Changes to federal law open new avenues for business owners seeking capital.

• Author: Babiarz, David
• Position: LEGAL INSIGHT SPECIAL SECTION

Provisions of the Jumpstart Our Business Startups (JOBS) Act adopted by the U.S. Congress in 2012 create new opportunities for business owners seeking to raise capital to start or grow their businesses. Business owners who do not qualify for traditional bank financing have historically been very limited in the means by which they can contact investors to raise money. However, certain provisions of the JOBS Act, together with rules recently proposed by the Federal agency charged with overseeing capital formation, make that process easier. Business owners need to be aware of these provisions to take advantage of what might be a historic window of opportunity for job creation.

Background

When a company seeks to raise money to start or expand its business, there are two broad categories of financing available - debt or equity. Debt financing typically takes the form of a bank loan, while equity financing involves the sale of a portion of the company to investors. Equity investments generally come from friends, family and more rarely from professional investors such as angels, venture capitalists, investment banks and private equity firms. When raising equity and some forms of debt, companies must be mindful of securities laws, which regulate such activities.

At the core of the securities laws is the prohibition against the offer and sale of securities unless the transaction is registered or unless the offering qualifies for an exemption. Registration is an expensive and time-consuming process generally reserved for larger companies, but which give rise to the company's stock trading on a stock exchange. Exemptions, on the other hand, allow a company to raise money without such time and expense. A private offering is an exemption that allows a company to raise money without many of the expensive elements of a public offering such as filing a registration statement with the Securities and Exchange Commission (SEC) and navigating many additional rules applicable to being a public company and making a public offering.

When conducting a private offering, companies frequently rely upon the rules under Regulation D adopted by the SEC, including Rule 506. Rule 506 is attractive to companies because they do not have to register with the SEC, it pre-empts state securities laws, and there is no ceiling on the amount that can be raised. Billions of dollars are raised every year by U.S. companies using Rule 506.

Prior to the JOBS Act, Rule 506 prohibited...