Skip to content

Crowdfunding: bringing Wall Street to Main Street?

Are we about to start a new era of American capitalism? With the Jumpstart Our Business Startup (JOBS) Act just days away from being passed into law, start-ups will soon have new avenues to raise money. Currently, only accredited investors can buy equity in private companies. If the JOBS Act passes, private companies will be able to present securities offerings to the masses through the Internet. This is known as equity-based crowdfunding.

Crowdfunding itself isn’t new. Donation-based crowdfunding (such as kickstarter.com) and debt-based crowdfunding (such as LendingClub.com) are both legal forms of this. In the former, “investors” receive either a gift in return or no return at all. In the latter, investors are actually creditors, lending companies up to $50,000 a year.

Under the JOBS Act, equity-based crowdfunding will allow anyone to purchase equity in a company and receive a portion of its profits. It’s like selling shares on a public stock market without actually going public in the traditional sense.

Start-ups will be able to raise up to $1 million a year online from a large number of small investors in exchange for equity. Start-ups will also be able to raise up to $2 million a year if they provide audited financial statements. When the JOBS Act is passed into law, private companies will be able to take on as many as 2,000 investors before triggering securities regulations. Right now, private companies are limited to 500 investors before the SEC requires action.

What are the pitfalls?

There’s a lot of debate and concern about crowdfunding and the potential for fraud. When mom-and-pop investors buy shares in a public company, they do so with the assurance that that company’s books are open and have been audited. This isn’t always the case with crowdfunding, so it’s even more important for investors to do their due diligence. To limit exposure to fraud, the act stipulates that an investor with an income or net worth below $100,000 is limited to investing 5% of their annual income up to a maximum of $2,000. For wealthier investors, it’s 10% of their income or net worth, up to a maximum of $100,000.

Where to from here?

The core purpose of crowdfunding and the JOBS Act is to increase American job creation and economic growth by improving access to the public capital markets for emerging growth companies. In theory this makes a lot of sense and I am always a proponent of helping entrepreneurs. However, I’ve personally heard from a few start-ups in the Bay area that they wouldn’t be interested. One of their main concerns is related to follow-on funding. Imagine you have been successful at raising $100K from 200 separate investors. This has the potential to scare off angel investors or venture capital investors down the road. I also hear that the biggest hurdle to new start-ups is not always the money. Rather, it’s the network of professionals and advisors they need to be successful.

While jury is out on equity-based crowdfunding, it’ll be interesting to see if this really is the dawn of a new era of American capitalism.

Let us know what you think.

 

Read more about Business

 

2 comments

Nick Bird
5 April 2012 #

Great article Jamie. I think you have outlined some legitimate concerns on the effectiveness of the JOBS Act that are worth discussion. Though I’m not into the politics of this act, perhaps one of the goals of the ACT was to target companies that wouldn’t seek for significant funding down the road from Angel investors or other venture capitalist firms. I think there exists a market of small businesses that will have different business goals then expanding into a large market. There are niche markets all over the economy that could be filled really well by small business.

There are several industries where the barriers to entry are higher than others, and perhaps the Act could aid in creating an easier path for entry into those markets. After all, most Americans work for small to medium sized businesses so I think there is a market out there for it.

One thing that I feel certain will be needed, as you mentioned at the end, will be the need to have good professionals and advisers for both small businesses looking for funding and investors. Hopefully those seeking funding and those investing will be wise enough to take the plunge into equity markets with some proper advice. This could create a market at the small business level where all of us Xero advisers could provide some expertise.

Sunil Pande
5 April 2012 #

Thanks for flagging the crowdfunding aspect of the Jobs Act. I for one think it is a great move and there will be many startups that go this route if the mechanics can be figured out to prevent fraud etc. This method of funding keeps control in the hands of the entrepreneurs and employees of the company and that is good because those are the people we are investing in, in the first place. Concerns related to follow-on funding etc. are overblown. Nothing succeeds like success and if a company can get good traction through bootstrapping and crowdfunding, traditional investors will be knocking at their dooors no matter how many small funders they already have or how screwed up their capital structure is etc. Traction makes everything fixable. If top-tier VCs could agree to Google and Facebook terms, they will agree to anything, if they think they can make money. I would suggest entrepreneurs focus on shipping the product and getting traction with as little money and as soon as possible. None of the other stuff matters one bit.

Add your comment





We welcome all feedback but prefer a real name and email address.