Are you a business owner who’s leveraged new fundraising opportunities created by the JOBS Act? Then you may have more D&O exposures than you realize, and you may not have adequate insurance in place to cover potential shareholder lawsuits. Here’s what Reg A and Reg CF businesses and their advisors need to know.
How the JOBS Act Expanded Funding Options
In 2012, the Jumpstart Our Business Startups (JOBS) Act became law, making it easier for startups to raise capital and for retail investors to invest in startups.
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Regulation Crowdfunding (Reg CF) allows companies to offer and sell up to $5 million of their securities without registering with the SEC.
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Regulation A (Reg A/Reg A+) allows companies to offer up to $20 million or $75 million in a 12-month period, depending on which tier they fall into, and not have to register as long as certain requirements are met.
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General solicitation is also an option now, but with some restrictions. Advertising securities in public spaces like websites, magazines and seminars is known as general solicitation, and it used to be subject to a blanket ban under Rule 506 of Regulation D. General solicitation is now when the issuer takes reasonable steps to verify that the purchasers are accredited investors.
The Unintended Consequence of Funding Options: Investors
In the years since the JOBS Act passed, investors and small business owners have leveraged these opportunities. Companies like StartEngine and DealMaker have emerged to help connect investors and small businesses, and these sites have raised billions of dollars.
However, this type of crowdfunding is not like the crowdfunding seen on sites like Kickstarter and IndieGoGo, where businesses raise funds in the form of pre-order and rewards.
When businesses leverage Reg CF or Reg A to raise capital, they take on investors. These investors are shareholders, and they have a financial stake in the success of a company. Business owners are accountable to them, and lawsuits are possible if expectations are not met.
The D&O Coverage Gap
For public companies, D&O coverage is a crucial coverage. When you’re subject to shareholder lawsuits and SEC actions, you need to have robust executive liability insurance in place.
D&O insurance is also a smart idea for private businesses because they can also face D&O lawsuits. However, the risks are much greater for companies with shareholders, and many small business owners don’t think about getting coverage unless they are planning to take their company public.
Now thanks to the JOBS Act, many privately-owned small businesses have shareholders. They’re still considered private companies, but they operate in a new gray area that blurs the line between public and private – and many of them lack appropriate D&O insurance.
Do you or your clients fall into one of these exposed categories?
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Raised funds with Reg A or Reg CF and have NO D&O protection. These businesses still think of themselves as private companies, and while that’s technically true, they’re taking on many of the risks associated with public companies and could be sued by shareholders.
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Raised funds with Reg A or Reg CF and have PRIVATE D&O protection. Private D&O insurance policies typically contain a 1933 and 1934 Act claims exclusion that bars coverage for claims arising from a public offering. Before the JOBS Act, this exclusion wasn’t normally a problem because private companies didn’t have public offerings. With the new crowdfunding options, this clause could come back to bite some companies. In the event of a shareholder lawsuit, they will likely have no coverage under this public offering exclusion.
Is a Wave of Litigation Just Around the Corner?
D&O risks take time to develop, and shareholder lawsuits often occur months or even years after the alleged negligence. Although the Jobs Act has existed for a while, it took some time for Reg A and Reg CF to catch on. In other words, just because we haven’t seen a lot of litigation yet doesn’t mean a wave of litigation isn’t around the corner.
There could be many lawsuits lurking, and most executives are unprepared. It’s not just small business owners who don’t understand the risks. Many broker dealers, accountants and insurance agents aren’t aware of the problem yet, either.
It’s time to raise awareness and secure solutions. All businesses, including those that use Regs CF and A to raise funds need D&O protection. Those who have private D&O coverage must have the 1933 and 1934 Act claims exclusion removed so coverage functions as intended.
Wondering if your Reg A or Reg CF business has the right coverage?
Don’t wait another day to find out. Contact me for a comprehensive D&O insurance analysis.
