On April 5, 2012, President Obama signed into law the Jumpstart Our Business Start-ups, or JOBS Act, which expands access to capital to small businesses and start-ups previously hindered by financial regulations. According to the Act, its purpose is to “increase American job creation and economic growth by improving access to the public capital markets for emerging growth companies.” An “emerging growth company” is defined as one with revenues of less than $1 billion during its most recent fiscal year. The law makes it easier for small businesses and start-ups to raise money, with a secondary benefit of bolstering job creation
Of particular interest to entrepreneurs—and for those whose companies rake in annual revenue of significantly lesser amounts than $1 billion—is the JOBS Act provision on crowdfunding. Title III of the JOBS Act, the provision is called the “Capital Raising Online While Deterring Fraud and Unethical Non-Disclosure Act of 2012 or the `CROWDFUND’ Act.” Entrepreneurs may raise up to $1 million per year from individual investors, while also facing a reduction in the required amount of financial disclosure.
Prior to the JOBS Act, financial regulations prevented small businesses from attracting average (i.e. small) investors, due to the burden of the disclosure requirements. In order for the public to invest in a small business, the business had to prepare a private placement memorandum or public offering, each requiring substantial manpower and legal fees. Now through crowdfunding, instead of relying solely on banks, venture capitalists and angel investors, companies may attract these average investors to provide grass-roots infusions of capital.
Consumer protections in the Act limit the amount of any individual investment to $2000 or 5% of the annual income or net worth of the investor, if such amount is less than $100,000. For individuals with income or net worth equal to or exceeding $100,000, the investment limit is 10% or $100,000. Transactions must be completed through a broker or “funding portal,” such as an impartial web site, and issuers must comply with the Act’s requirements. The aggregate amount of crowdfund investments is restricted to $1 million per year.
Brokers and funding portals must advise investors on the risk involved in start-up investments, and that they could lose their entire investment. Issuers—the start-up companies, entrepreneurs and small businesses—must still adhere to a list of disclosure and filing requirements, but the Act eases this burden significantly. Audited financial statements are not required, and while liability for material misstatements and omissions may be imposed on issuers, only an aggrieved investor may bring such an action.
Critics Find Drawbacks
Proponents of the JOBS Act call the crowdfunding provision a “no-brainer win” for both businesses and investors, and a “remarkable reversal” of a century of policies restricting grass-roots support for business. But the Act is not without its detractors. While some say crowdfunding will move money from Wall Street to Main Street, others say it creates new opportunities to commit securities fraud, calling the law a “field day for scammers.” With reduced disclosure requirements, clever fraudsters may find ways to bilk investors. Even without fraud, investors are at risk to lose their entire investments. And investors could be in the dark about the quality of their investments, since the funding portals are forbidden from making recommendations or giving rankings or scores.
Also in the Act, start-up CEOs are exposed to personal liability for material misstatements and omissions in their disclosure documents. With the risk of losing everything, the quality of crowdfunding projects could be lower than is being touted by the Act’s proponents. Finally, the crowdfunding rules might allow weaker companies to go public, resulting in what one critic calls “more crappy IPOs.”
What to Do Now
The Securities and Exchange Commission (SEC) has 270 days from April 5 to issue rules for investor protections in accordance with the JOBS Act. Until the rules are finalized, the precise effects and requirements of the Act will remain somewhat uncertain, but in the meantime, small businesses can prepare to use crowdfunding by taking the following steps:
•Prepare disclosure documents. Companies will need to share their business plan, incorporation documents, financial forecasts and full executive team bios.
•Research your market. Issuers—you—should understand the market in order to make a strong argument as to why people should fund your project.
•Network. The concept of crowdfunding involves work from the issuer seeking funds, and a substantial amount of the initial effort begins with reaching out to your established network. Organize your contact list to share with others, and request that key people share their contact list with you, making sure their audience fits your audience as well.
•Make a video. In the world of the Internet, videos are an important selling tool, and will help attract investors. In the video, sell your company or project. Use three minutes or less to explain your entire project and entice people to support you.
•Hone your pitch. Create excitement about your project. Remember this is a sales pitch, and you want to find the best possible way to tell your story.
For further information or assistance on this or any intellectual property or business law matter please contact: Natoli-Lapin, LLC