Congress passed the Jumpstart Our Business Act (JOBS Act) in April of 2012. One of the main implications of this legislation was the passage of Title II, which lifted the ban on general solicitation of private placement securities.
Before the passage of the JOBS Act under rule 506(b) regulation D, an issuer could raise an unlimited amount of capital from an unlimited amount of accredited investors plus 35 non-accredited. If this criteria was met, the issuer was exempt from registration with the SEC, and could raise private capital. However, the issuer was not able to advertise the offering outside of immediate networks.
The JOBS Act created a new type of offering under regulation D called 506(c). In this new ruling the issuer may solicit an offering through marketing channels, including advertisements through social media. Under 506(c) the issuer must take ‘reasonable steps’ to ensure that all investors are accredited. SEC guidelines suggest some non-exclusive methods of accredited investor verification such as income verification, written confirmation from a registered broker-dealer, or the verification that the investor participated in a past private placement offering.
Much of the reasoning behind this legislation was formed out of necessity to keep up with the proliferation of digital channels and the increased access to information. The private capital marketplace inherently requires oversight and regulation. This legislation’s intent is to increase visibility and transparency with the understanding that digital investment platforms would emerge to meet the demands of both issuers and investors. Private issuers raising capital can utilize digital platforms for both 506(b) and (c) offerings. Typically, 506(c) offerings display deal information to the general public, while 506(b) offerings require an accreditation firewall in order for investors to view information. Other than these differences, the fact that investment opportunities can be housed digitally means that access can be worldwide, bringing investments to individuals and institutions that would not normally have access just a couple of years ago.
So what are the implications for fund managers raising capital in the new age of the JOBS Act? We know that there’s tremendous opportunity to enhance investment access and distribution. However, some critics say many things won’t change significantly and it may be an additional burden on fund managers. The extra steps involved in complying with the extra accreditation standards may be costly to managers and scare away some investors. This could be additionally burdensome and legally costly to make sure the financing round remains compliant. The regulatory environment is so new that some fund managers understandably do not want to bother with delving into this new territory.
Expanding on this, not every fund manager has a need or want for general solicitation. For example, many fund managers do not need to advertise for capital; a good number of popular funds are in fact oversubscribed. Many managers do not want their information out for dissemination publicly, considering the reputation risk in having materials floating around publicly. As an example, some managers want to keep the spotlight away from them and their fund in order to focus on investing the current capital that they are managing. There are also deep traditions in the private markets related to personal relationships built on trust. Many fund managers are skeptical of the value of general solicitation, given that it is difficult to have a trusted relationship based on connections made through outside advertising. Branding is a consideration as well – it doesn’t make sense for a luxury good to be marketed to the masses – the goal is to advertise to the premium market. In order to protect a brand, funds may not want information readily accessible.
Despite the reservations some managers may have regarding general solicitation, there are also advantages for funds raising capital in the digital age. Typically very early-stage startups and funds rely on friends and family rounds to jumpstart business. After close-knit networks are tapped, there is a point of disconnect in which startups and funds without significant track records are unable to attract institutional capital. General solicitation creates a new type of marketing environment where funds can advertise to attract capital, many times bridging the gap between early-stage and later-stage or institutional rounds. This also allows issuers to circumvent traditional money gatekeepers eliminating the need and costs for placement agents and capital raising agents. 506(c) offerings also enable for great cost-effective marketing through social media channels. The more information that is readily available on fund performance and managers, the more transparent the alternatives landscape will become. In its infancy, the JOBS Act has the ability to redefine the private capital markets, creating more efficiency and transparency in an otherwise opaque marketplace.
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