On Thursday, President Obama is expected to sign the Jumpstart Our Business Startups (JOBS) Act, which is designed to make crowdfunding a legal option. Both the U.S. Senate and the House of Representatives resoundingly approved the JOBS Act, which had broad bipartisan support. As the name implies, the JOBS Act is intended to create jobs by facilitating the initiation and growth of entrepreneurial companies.
One of the notable provisions of the JOBS Act is that it allows non-accredited investors to make limited investments in startups raising $1 million or less through approved portals. Under current law, an issuer can raise funds from an unlimited number of accredited investors, but is limited to 35 non-accredited investors. Examples of accredited investors include banks, insurance companies, and individuals with a net worth of $1 million or more.
Another significant change for growth companies is the elimination of the rule that requires issuers with more than 500 shareholders to register as a public company with the Securities Exchange Commission (SEC). Finally, the JOBS Act permits advertising and general solicitation of investments.
Early-stage technology companies are most likely to benefit from the new legislation. Currently start-ups typically rely on investments from friends and family, or perhaps angel investors. The new rules will certainly loosen restrictions by, among other things, permitting the start-up to obtain investments from non-accredited investors and advertise the investment opportunity.
Many early-stage companies, particularly software companies, don’t need that much capital, at least to get started. Institutional investors, and even angels, may not be interested if the business is too early or the opportunity is too small. It will be somewhat easier to raise a small amount like $50,000 to $100,000 by virtue of the crowdfunding now facilitated by the JOBS Act. The issuer can advertise, and can accept small investments from a large number of non-accredited investors.
Many detractors have expressed concern that crowdfunding will lead to fraud and abuse, creating a “boiler room” environment. The final legislation does include some investor protections. Any company using crowdfunding methods must file basic information with the SEC concerning directors, officers and large shareholders, a description of its business and financial condition and, depending on the size of the offering, reviewed or audited financial information. Certain intermediaries involved in crowdfunding must register with the SEC, make sure investors are advised of the risks, and take measures to prevent fraud. Anti-fraud provisions of securities laws will remain in place as well, and the SEC will provide regulations under the Act prior to its effective date. At the end of the day, an increase in fraud may be the price that society has to pay for greater liquidity and job creation.
After a successful capital-raise through crowdfunding, the issuer may face unexpected negative consequences. For example, a company with a large number of investors will bear additional administrative costs, and venture capitalists and other institutional investors may be reluctant to invest in an early-stage company with such a large shareholder base.
It will be interesting to see how this works out. I expect that some of my smaller law clients will seek advice as to the new crowdfunding provisions and whether this type of offering is right for them. It is also possible that one of my companies may explore the use of crowdfunding for its own fundraising. At the TAG Summit there was a lot of excitement about the JOBS Act and talk of companies vying to be the first to launch an offering in Georgia. In any event, this legislation represents a welcome change from the previous trend towards increasing regulation that has had the effect of limiting access to capital markets and decreasing liquidity.