What Does the JOBS Act Mean for Your Small Business?

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© Copyright 2012. Andrew J. Sherman. All Rights Reserved.

Andrew J. Sherman
Mr. Sherman is a partner in the Washington, D.C. office of Jones Day with over 2,700 lawyers
worldwide.
He is the author of 23 books on business growth, capital formation and the leveraging of
intellectual property. His twenty-second (22nd) book, Harvesting Intangible Assets, Uncover
Hidden Revenue in Your Company’s Intellectual Property, (AMACOM) was published in
October of 2011. Other recent titles include the best-selling Mergers and Acquisitions from A
to Z, third edition was published by AMACOM in 2010. He is also the author of the 2nd edition
of the Due Diligence Strategies and Tactics, which was published in the Spring of 2010. His
Twenty-third book Essays on Governance, will be published June of 2012. He has appeared
as a guest and a commentator on all of the major television networks as well as CNBC’s
“Power Lunch,” CNN’s “Day Watch,” CNNfn’s “For Entrepreneurs Only,” USA Network’s “First
Business,” and Bloomberg’s “Small Business Weekly.” He has appeared on numerous
regional and local television broadcasts as well as national and local radio interviews for
National Public Radio (NPR), Business News Network (BNN), Bloomberg Radio, AP Radio
Network, Voice of America, Talk America Radio Network and the USA Radio Network, as a
resource on capital formation, entrepreneurship and technology development.
He has served as a top-rated Adjunct Professor in the Masters of Business Administration
(MBA) programs at the University of Maryland for 23 years and at Georgetown University for
15 years where he teaches courses on business growth strategy.
He has served as General Counsel to the Young Entrepreneurs’ Organization (YEO) since
1987. In 2003, Fortune magazine named him one of the Top Ten Minds in Entrepreneurship
and in February of 2006, Inc. magazine named him one of the all-time champions and
supporters of entrepreneurship.


Overview of the Capital Markets
Overview of the Capital Markets


Assessing Capital Market Conditions
Truly Excellent Open
(a) Normal Private Equity Conditions (ex. 1994 to 1997, 2010-2011) Companies Access
All truly excellent companies Typical Growth
and some typical growth Companies
companies have access to
the capital markets. Weaker (Limited Growth) Closed
Access
Companies
(b) Weak Capital Market Conditions (ex. 2000 to 2002, 2008-2009) Open
Truly Excellent Access
Only the “best of the best” in
favored industry sectors get Companies
access to the private equity
markets (and even those Typical Growth
face much tougher terms Companies Closed
and conditions). Access
Weaker Limited Growth
(c) Abnormally Exuberant Market Conditions Companies
(ex. 1998 to 2000) Open
Access
Truly Excellent
The exuberance of the Companies
markets provides capital to all
excellent, typical, and even Typical Growth
some weaker companies, and Companies
business models in a “gold Closed
rush” mentality. Weaker Limited Growth Access
Companies

Sources of Growth Capital

$

Debt
• Commercial Banks
Hybrids
Equity • Governmental Lending
• Bootstrapping
• Angels/ and guaranty programs
• Alliances and Joint
Bands of Angels • Commercial Leasing and
Ventures
• Private Placements Equipment Finance
• Employee Financing
• Venture Capital Funds • Factoring and Specialty
• Customer Financing
• Strategic Investors Lenders
• Consortiums
• Vendor Financing and
Trade Credit
Dilution and Control Risk of Default and
Obligation to Repay


Three Types of Investors

Emotional Financial Strategic

• You • VC Funds • Corporate
• FFF’s • PE Sources Investors and
• Angels Corporate VC
• PPM’s Funds
• Customers
and Vendors
• Corporate
VC Funds
• Some types
of PE Funds
• Consortiums

State of the Capital Markets (Not a pretty picture)
• Economy is slowly recovering (not recovered) and
business and investment transactions are taking
longer to close
• More business deals and financing transactions
derailing due to market conditions or buyer cold
feet/seller remorse/valuation disappointment or
overall transactional fatigue (loss of
momentum/parties run out of steam and passion)
• Cost of transactional capital is rising
• Breadth and depth of due diligence is wider and
deeper and taking longer
• “Sky is Falling”/“Boy who cried Wolf”/Fear of Your
Own Shadow Market Mindset

(Cont’d)
• Perceived vs. Real Lack of Quality Deal Flow Relative to
Capital (Overhang)
• Protection & Risk Allocation-driven deal terms more hotly
contested (less wiggle room)
• Players seem content on the bench vs. the playing field
(are they on injured reserve or out for the season?)
• Many VC funds are focused on existing relationships vs.
new portfolio companies
• The net worths (home values, stock values, etc.) of
angels have taken a significant hit and they are feeling
less “angelic”


(Cont’d)
• Focus is on follow-on investment to existing portfolio
companies vs. open to new relationships
• Big rock stars (Groupon, Living Social, Zynga) and
everyone else
• The “small deal” ($250 to $750k) that nobody seems
to want to do
• When bad markets happen to good entrepreneurs
(bar is higher and narrower.…)
• The social media consequences of the Facebook
IPO and the impact on capital formation


The JOBS Act
The JOBS Act


JOBS Act
(Jump Start Our Business Act)
• Became law on April 5, 2012
• Designed to facilitate capital raising by reducing
regulatory burdens
• Many provisions are self executing and were
effective immediately, including the provisions
relating to:
 Facilitating IPOs
 Increased shareholder numerical thresholds
• Allows “crowdfunding” to include certain types of
equity issuances (regulations from the SEC
pending)

JOBS Act (Cont’d)

• Other provisions require SEC rulemaking including
 The elimination of the restriction on general
solicitations (within 90 days)
• Many “reforms” will involve policy decisions on
whether and to what extent to adopt


JOBS Act (Cont’d)
Most but not all of the JOBS Act provisions are only
applicable to EGCs

Emerging Growth Companies
•IPO companies with annual gross revenues of less
than $1 billion during their most recent fiscal year


JOBS Act (Cont’d)
• A company would retain EGC status, and the
reduced regulatory and reporting requirements
associated with it, until the earliest of:
The first fiscal year after its annual revenues
exceed $1 billion
The first fiscal year following the fifth anniversary
of its IPO


The JOBS Act Crowdfunding Exemption
The JOBS Act creates a new exemption for
“crowdfunded offerings”
Basic Requirements:
• The aggregate amount sold to all investors by the
issuer during a 12-month period is no more than
$1 million
• Individual investment amounts are limited 10% of
annual income or net worth up to $100,000.[*]

___________________________________
[*] The limit is the greater of $2,000 or 5% of annual income or net worth
if the investor’s net worth or annual income is less than $100,000.



• The transaction must be conducted through a broker
or “funding portal.”
 A funding portal cannot:
(1) provide investment advice or make
recommendations;
(2) solicit purchases, sales, or offers to buy
the securities offered or displayed on its
website or portal;


(Cont’d)
(3) compensate employees, agents, or other
persons for such solicitation or based on the
sale of securities displayed or referenced on
its website or portal; or
(4) hold, manage, possess, or otherwise handle
investor funds or securities; or
(5) engage in any other activities the SEC
determines to prohibit in its crowdfunding
rulemaking.


The JOBS Act, Private Placements and
Regulation D
Prior to the JOBS Act passage, crowdsourcing had
been limited to “donations” to early-stage enterprises,
musicians, artists, non-profits, etc. without the
issuance of equity or debt securities


Regulation D (Cont’d)
• Overview of Regulation D today (pre-JOBS Act)

 The JOBS Act requires the SEC to revise
Regulation D to remove the prohibition against
general solicitation and advertising in offers and
sales of securities conducted under Rule 506,
provided that the ultimate purchasers of
securities qualify as "accredited investors" under
the SEC's current definition.



 The legislation also requires the SEC to make
comparable changes to Rule 144A to permit
solicitation of nonqualified institutional buyers,
provided that only qualified institutional buyers
purchase the offered securities.


 The JOBS Act requires the SEC to adopt
implementing rules on these changes to
Regulation D within 90 days.
 These changes represent a major shift in the
private placement process and provide issuers
and placement agents with additional tools to
raise capital without the burden and expense of
filing a registration statement.


 These changes permit persons engaging in
unregistered transactions to enjoy many of the
same benefits of public offerings, but avoid the
time constraints of SEC review and the burden of
SEC registration.[*]
____________
[*] The JOBS Act also amends Section 3(b) of the Securities Act to
require the SEC to establish an exemption for securities that are
offered and sold in a 12-month period with an aggregate offering price
not to exceed $50 million. This exemption contains conditions,
including the requirement that covered issuers file audited financial
statements annually with the SEC, and provides that the civil liability
provisions of the Securities Act are applicable to offers and sales of
these securities.


 Among the topics that the SEC must address in
its rulemaking is what steps an issuer must take
to verify "accredited investor" status.[**]
_____________
[**] In order to comply with Sections 3(c)(1) or 3(c)(7) under the
Investment Company Act, private funds (e.g., private equity,
venture capital, real estate, and hedge funds) need to conduct
their securities offerings in a manner that does not constitute a
public offering. The JOBS Act addresses this issue by
providing that an offering conducted under revised Rule 506 of
Regulation D would also not be viewed as a public offering for
purposes of the federal securities laws, including the
Investment Company Act.


The JOBS Act and The Registration
Threshold
• The legislation also raises the threshold for
registration under the Exchange Act.
• The JOBS Act amends Section 12(g) of the
Exchange Act to increase the limit on
shareholders of record from 500 to 2,000 or, in
the alternative, 500 persons who are not
(i) "accredited investors,"
(ii) employees of the issuer who received
shares pursuant to an employee
compensation plan, or


Threshold (Cont’d)
(iii) investors who received shares under the
"crowdfunding“[*] exemption of the JOBS Act.
[**]
______________
[*] The JOBS Act's "crowdfunding" provisions would also exempt from
registration small capital raising transactions—up to an aggregate
amount of $1 million per year—with individual investors. The
aggregate amount sold to each individual investor under this
exemption is limited to a maximum amount based on the investor's
income or net worth, and issuers engaged in eligible transactions
must satisfy basic informational and SEC filing requirements, among
other conditions.
[**] The JOBS Act also provides for increased thresholds for banks and
bank holding companies.


Threshold (Cont’d)
• Calculation excludes shares issued under
employee benefit plans
• Shareholder count continues to be based on
“record ownership” rather than “beneficial
ownership”
• Enables issuers to remain private longer
• May result in further development of private
secondary markets such as SharesPost and
SecondMarket


Practice Tips and Next Steps
• CEO’s, CFO’s and entrepreneurs need to evaluate
crowdfunding with the same analytical view towards
any other type of capital formation strategy – it is not
a magic elixir
• Business plans, business models, cap tables,
dilution impact, etc. all need to be clearly
understood and communicated– think through the
terms of the offering, valuation issues, risks, etc.


Practice Tips and Next Steps (Cont’d)
• From a governance standpoint, be sure the
company is ready for an influx of 100’s of small new
investors (who may or may not be sophisticated)
• Develop screens and filters and criteria for
accepting investor subscriptions


Are You Really, Really
Are You Really, Really
Ready to Raise Capital?
Ready to Raise Capital?


Key Variables In Readiness Assessment
• Current dynamics of leadership team and stakeholders
• Current methodologies for decision-making and how that
paradigm will change
• How will you react to the typical controls in a Term Sheet
(honest self-assessment)?
• Are you ready to listen? Adjust? Collaborate?
• Do you understand and embrace what it truly means to
have a fiduciary duty and stewardship role to protect the
best interests of minority shareholders?
• Will you be accountable for deadlines, milestones,
performance conditions, staggered tranches, penalties
for default, etc.?


Emotional and Psychological Aspects of
Capital Formation
• In venture investing, due diligence is both strategic and personal
• Alignment of core values beliefs, moral fiber and goals with
investors
• Understanding investor expectations in an era of transparency
and distrust
• The emotional aspects of angel investing
• The delicate balance between love/friendship and money with FFF
investors
• The dynamics of a business marriage with one or more co-
founders/early team members
• Embracing your FUD’s about having investors and raising capital
• What makes you the happiest? Describe your lifestyle, hobbies,
interests, etc. Are these activities aligned with the best interests
of the investors?
• Can you live your life in a fishbowl?


Breaking Some Myths
• People invest in people (that they trust, like and
respect) not in things or plans
• A Team/B plan wisdom
• Numbers follow, they don’t lead
• Real commitment/skin in the game
• Some new acronyms to replace IRR, ROI and
EBITDA: WSIGAS, CITY AND SMTM
• Walk a mile in the shoes of the investor: How does
your proposal meet their needs or solve their
challenges?


Developing Capital Formation
Developing Capital Formation
Strategies
Strategies


Understanding The Capital Formation
Strategic Planning Process
• Capital Formation Strategic Plan ≠ Business Plan
• No “Emperor’s New Clothes” – Must Have A Realistic
Assessment of Current Growth Opportunities and SWOT
Analysis
• Capital Must Be The Fuel That Will Make Your Company
Bigger/Better/Faster/More Profitable or Investors Will Take A
Pass (Your job is to demonstrate and prove the investment
thesis in your Business Plan and presentations)
• Understand both the quantitative and the qualitative “cost” of
capital (e.g. are you really ready for investors?)
• Avoid DITH and DCMBU syndromes!


Understanding The Capital Formation
Strategic Planning Process (Cont’d)
• Capital Formation is a Process (in multiple parts) not
an Event
• Be prepared to invest time and resources into the
capital formation process
• Have the right advisors in place
• Be realistic in your valuation expectations (reflective
of industry trends, market conditions, growth plans,
operating margins, etc.) to avoid looking like a “pie-
in-the-sky” entrepreneur


Types of Capital To Be Raised
(Allocation of Proceeds)
Opportunity Capital
(take advantage of
unforeseen
Fudge Factor opportunities
(because
Murphy’s Law Debt
is a law) Repayment
(as approved)

Capital Raised

R&D Capital
Day-to-Day
Operating
Project-Specific Capital
Capital


Balancing Competing Interests Is Key
THE DEAL
(meeting of the
minds/compromise)

INVESTOR WANTS/ NEEDS ENTREPRENUER WANTS/NEEDS

• Maximum return • Maximum capital/valuation
• Mitigate risk/downside • Avoid dilution/control
protection
• Affordable cost of capital
• Input on future and growth of
the business/control
COMMON OBJECTIVES
• Growth in the value of the business
• Additional rounds of $ at more
favorable valuations
• Mutually beneficial exit strategy


Key Issues For Investor Due Diligence
(Value Drivers)
Marketing and
Defendable branding
competitive strategies Durable revenue
advantage (IP) streams

Strategic, alliances, GROWING Management
channels & networks teams ability to
COMPANY lead/execute

Strong base of loyal
and diversified
customers Path to
Large and clearly
profitability
defined target
is clear
market(s)


Ten Questions All Types of Venture Investors Ask
Leaders of Growing Companies

1. How much can I make?
2. How much can I lose?
3. What is my exit strategy from this deal?
4. Who else says this deal is viable? (Risk mitigation/credibility)
5. Does the founder (and others) already have resources at risk?
(Skin in the game)
6. What other value (beyond money) can I bring to the table?
7. Can I trust this management team?
8. Is this company’s target market large, growing (not stagnant or
shrinking), and reachable?
9. Does the company have (or will it have) a sustainable competitive
advantage – as a result of either operational effectiveness or its
strategic positioning or its intellectual capital or other barriers to
entry?
10. Is the company’s business, revenue, and profit model credible,
verifiable, efficient, and sustainable?


Key To Capital Formation Planning: Know Your
Audience (and its needs/wants/preferences)
• •
Angels Venture Capitalists
• Economic/Strategic Investors
• The business model may be • Clear path for growth
secondary to team/personality fit • Strength of management team
• Understanding the different levels and willingness to listen
of angels • Size of market and
• Strategic opportunity/competition
• What corporate objectives do
they have in place that an • Viability of an exit strategy
investment in your company will • Private Placement Investors
help facilitate?
• Understand synergies, politics, • Sizzle vs. Steak
red tape • Understanding their investment
• Commercial Lenders objectives/needs
• Creditworthiness • Use of intermediary
• Ability to Repay
• Mitigate and Manage Risk


Key Strategic Questions Regarding Capital Formation
• In what ways are your financial capital issues a strategic
growth opportunity vs. a growth impediment?

• Debt vs. Equity vs. Hybrid – What Flavor Of $ Should You
Raise?

• Market Conditions – Help or Hinder To Your Plans?

• Proposed Allocation of Proceeds

• Analysis of Current Balance Sheet

• Development and Analysis of Forecast and Growth Projects

• Needs Analysis/Timetable (Openness to Staging)


(Cont’d)
• Before exploring the different type of financing available, you should
thoroughly understand the fundamentals of developing a capital
formation and business growth strategy because regardless of what
kind of capital you’re raising—or how– any lender, underwriter,
venture capitalist, or private investor will expect you and your
management team to be able to prepare a meaningful business
plan. The capital formation strategy will have to address specific
financial questions, such as:

• What market problems and financial opportunities have you
identified?

• What services, products and projects are planned to exploit
these opportunities or solve these problems?

• How much capital will you need to obtain the resources
necessary to bring these projects to fruition?

• Exactly how will you allocate the capital? How will this infusion
of capital increase sales, profits and the overall value of the
company?

(Cont’d)
• How will you meet your debt service obligations and
provide a meaningful return on investment to your investors
and lenders?

• How much equity in the company are you offering to
investors? How is it being valued?

• What “exit strategies” will be available to the equity
investors?


What Does the JOBS Act Mean for Your Small Business?

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