Part 13 and the last of a series of posts on the JOBS Act
Title V is the final portion of the JOBS Act of 2012 and raises the threshold on the number of shareholders a company can have before it is subject to annual reporting requirements under the Securities Exchange Act of 1934.
Before the JOBS Act, a private company could remain private until it reached the magic number of 500 shareholders.
Title V, not yet finalized by the SEC, increases the limit to 2,000 shareholders, or 500 shareholders who are unaccredited (not having total assets exceeding $1 million).
In combination with Title II of the JOBS Act, the change means many private companies may be able to raise more money privately and remain private longer than in the past.
While the SEC made several rule securities-issuing changes over the years since 1934, the number of shareholders of record never changed.
Over time, the 500-shareholder limit began to raise concerns. Companies could inadvertently trigger SEC registration by accidentally amassing more than 500 shareholders of record, particularly through the growing use of stock as employee compensation.
That low threshold eventually acted as a disincentive for businesses to use business equity – shares in the company — as a form of worker compensation.
The securities market also shifted from an emphasis on “holders of record” to “beneficial or street name owners,” with multiple shareholders under one account name, making it difficult to know exactly how many shareholders a company might actually have at any given time.
On June 14, 2011, Rep. David Schweikert introduced what would later become Title V of the JOBS Act as part of the “Private Company Flexibility and Growth Act.”
The change in the number of shareholders of record was viewed as necessary because the existing threshold had become an impediment to capital formation for small startup companies that are innovative and could create jobs.
By avoiding registration and the associated costs that go with public status, companies could use the saved funds to create jobs.
Also, the Title V provisions excluded from the definition of “holder of record” those persons who received shares in the company under employee compensation plans.
While the provisions of Title V generally are intended to make it easier for a new company to remain private longer, it has features that keep things from remaining static.
Over time, an accredited investor’s income may drop, changing their status to unaccredited. In addition, accredited investors can – after a brief holding period – sell their shares to unaccredited investors.
Once sales begin, companies will find it difficult to know if their shareholders are accredited or unaccredited.
The rule makes it critical that companies continuously monitor accredited investor status — potentially a tedious, annoying and expensive process.
Issuers could try to control the number of unaccredited investors through contracts, but doing so could impose significant restrictions on transferability, interfere with secondary trading and possibly reduce the value of the shares.
And if a company does not know a shareholder’s status, it will presumably need to assume they are unaccredited and have to register with the SEC when it has more than 500 shareholders of unknown status.
So while Title V holds the promise of keeping a private company private longer so it can raise more money without registering with the SEC, it also will likely require more extensive and difficult record-keeping to hold onto that status.