The JOBS Act and Crowdfunding – Letting Go

by Gray Reed & McGraw

President Obama is scheduled to sign the JOBS (Jump Start Online Business Startups) Act today that includes provisions to relax the rules on raising capital for equity to allow for crowdfunding.   See, sometimes the Government can work together to get things done. 

But, like with everything else, the devil is in the details — details that will be hammered out over the next few months and hopefully with the eye of letting us make some mistakes along the way.  You can read the CNN story on the law here.

Crowdfunding for start-ups

In short, the new law will make it easier to allow crowdfunding for actual investors.  Before now, a site like KickStarter, could raise money online from a large group of people, but not in exchange for stocks.  Currently, the law makes it difficult to solicit funds from a large amount of investors who are not considered “accredited” investors.  To be an accredited investor you have to have more than $1 million in assets excluding your residence or $250,000 in income for the last two years for an individual; i.e., rich.

With passage of the JOBS Act, companies can now raise up to $1 million through crowdfunding.  Investors with a net worth of less than $100,000 may now invest 5% of their yearly income or $2,000, whichever is higher.  People with more money will be allowed to invest more, up to 10% of their income. The ball is now in the SEC’s court to lay out some more detailed regulations. 

Does it help more established companies?

Currently, if a company has 500 or more investors or is raising $5 million, the company has to file a lot of paperwork with the SEC.  Securities lawyers like that — companies don’t.  Under the new law, a company with $1o million in assets would not have to register with the SEC until they obtain 2,000 investors (500 of whom can be non-accredited).   The SEC will also allow a five-year phase in plan for companies with less than $1 billion in annual revenues.  

What’s the downside?

The main concern is fraud.  It will be easier for companies with nothing more than in idea to swindle investors.  This is always the balancing act of a mixed economy.  We want to have a free and robust market while protecting the unsuspecting. 

Yes, there will be more fraud.  People were swindled before this law and will be after.  But, I’ve got to believe people who want to invest in startups through crowdfunding will be going in with their eyes open.  My retired parents don’t invest in start-ups, don’t electronically day trade and I don’t suspect they will suddenly go crazy doing it online.  To allow for this process, we, as a society, are going to have to accept a little more risk. 

This is an idea whose time has come.  It is already legal in parts of Europe.  Let’s give it a try and see how it goes.  If the world starts falling apart, then we can pull back.  This will open up a whole new marketplace.  If there’s rampant fraud, investors won’t be there long and the free market will force investors somewhere else.  It will still be illegal to make fraudulent representations and you can still go to jail.  

What’s Next?

The law calls for the SEC to provide more guidance about how this will work.  Will licensed brokers have to be involved?  Will there be licensed and regulated intermediary websites?  What reporting requirements will there have to be?  What information will have to be revealed to seek crowdfunding?  There are a lot of questions left to be answered.  The law is promising, but the good feeling could be doused if the SEC makes it too difficult to invest $2,000 in your buddies’ start-up. 

I recently started to let my kids cross the street on their own in our neighborhood.  It’s good for everyone.  They become more independent and grow.  I get to witness and harness this.  They get to visit friends.  The first time they forget to look for traffic, however, they will lose some of that privilege.  Let’s hope the SEC does the same when they get to the details.  Crowdfunding is growing up.  It’s time to let it cross the street on its own.  

You can read the text of the Act here.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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