Great News! Raising Capital Has Just Gotten Easier for Many Small Businesses and Startups!
In April 2012, President Obama signed into law the Jumpstart Our Business Startups Act (JOBS Act), a multifaceted piece of legislation intended to make it easier for small companies to gain access to the funding necessary to start and run their businesses.
Title III of the JOBS Act was enacted in order to upgrade the provisions of the Securities Act of 1933 and the Securities and Exchange Act of 1934, which required companies to undergo rigorous and expensive initial public offering procedures prior to publicly offering their stock to investors. Alternatively, when it came to private offerings, only "accredited investors" (i.e.: individuals whose net worth or income exceeded specific statutory minimums and who met a certain level of financial sophistication,) were allowed to invest in a company under the existing rules. This all changed under the new Regulation Crowdfunding* rules of Title III, and now any individual (accredited or not) can invest as into any company or business of their choice.
The significance of this legislation is monumental because it benefits both companies and investors alike. Specifically:
High Net-worth Investors Prefer "Home Runs". Typically venture capital firms and angel investors prefer to put their money into those companies that they believe have potential for very lucrative (i.e.: multi million dollar) IPOs or acquisitions. Companies that do not meet this valuation criteria (e.g.: small startups, local businesses and socially-focused companies) are largely overlooked. Under these new rules, money will be available to startups and small businesses of all type, size and with all kinds of valuation potential.
You Can Invest in Something You Believe In. Individual investors do not always invest for the same reasons as big investors do. Now, if someone believes in a company or loves what it stands for - they can invest in that company and help them do what they set out to do (while hopefully still making some money).
As so, now entrepreneurs who typically have a difficult time raising capital have direct access to investors who previously did not qualify to invest in small companies.
While the ability to crowdfund presents companies with an exciting new financial opportunity, there are several drawbacks to raising capital in such a way. Among other things:
Offering Limit. There is a 12-month, $1 million dollar aggregate offering limit for companies, which seems large, but realistically may not be enough for some companies.
Individual Investment Limit. There is a relatively low cap on the amount an individual can invest in any given 12-month period. This amount is based on each individuals annual income or net worth. Placing a limit on an individuals ability to invest inadvertently places a limit on how much money they can make. Consequently, this can be a deterrent for certain investors and thereby hinders a companies ability to raise the amount of capital they need.
Advertising Restrictions. The Regulation Crowdfunding advertising rules are quite restrictive and heavily limit a companies' ability to advertise the terms of the crowdfunding offering. These restrictions may prevent a company from reaching a wide range of investors, thereby placing a limitation on their investment pool.
Limits on Transfer of Offered Securities. Barring certain exceptions, securities purchased through a crowdfunding transaction cannot be sold or otherwise transferred for a period of one or more years. This high degree of illiquidity, can be a further deterrent for investors who do not wish to have their money tied down for a long period of time.
Accordingly, companies looking to raise funds Regulation Crowdfunding may be subject to substantial compliance costs as well as open themselves up to potential liability associated with disclosure and reporting obligations required under Title III of JOBS Act.
When these costs are weighed against the amount of capital that can realistically be raised, Regulation Crowdfunding may not be a viable option for some companies. However, for many other startups or small businesses, having the ability to raise capital in this manner opens doors and gives them access to money that was previously beyond their reach.
The Regulation Crowdfunding rules of Title III of the JOBS Act became effective on May 16, 2016.
*Regulation Crowdfunding should not be confused with existing crowdfunding platforms such as Kickstarter and GoFundMe. Unlike the existing platforms, where you essentially donate money and receive something in return (e.g.: a gift, recognition, etc.), the new rules of Title III allow an individual to receive a financial stake (i.e.: stocks or bonds) in the company in return for their investment.