by Maital Ben-Baruch and Shemer Sendak, Adv.
In our last article, we discussed Crowdfunding as the new game-changing tool for raising capital. The Crowdfunding was brought into law by means of the JOBS Act. This Act, for the first time in 80 years, relaxes investment securities offerings rules first enacted during the Great Depression, bringing them in line with modern financial markets. These new regulations lift the ban on general solicitation and permit startups, venture capitalists and hedge funds to market private securities offerings via the media, therefore directly connecting investors and companies.
In this article we will discuss a further ban lifting on general solicitation by easing some of the restrictions that were part of Reg D. In general, Reg D establishes the exemptions from the Securities Act registration, i.e. when is a company exempt from registering with the SEC and allowed to sell securities via a private placement. Unlike Crowdfunding which is limited to $1M a year, if a company meets the requirements of Rule 506, it can raise an unlimited amount of capital. However, until now, offerings of this sort were almost secret, as the startups and funds were banned from soliciting the general public, and were restricted to contacting people they already knew. The SEC has now approved the elimination of this ban. In addition, the no. of investors under this Rule was increased from 35 to unlimited, although they now must all be Accredited Investors (worth more than $1M liquid net worth or having an annual income of more than $200,000 in the last two years). This will allow companies to reach over 8.99 million (!) U.S. households who could qualify as Accredited Investors, who up until now wouldn’t have been aware of these offerings.
This is the source of the revolution. Rule 506 has now become an efficient and powerful tool for raising capital from the public, without having to go through the costly and time-consuming process of being registered with the SEC. Companies and hedge funds will be able to reach out to these Accredited Investors via the Internet, social platforms, TV and newspapers, hence increasing their chances of raising the needed resources at a cost much lower than when borrowing from a bank. The potential investors will benefit as well, now having access to many promising startups, and being able to invest in private placements and not only through the Stock Exchange.
Even though this appears to be a win-win situation and the Act was approved by both U.S. parties (a Bipartisan Act), these new rules have drawn fire from opponents who see them as reckless. The antagonists are troubled by the lack of safeguards and regulations to protect the investors from fraud. Though the SEC has barred “felons and bad actors” convicted of securities fraud from raising money through private offerings, and proposed a number of additional issuer disclosure requirements and investor safeguards (yet to be adopted), there is an ongoing debate whether it was wise of the SEC to lift the ban prior to placing additional safety measures.
In Israel the situation is somewhat different. Unlike the situation in the Us, the restriction on the no. of potential offerees is stringent and limited to 35, regardless of their financial prowess. Private offerings in Israel are still limited to large institutional bodies such as provident funds, training funds and insurance companies. Private placements cannot be advertised and as such only a limited group has access to them. It seems then, that raising equity in the U.S. might now be a more viable and attractive option for Israeli start-ups. The law is of course American, and thus applies to U.S. companies alone, but there are no contingencies as to the maturity or size of the company and an Israeli startup company wishing to raise equity in the U.S., may form a new American entity to manage the private placement.
Many claim that these changes to U.S legislation will result in mass migration of Israeli entrepreneurs and companies of all sizes to the United States. And so the Israeli Parliament was recently presented with a few bills inspired by the latest changes in the U.S, and the Israel Securities Authority has submitted its own plan as well. However, one could assume that legislation of these laws will be a lengthy process, if they are at all accepted.
The local and global ramifications of these changes are yet to be determined. With general solicitation allowed, startups will be able to raise money more quickly and from a wider range of investors than before which would probably cause an escalation in the number of new companies. Yet the current lack of safety measures may put investors at greater risk leading to an upsurge in cases of fraud and bankruptcy, and turn the private investment arena into the Wild West. Nevertheless, whatever the future has in hold, it is undeniable that the U.S., and the nations following it, have just taken a giant step into the 21st century.