonating with me. I know the cost of going through the public offering process with the S-1 filings and the proxy statement. It’s very expensive, especially when you use high-priced guys like Jeremy. You have a mini version of this.
Jeremy: It’s very mini. It’s not going to be anywhere near the cost of doing a full-on IPO, which can be $1 million plus in legal fees alone.
Patrick: Then you have the accounting on top of it. Then you have to pay your bankers. It’s very expensive.
Jeremy: You’re going to have legal fees. You’re going to have accounting fees. There is a requirement that the financials be reviewed if it’s under $500,000 or audited if it’s between $500,000 and $1 million. You’re going to have these portals involved.
Patrick: Ballpark it for me. How much money are we talking about to put a shelf registration crowdfunding campaign out there?
Jeremy: To be honest with you, I don’t know. The rules aren’t out yet and we haven’t done them so I don’t have a sense of what these are going to cost.
Patrick: In the general sense, knowing the process, it’s likely going to be prohibitively expensive unless there is some other psychic benefit of customer loyalty?
Jeremy: What I do know is that, if you come to me and you want to raise $1 million on a convertible note deal, we can do that probably for under $5,000 with total legal fees. I don’t think there is any way that the total legal fees on a crowdfunding deal are going to be anywhere near that.
Patrick: On a relative basis, there are more likely better ways to do that?
Patrick: Are there any other key things that you wanted to cover about the JOBS Act?
Jeremy: There is another aspect that is effective that came out recently. It’s called Reg A+. It is something that I’m very excited about. It allows companies to raise up to $20 million under one tier or up to $50 million under another tier to anyone. It’s like your public offer, but on a much more reduced regulatory scale. There have been a number of these Reg A+ deals filed.
We do have a sense of what the legal fees are on those. They are required to disclose them in their filing document. What’s interesting is that there is a huge, wide band. You have some that are being filed as low as $10,000 with the legal fees. There are others showing $300,000. They’re all still less than the traditional public offering.
But there is a pretty wide range. I think that Reg A+ is a very interesting alternative for companies versus going down the traditional venture capital route. You can sell your securities broadly. There is a regulatory process. There is a filing with the FCC. There are requirements around reviewed financials.
Because you can raise so much more money, like $20 million or $50 million as opposed to the $500,000 or $1 million under crowdfunding, I think Reg A+ is going to be used a lot more by traditional tech companies.
Patrick: This would open up the door for syndicates of angel investors and super angels as opposed to traditional venture capital putting that kind of money into deals.
Patrick: This has been helpful. I learned a lot. Hopefully this is valuable for the entrepreneurs out there. This is Patrick Henry, the CEO of Quest Fusion, with the Real Deal…What Matters.
This is Patrick Henry, CEO of QuestFusion, with The Real Deal…What Matters