In April 2012, President Obama signed the ‘Jumpstart our Business Startups Act’ – known as the JOBS ACT. A significant section of the JOBS Act pertained to rule 506, informing the SEC that they were to amend rule 506 accordingly. The amendment would allow startup companies the right to use general solicitations (ie internet, web sites, advertisements, etc.) and advertising to raise unlimited investment capital from the public, providing that sales were reserved for accredited investors and the issuer had taken sufficient steps to ascertain that the investor was indeed accredited. Accredited investors being those whose:
• Net worth exceeds $1M (excluding the value of their primary residence , but including any debts on said residence that is greater than the market value).
• Or their annual income for the previous two years is 200,000+ (300,000+with spouse).
Since the old rule 506 did not allow a startup company to seek investors until first submitting a complete disclosure document to the SEC and then receiving a declaration of effectiveness, the proposed changes created great controversy – especially since startup businesses can be prone to failure.
Although the SEC drug its feet, they finally adopted the proposed changes on July 10,2013 and made them effective on September 23, 2013.
The new 506 ruling:
• Allows issuers to use public solicitations and advertising to raise unlimited capital from unlimited, but accredited, investors.
• Does not require a disclosure/prospectus or an SEC review
• Holds the issuer accountable for taking reasonable steps to ensure all investors are indeed accredited.
• Determines that reasonable steps require obtaining two years tax returns or a written confirmation from an investor’s financial advisor, attorney, or CPA to substantiate his/her net worth.
• Forbids a startup, who has an executive officer, director of a corporate issuer or manager of an LLC issuer, or a 20% owner of the issuer, who has been convicted of certain crimes, became subject to certain judicial orders or suspended from certain securities activities, to utilize the new 506 ruling.
• Requires an issuer using Rule 506 to file a Form D with the SEC within 15 days after the first sale in an offering. (This includes filing the Form D in each state where sales are anticipated and the issuer is asserting reliance on federal Rule 506 for compliance with that state’s blue sky regulations.)
While the new ruling removes the regulatory burden of preparing disclosure documents, it does not eliminate the business prudence of preparing such documents. Under the old rule, a comprehensive disclosure document was invaluable in describing an issuer’s business, management, use of proceeds, and the company’s potential for success. It also openly stated the risks. Without this disclosure or the benefit of SEC review and clearance, having experienced securities drafters, such as Virtual Paralegal Services, to draft and prepare these documents is imperative. Furthermore, if the startup should fail, having a complete and candid prospectus, though not required, becomes a significant tool for refuting any allegations of misrepresentation.
Are you considering a business a startup under the new 506 ruling? Contact Virtual Paralegal Services for assistance.