Business Startups Act – Implications for Sponsors of Venture
Capital, Private Equity and Hedge Funds
On April 5, 2012, the Jumpstart Our Business
Startups Act (the "JOBS Act") was
enacted into law. This bipartisan legislation is intended to
stimulate economic growth by improving access to the U.S. capital markets
for U.S. and non-U.S. startup and emerging companies.
This Client Alert focuses on those provisions of the JOBS
Act that most directly affect sponsors of "venture capital
funds," "private equity funds" and "hedge
funds."  These funds customarily are organized under
exclusions from the provisions of the Investment Company Act of 1940 (the
"Company Act") provided by Section 3(c)(1) or Section 3(c)(7)
thereof ("Section 3(c)(1)" and "Section 3(c)(7),"
respectively) and are referred to herein, collectively, as "Private
In particular, the JOBS Act: (i) eliminates the prohibition
on "general solicitation" and "general advertising"
in connection with the private placement of Private Fund securities,
provided the securities are purchased solely by "Accredited
Investors;"  and (ii) provides a new safe-harbor exemption
from broker-dealer registration for persons who take certain actions or perform
certain services in connection with such transactions.
For an overview of all of the provisions of the JOBS Act,
please refer to the "JOBS Act Alert."
Placement Offerings of Securities to Accredited Investors.
Section 3(c)(1) excludes from the definition of "investment
company" a fund that, among other things, limits to 100 the number
of beneficial owners of its securities. Section 3(c)(7) excludes
from the definition of an "investment company" a fund, the
outstanding securities of which are owned exclusively by persons who, at
the time of acquisition of such securities, are "Qualified
Purchasers," if certain other conditions are met.  The
exclusion provided by each requires that the fund is not making and does
not propose to make a "public offering of its
securities." In other words, a fund that seeks to rely upon
either of these exclusions must offer and sell its securities in a
transaction that qualifies as a "private placement" under the
Securities Act of 1933 (the "Securities Act").
Customarily, Private Funds issuing interests to investors
rely upon Section 4(2) of the Securities Act  and Regulation D
thereunder ("Regulation D"), which provides a "safe
harbor" exclusion from the registration requirements of the
Securities Act. The broadest exclusion available under Regulation D
is provided by Rule 506 thereof ("Rule 506") which does not
limit the dollar amount of the offering or the number of Accredited
Investors who can participate. However, Rule 506 requires, among
other things, that:
neither the issuer nor any person acting on its behalf shall
offer or sell the securities by any form of general solicitation or
general advertising, including, but not limited to, the following: (1)
Any advertisement, article, notice or other communication published in
any newspaper, magazine, or similar media or broadcast over television or
radio; and (2) Any seminar or meeting whose attendees have been invited
by any general solicitation or general advertising . . . .
Accordingly, since its adoption in 1982, the prohibition on
"general solicitation" or "general advertising" under
Regulation D has severely limited the number of prospective investors to
which a Private Fund, or any person acting on its behalf, can offer
interests in the fund without relying upon the assistance of a properly
authorized placement agent, such as a broker-dealer registered under the
Securities Exchange Act of 1934 ("Exchange Act").
Effectively, Regulation D has regulated both the "offer" and
"sale" of securities to Accredited Investors.
B. The JOBS Act
Eliminates the Prohibition on General Solicitation and General
Advertising in Connection with Certain Private Placements.
Section 201(a)(1) of the JOBS Act mandates that no later than 90 days
after its enactment the Securities and Exchange Commission
("SEC") shall revise Rule 506 to provide that the prohibition
against "general solicitation" or "general
advertising" not apply to offers and sales of securities
"provided that all purchasers
of the securities are accredited investors." (Emphasis added.) Such rules
must "require the issuer to take reasonable steps to verify that
purchasers of the securities are accredited investors, using such methods
as determined by the [SEC]."
Section 201(a) also confirms that offers and sales that are
exempt under revised Rule 506 "shall not be deemed public offerings
under the Federal securities laws as a result of general advertising or
general solicitation." Accordingly, the "no public
offering" condition of Section 3(c)(1) and Section 3(c)(7) should
not be violated as a result of such offers.
C. The JOBS Act
Provides a New Safe-Harbor Exemption from Broker-Dealer Registration for
Certain Persons Engaged in the Offer and Sale of Securities in Compliance
with Rule 506. Section 201(b) of the JOBS Act provides that
with respect to securities offered and sold in compliance with Rule 506,
no person who meets certain conditions shall be subject to registration
as a broker or dealer under the Exchange Act solely because they take
certain actions or perform certain services, most notably, maintaining
"a platform or mechanism that permits the offer, sale, purchase, or
negotiation of or with respect to securities, or permits general
solicitations, general advertisements, or similar or related activities
by issuers of such securities, whether online, in person, or through any
other means." Other "Ancillary Services" that can be
provided include "the provision of due diligence services, in
connection with the offer, sale, purchase, or negotiation of such
security," provided that these services do not constitute advisory
services for which the person is separately compensated. The most
notable condition of this exclusion is that "such person and each
person associated with that person receives no compensation in connection
with the purchase or sale of such security."
Impact of the JOBS Act on Existing Private Placement Practices.
Marketing by Fund Managers. The JOBS Act, when fully
implemented, should enhance the ability of Private Funds to engage in
direct marketing and reduce the cost of fund raising. Private Fund
managers would also be permitted to respond to media inquiries and
provide information that, under existing regulatory standards, might be
deemed to be "conditioning the market" or the commencement of
an offering. Examples of marketing activities that have been problematic,
but may now be permissible, include: public statements or
advertisements concerning a fund offering, including, in particular, the
investment strategy of the fund and its range of targeted returns;
placing advertisements in newspapers or trade publications; posting
information on non-password protected websites, or making presentations
at conferences whose attendees were invited by means of a "general
At the same time, it must be borne in mind that the JOBS Act
does not modify in any way the anti-fraud provisions of the securities
laws, including disclosure obligations that are applicable to issuers and
third-parties engaged in a securities offering and sale, such as full and
fair disclosure of the risks presented in connection with an investment
in a particular fund or its trading strategies, etc.
Moreover, at this time there is no reason to believe that
other conditions of Regulation D will be modified, such as the
requirement that all sales that are deemed to be part of the same
Regulation D offering must meet all of its requirements, i.e., sales that are deemed to be
"integrated" for purposes of determining whether the conditions
of Regulation D have been satisfied. For example, if shortly after
having completed an offering of interests in a Private Fund in compliance
with the requirements of revised Rule 506 that: (i) involved the
use of "general solicitation" or "general
advertising"; and (ii) did not include any non-Accredited Investors
as purchasers, a Private Fund conducts another offering of
interests of the same class to fund the same investment program under
revised Rule 506 that: (i) does not involve the use of
"general solicitation" or "general advertising"; but
(ii) includes non-Accredited Investors as purchasers, the two offerings
might be "integrated" under the standards set forth in
Regulation D with the risk that the second offering would not satisfy its
of Non-Registered Sales Personnel. It has been a concern of
investment managers of Private Funds that are engaged in an ongoing
offering of interests in their funds that an employee who devotes
substantially all of his/her time to client relations and marketing might
be deemed to be acting as a broker-dealer and subject to the registration
requirements of the Exchange Act. It has also been a concern of
these investment managers that third-party referral agents or service
providers might be subject to these requirements. The safe-harbor
of Section 201(c) of the JOBS Act may substantially reduce those
concerns, although the scope of the relief granted will be highly
dependent on how the permitted activities and the prohibition on
compensation "in connection with the purchase and sale of [a]
security" are interpreted in any implementing rules adopted by the
For example, would the activity of acting in the traditional
role of a referral agent come within the safe harbor of
"maintain[ing] a platform or mechanism that permits the offer, sale,
purchase, sale or negotiation of or with respect to securities . .
." ? Might the prohibition on compensation to persons "in
connection with the purchase or sale of such security" be
interpreted to preclude only "transaction based compensation,"
generally regarded by the SEC and the Financial Industry Regulatory
Authority ("FINRA") as a "red flag" connoting
broker-dealer status, or would the prohibition extend to any compensation
that clearly is not
attributable to marketing activities or investment advice?
of Access to, and Content of, Websites of Investment Managers to Private
Funds. Under the regulatory guidance provided by the Staff of
the SEC, investment managers of Private Funds have developed procedures
under which investors have been able to access Private Fund offering
materials. These procedures, generally, entail a two-stage process
under which a prospective investor first will provide sufficient
information that allows the investment manager to make a reasonable
determination that the prospective investor is an Accredited Investor and
then the prospective investor must wait at least 30 days before being
granted full access to the website in order that a "pre-existing
relationship" be established with the issuer, so as to satisfy the
offering requirements of Regulation D.
As noted above, implementation of Section 201(a) of the JOBS
Act is subject to the adoption by the SEC of rules that "require the
issuer to take reasonable steps to verify that purchasers of the
securities are accredited investors, using such methods as determined by
the [SEC]." Hopefully, these rules will be modeled upon
existing Staff guidance.
4 . Better
Alignment of U.S. and U.K. Marketing Standards. Prior to the
enactment of the JOBS Act, the U.S. private placement regulatory regime
was significantly more restrictive than its counterpart in the U.K.
The JOBS Act should broadly bring the U.S. and U.K. regulatory regimes
into closer alignment and facilitate cross-border offerings of interests
in Private Funds.
In the U.K., under Section 21 of the Financial Services and
Markets Act 2000 (the "FSMA"), an unauthorized person is
prohibited from communicating a financial promotion unless the content of
the promotion is approved by an authorized person or is exempt. The
exemptions are set out in the FSMA (Financial Promotion Order) 2005 (the
"FPO"). These include promotions made publicly to
"Investment Professionals,"  "Certified High Net Worth
Individuals"  and "Sophisticated Investors." 
Recent guidance of the Financial Services Authority has confirmed
that promotions made publicly can be targeted at Investment
Professionals, provided that they must be effectively targeted through
the publication or medium used, be fair, clear and not misleading and
clearly state the target audience. For example, to take advantage
of the investment professionals exemption, the promotion should be
accompanied by an indication that it is directed at persons having
professional experience in matters relating to investments, that persons
who do not have professional experience in matters relating to
investments should not rely on it, and that there are proper systems and
procedures in place to prevent recipients other than Investment
Professionals from engaging in the investment activity.
Relevant Provisions of the JOBS Act.
Communications with Accredited Investors and "Qualified
Institutional Buyers." As more fully discussed in the JOBS
Act Alert, a possible benefit to a sponsor of a Private Fund, particularly
a venture capital fund, is that an "Emerging Growth Company,"
 or its authorized representatives, can communicate orally or in
writing with institutions that are Accredited Investors and
"Qualified Institutional Buyers"  to determine whether
these investors would have an interest in a proposed securities
offering. Such communications could take place before or after the
filing of a registration statement under the Securities Act.
– Unavailability to Private Funds. As discussed in detail in
the JOBS Act Alert, the JOBS Act provides a new exemption from the
registration requirements of the Securities Act for capital raising by
issuers using on-line internet services in compliance with certain
requirements (the "Crowdfunding Exemption"). The
Crowdfunding Exemption is not available to an issuer that is:
"an investment company, as defined in section 3 of the Investment
Company Act of 1940, or is excluded from the definition of investment
company by section 3(b) or section 3(c) of that Act." 
Accordingly, a Private Fund would not be eligible to raise capital
through the Crowdfunding Exemption.
C. Increase in
Limit on the Number of Holders of Record an Issuer May Have Before Being
Required to Register Securities Under the Exchange Act. Section
501 of the JOBS Act amends Section 12(g) of the Exchange Act to change
the limit on the number of holders of record of a class of equity
securities an issuer may have before it is required to register such
securities under the Exchange Act from 500 to either: (i) 2,000
persons; or (ii) 500 persons who are not Accredited Investors, excluding
persons: (i) who received securities pursuant to employee
compensation plans in transactions exempted from the registration
requirements of the Securities Act; and (ii) investors who acquired
securities in an offering under the Crowdfunding Exemption. This
change will allow managers of large Private Funds to expand their
investor base and more efficiently raise funds for particular investment
programs without being subject to the reporting burdens of the Exchange
Observation. The JOBS Act provisions discussed above
raise a number of interpretative issues and the lifting of the
prohibition on "general solicitation" and "general
advertising" for offers and sales of securities under Rule 506
(provided that the securities are purchased solely by Accredited
Investors) is subject to the adoption of rules by the SEC.
Against this background, it should be anticipated that other regulatory
bodies, such as FINRA and the North American Securities Administrators
Association (which has expressed concerns about the legislation), will be
carefully considering the potential impact of the JOBS Act and SEC
rulemakings. Therefore, the impact of the legislation on the
private funds industry will not be fully known until the rulemaking
process has run its course. Orrick will be closely monitoring these
developments and will provide timely updates as warranted.
Please do not hesitate to contact the authors of this Alert,
any of the members of the Private Investment Funds Group, or other Orrick
attorneys with whom you work to discuss any questions that arise.
* Only admitted in New Jersey
 Each of these terms is defined in the Glossary of Terms
contained in Form PF adopted under the Investment Advisers Act of 1940.
The definition of "Accredited Investor" is set
forth in Rule 501(a) promulgated under the Securities Act.
 Section 3(c)(1) and Section 3(c)(7) of the Company Act
provide in relevant part:
(c) Notwithstanding subsection (a), none of the
following persons is an investment company within the meaning of this
title: (1) Any issuer whose outstanding securities (other than
short- term paper) are beneficially owned by not more than one hundred
persons and which is not making and does not presently propose to make a
public offering of its
(7)(A) Any issuer, the outstanding securities of which are
owned exclusively by persons who, at the time of acquisition of such
securities, are qualified purchasers, and which is not making and does
not at that time propose to make a public offering of such securities
The definition of "Qualified Purchaser" is set
forth in Section 2(a)(51) of the Company Act.
 Section 4(2) of the Securities Act provides:
4. The provisions of [the registration requirements of
the Securities Act]shall not apply to—
(2) transactions by an issuer not involving any public
 The definition of "Investment Professionals"
is set forth in Article 19(5) of the FPO.
 The definition of "Certified High Net Worth
Individuals" is set forth in Article 48(2) of the FPO.
 The definition of "Sophisticated Investors" is
set forth in Article 50(1) and the definition of "Self-Certifying
Sophisticated Investors" is found in Article 50A(1) of the FPO.
 The term "Emerging Growth Company" is defined
in Section 101 of the JOBS Act to mean, generally, a company that had
total annual gross revenues of less than $1 billion during its most
recently completed fiscal year.
 The definition of "Qualified Institutional
Buyer" is set forth in Rule 144A promulgated under the Securities
 Generally, in order for an issuer to rely upon the
Crowdfunding Exemption it must either not be an "investment
company" as defined in the Company Act or it must satisfy the
requirements of one of the exceptions from investment company status
under the Company Act available under Rule 3a-1 ("certain prima
facie investment companies"), Rule 3a-2 ("transient
investment companies"), Rule 3a-3 ("certain investment
companies owned by companies which are not investment
companies"), Rule 3a-5 ("finance subsidiaries"),
Rule 3a-6 ("foreign banks and foreign insurance companies"),
Rule 3a-7 ("issuers of asset backed securities"), or Rule 3a-8
("certain research and development companies").