When the Jumpstart Our Business Startups Act (JOBS Act) was signed into law on April 5, it gave Congress’ okay to an interesting way of funding start-ups. Collecting small investments from members of the public who love the idea of your new business venture (“crowdfunding”) is energizing entrepreneurs, especially in the tech sector.
The concept of crowdfunding has been around for a while, but it’s been mostly used by film-school grads trying to cobble together enough money to make their indies. For someone starting a business and looking for an alternative to taking out a loan or running up debt on a credit card, there were rules covering “general solicitation” written into 2002’s Sarbanes-Oxley Act (SOX), supposedly to protect investors in the wake of accounting scandals, like Enron. The effect was that funding for startups shriveled up after it became law. Big ideas withered and the companies never got going because entrepreneurs couldn’t advertise that they were fundraising.
Starting a company when the Crowdfunding section of the JOBS Act1 becomes effective will be much more democratic: an entrepreneur can solicit investments from hundreds of individuals. These investors can be given equity in the new company.
A lot of people are excited about this idea. But there have been criticisms, and not just those registered by AARP and others who fear individual investors will be bilked out of their savings. In an article for Bloomberg Businessweek’s section on small business, Catherine Mott, chair of the Angel Capital Association, is quoted: “Companies that want to raise big chunks of money later on will run into trouble if they already have lots of investors who own tiny pieces of equity.”2
The article, by John Tozzi, goes on to state: “[Mott] supports the idea for businesses that don’t plan to raise further money, such as a retail store trying to expand or even a social media startup that needs a relatively small amount to launch a product.” High-growth companies (like start-ups in the clean energy, life sciences, or manufacturing areas) that will need to go back to the venture capital market or to angel investors for sizable increments of additional funding will run the risk of “spooking” the serious money, if they already have scores of small investors, she argues.
The same article quotes Chicago angel investor Bob Okabe, “Do the VCs really want to mess with 75 crowdfunding investors? They have enough heartburn when there’s 10 angels on the table.”
Another angel investor, Bill Payne, wrote in his own blog that one of the biggest advantages entrepreneurs receive from angel investors is the “mentoring and coaching,” which is actually “considered by many entrepreneurs as even more valuable than their financial contribution.”3
The bill was signed on April 5, 2012, and the SEC has nine months to work out the rules that will apply. Any companies itching to start seeking new “kickstarter” funding before the rules come out should be aware that the SEC will not be friendly about violations. Its website contains a notice saying, “The Act requires the Commission to adopt rules to implement a new exemption that will allow crowdfunding. Until then, we are reminding issuers that any offers or sales of securities purporting to rely on the crowdfunding exemption would be unlawful under the federal securities laws.”
For more information, visit:
1. Jumpstart Our Business Startups Act
2. BloombergBusinessweek – Alone in a Crowd: How Crowdfunding Could Strand Startups
3. Bill Payne.com – Crowd Funding: A Critique for Entrepreneurs and Investors