If you’re thinking about raising additional capital for your business, or perhaps investing in an early stage company, heads-up. The rules are about to change, thanks to the Jumpstart Our Business Startups Act (JOBS Act).
Leaders from both parties hope the legislation will help small businesses and startups raise capital by loosening certain regulations that had slowed or restricted funding processes.
President Obama signed the legislation in early April, after it had easily cleared both the House and Senate.
Background
The JOBS Act is the creation of the President’s Council on Jobs and Competitiveness, and was originally part of a more comprehensive plan to stimulate growth.
The jobs council had recommended lowering the corporate tax burden (the federal corporate tax rate is now the world’s highest) and easing various regulations across the board. These were ambitious proposals that had only marginal chances of passing during an election year.
But one of the council’s recommendations had broad political appeal – the easing of regulations for private companies planning to sell shares of stock to the public via an initial public offering (IPO). By making it easier to secure funding, the reasoning goes, growing companies could expand operations more quickly and hire additional workers.
According to information provided by Pennsylvania Senator Pat Toomey, it used to take businesses four and a half years to grow large enough to go public. Currently, even companies that would make for attractive public offerings wait nearly nine years, on average. This is due in part to the expensive regulations created by the 2002 Sarbanes-Oxley law.
What Changes
Key components of the JOBS Act include:
- The removal of certain restrictions which prevent small businesses and investment funds from broad-based, general advertising to attract new investors.
- Increasing the offering threshold for companies exempted from Securities and Exchange Commission (SEC) “Regulation A” registration from $5 million to $50 million.
- Exempting companies from independent accounting requirements for up to five years after they first begin selling shares in the stock market, thereby dramatically reducing administrative costs.
- Allowing startups and small businesses to raise up to $1 million annually through “crowd sourcing” techniques. Companies can pursue equity investors through the Internet with minimal restrictions.
Business Groups Divided
Interestingly, not all small business groups are in support of the changes being brought by the JOBS Act.
The National Federation of Independent Businesses, the largest and normally most vocal small business advocacy group, is not taking a position.
The National Small Business Association supports the Act, pointing out that according to its data there exists, for the past 20 years, a direct correlation between job growth and small business owners’ ability to secure financing. In essence, when small businesses have adequate financing, they create jobs.
But The Main Street Alliance continues to oppose portions of the Act, writing in a letter to the U.S. Senate, “Rolling back basic transparency rules, like SEC registration, won’t help small businesses. Instead, it will tilt the playing field toward unscrupulous actors who are looking to game the system.”
A Crowd Sourcing Primer
Crowd sourcing involves asking an online “crowd” of people to put money into a project or company. For example, if you want to raise $50,000 to produce a new product prototype, you would find a crowd sourcing platform on the Internet, set the goal amount, and a funding deadline, which is typically 60 days. According to Crowd Source Daily, individuals plunked down $123 million to Crowd Source sites last year, a nearly 300% increase over 2010.
Until now, crowd sourcing was used mostly by not-for-profits. But the JOBS Act permits startups to pool capital through crowd sourcing by selling as much as $1 million in securities a year. Investors could potentially by selling the shares after a required year-long holding period, or if the company eventually goes public.
Many of the details regarding how crowd sourcing will work are unclear because the SEC has nine months to establish specific regulations. But in terms of consumer protection, the Act limits how much a person can contribute through crowd sourcing.
Investors with annual income or net worth of less than $100,000 will be allowed to invest the greater of $2,000 or 5% of their income or net worth a year. Individuals with more than $100,000 can invest as much as 10% of their income or net worth, up to $100,000.
More details regarding crowd sourcing – for both companies considering stock issues and their potential investors – is expected in the coming weeks.
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