September 2012 Bar Bulletin
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September 2012 Bar Bulletin

Will the JOBS Act Live up to Its Name?

By Kyle Hulten


When an entrepreneur seeks capital for a new company, he or she has two basic options: debt and equity. The entrepreneur can take out a loan or sell a portion of the company in exchange for capital. In the wake of the recent financial collapse, lending standards have become increasingly tight. Accordingly, equity offerings are a more important capital source than ever.

The first round of equity funding is traditionally offered to angel investors through Rule 506 of Regulation D. Fred Wilson, a well-known venture capitalist of Union Square Ventures, has expounded on the importance of angel funding:

The angel funding mechanism is potentially the single most important funding mechanism in startup land. Most entrepreneurs get their first real investments from angels, not VCs. If you lower the amount of angel capital in startup land, you'll end up lowering the number of entrepreneurs who can get their projects off the ground.1

Rule 506

The current version of Rule 506 exempts companies from registration with the SEC (registering with the SEC is commonly called "going public"), so long as certain criteria are met. Rule 506 offerings must not include general solicitation and only 35 unaccredited investors may invest in a 506 offering.2 An offeror must "reasonably believe" that any investor claiming to be accredited is, in fact, accredited.

Title II of the Jumpstart Our Business Startups Act (JOBS Act) made significant changes to Rule 506. From a public policy perspective, regulation of capital markets is always a balancing act between providing access to capital and investment opportunities, and providing protection for the unwary or unsophisticated. Title II is no exception.

The JOBS Act Rule 506 is different from the current Rule 506 in four fundamental ways.3 First, in an effort to increase access to capital for startups, Congress removed the ban on general solicitation. Second, "platforms," which do not have to be broker/dealers, are authorized to facilitate the solicitation of investment in offerings by accredited investors. Third, in an effort to protect unwary investors, Congress provided that unaccredited investors are prohibited from investing in the new 506 offerings. And fourth, offerors must "verify" an investor's status as an accredited investor.4

How Title II Could Create Jobs

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