The "JOBS" Act and the Capital Raising Process (Crowdfunding and the Costs of the Exemption)

Issuers seeking to use the crowdfunding exemption will discover that it is cumbersome and expensive.  As a result, many legitimate companies will likely shy away from it.  Less legitimate companies will have no such qualms. 

First, the idea is that issuers will need to use a portal (or broker) to effectively advertise the offerings.  Presumably, issuers will need to pay portals for the service.  Perhaps the fee will be up front; perhaps it will be a percentage of the amount of capital raised.  To the extent the former, issuers will have to take the risk that they will raise sufficient capital to compensate for the costs.

Second, success for issuers will often depend on the ability to promote their offering.  Yet the provision prohibits general solicitations by issuers (except to the extent they merely refer investors to the relevant portal).  See Section 4A(b) (issuers may "not advertise the terms of the offering, except for notices which direct investors to the funding portal or broker"). 

On the other hand, third parties can promote the offering and will be allowed to charge for this service (although they must use communication channels provided by the portal), subject only to the limitation that the financial arrangement be disclosed.  See Section 4A(b) (issuers may "not compensate or commit to compensate, directly or indirectly, any person to promote its offerings through communication channels provided by a broker or funding portal, without taking such steps as the Commission shall, by rule, require to ensure that such person clearly discloses the receipt, past or prospective, of such compensation, upon each instance of such promotional communication").  All of this will add expense. 

Third, issuers seeking to raise the maximum amount permitted under the exemption will find that they need an independent accountant.  Those with a capital raising target of more than $500,000 must have audited financial statements. 

Fourth, companies will incur costs arising out of the shareholder configuration resulting from the crowdfunding exemption.  All companies must have an annual meeting of shareholders.  Shareholder with voting rights need to be notified of the meeting.  Companies will, therefore, have to provide a notice every year to these shareholders. 

Fifth, the crowdfunding exemption imposes a requirement that companies keep investors informed even after they purchase the shares.  The provision requires companies to file reports with the Commission at least annually and provide the reports to investors.  The reports must contain "the results of operations and financial statements of the issuer, as the Commission shall, by rule, determine appropriate, subject to such exceptions and termination dates as the Commission may establish, by rule". 

Sixth, because investors purchasing pursuant to the exemption do not count as shareholders "of record" for purposes of Section 12(g), the company will need to maintain more intricate shareholder ownership records.  They will need to know which shares were acquired through the crowdfunding exemption (and therefore not "of record") and which ones were not. 

Seventh, while these shares will be difficult to sell (in many cases there will be no meaningful secondary market), the company is likely to incur increased expenses associated with the transfer of shares.  Companies must maintain a list of record owners.  In many cases, this entails the issuance of a stock certificate.  When a sale occurs, the certificate must be canceled and a new one issued.  Companies using the crowdfunding exemption will likely see an increase in transfers.  Either the company must do the paperwork (and pay an employee to do it) or hire a transfer agent (or perhaps increase the fees to the transfer agent).  Either way, the companies will incur increased costs associated with servicing the additional shareholders.

Finally, in addition to costs, issuers, their directors and executive officers will need to go through a background check.  It may not add expense but it is intrusive.  

Given these costs and restrictions, one has to wonder why an issuer wouldn't just rely on Rule 506 of Regulation D, particularly now that general solicitations are permitted in offerings limited to accredited investors.  Moreover, the issuer itself can conduct the general solicitation, without having to pay a portal for the same service.

J Robert Brown Jr.