One of the most innovative and exciting sections of the new Jumpstart Our
Business Startups Act (the “JOBS Act”) creates a new
“crowdfunding” exemption from state and federal securities law registration.
Through this new exemption, issuers and investors may communicate by way of the
Internet in connection with the issuance of new securities. This aspect of the
JOBS Act has the potential to create new funding opportunities for companies
from an extremely broad pool of investors, including even unsophisticated
investors.

The primary benefit of this new exemption is that companies will be able to
obtain small investments from an unlimited number of investors, whether
accredited or not, provided certain conditions are met. The conditions
include:

• The total amount of all securities that may be sold to all investors by the
  issuer (including any amount sold in reliance on the new crowdfunding exemption)
  during the previous 12-month period is limited to $1 million.
  
• If an investor has a net worth or annual income of less than $100,000, then
  the amount sold to such investor in any 12-month period is limited to the
  greater of $2,000 or 5 percent of such investor’s net worth or annual income.
  
• If an investor has a net worth or annual income equal to or greater than
  $100,000, then the amount sold to such investor in any 12-month period may not
  exceed 10 percent of the net worth or annual income of such investor, subject to
  an investment cap of $100,000.
  
• The issuer must file with the SEC and disclose to investors certain basic
  information including a description of the company’s business, risk factors, the
  company’s financial statements, the target offering amount, and the intended use
  of the funds raised through the offering. The level of financial reporting
  required is based on the issuer’s target offering amount - the greater the
  offering amount, the higher the level of financial disclosure.
  
• The securities must be sold through an SEC-registered broker or a registered
  “funding portal.”
  
• The issuer may not advertise the terms of the offering except for notices
  which direct investors to the broker or funding portal.

Brokers and funding portals will serve a “gatekeeper” function in that they
are required to positively affirm that each investor understands the risks of
the investment, can bear the loss of the entire investment, and is otherwise
educated in similar investment transactions. In addition, before a broker or
funding portal is permitted to sell securities under the crowdfunding exemption,
the broker or funding portal must first conduct a background and securities
enforcement regulatory history check on each officer and director of the issuer,
as well as each holder of more than 20 percent of the company’s shares. The
broker or funding portal must also ensure that the proceeds from the offering
are not sent to the issuer until the target offering amount has been
reached.

Although this new crowdfunding exemption has already become law, companies
will not have the ability to rely on this exemption until the SEC promulgates
the implementing rules. The JOBS Act gives the SEC 270 days from the date the
JOBS Act was passed in order to complete the SEC’s relevant rulemaking. So,
companies should be able to start conducting crowdfunding offerings in early
2013.

In addition to expanding the number of stockholders that a private company
may have before the company is required to register with the SEC under Section
12(g) of the Securities Exchange Act of 1934, the JOBS Act specifically exempts
from the calculation all stockholders who acquired their securities through
crowdfunding.

We expect the crowdfunding exemption will be particularly attractive to
start-up and emerging growth companies since it allows for an entirely new
method of fundraising, and also allows issuers to obtain funds outside of the
traditional angel or institutional sources.

We will provide further analysis and comment after these new SEC rules are
promulgated.

If you have any questions about this topic, please contact a member of our Venture
Capital/Emerging Company or Securities/Capital
Markets practice groups.