With the U.S economy falling into recession as a result of the credit crisis and a slower than expected economic recovery the U.S government introduced the JOBS (Jumpstart Our Business Startups) Act bill in 2011. Today, President Obama signed the historic bipartisan initiative into law. This Act forms part of the overall government strategy of kick starting the economy and increasing employment. A key part of this Act is relaxing the regulations that govern fund raising for small business start ups and effectively legalizes crowd funding.
The newly approved legislation exempts new and recently formed businesses and companies from Securities and Exchange Commission (SEC) regulations that require reporting and proof of financial worthiness, when raising startup capital. These new regulations reduce the costs and red tape associated with raising capital, giving small businesses greater access to capital than they have had before.
Under the previous regulatory system if a business wanted to offer an equity interest to the public it was required to register an Initial Public Offering (IPO) with the SEC. This was a complicated and costly process, which was generally only cost effective if the company was raising in excess of $50 million or more. There were some exceptions to this but each of these exceptions has specific restrictions as to the types of investors who could apply to invest. Typically, under these exemptions investors had to be high net-worth or professional investors and meet a series of tests that proved they fell within one of those categories.
The intent of the new legislation is clearly to encourage economic and employment growth by making it easier for small business to obtain access to seed capital and startup funding. The key mechanism for this funding that this legislation supports is ‘crowd funding.’ This is a very different funding model from other funding models as it allows an entrepreneur to attract a ‘crowd’ of people to provide startup funding for a business with each person taking a small stake in a business idea and a funding target.
This new regulatory system allows businesses and entrepreneurs to follow a relatively simple procedure to offer investment opportunities to the public over the internet. In fact this new legislation will support the growth of fund raising intermediaries, further enhancing the ability of entrepreneurs and small businesses to raise the seed funding which new business ideas need. This is without requiring them to go through the lengthy, burdensome and costly process of an SEC registration, as well as having to meet certain broker dealer restrictions.
For startups raising $1 million or less, investors can take up to $10,000 or 10 percent of the businesses annual income, whichever is less, in equity. Startups can raise up to as much as $2 million through crowd funding, if the company or business provides audited financial statements to their investors. The JOBS Act also makes it easier for small companies to go public because it has raised the threshold for exempting companies from SEC regulation to $50 million. Overall this is a solid win for companies as they can now stay private with twice as many investors and go public with a much smaller revenue stream. This should lead to a massive growth in small and medium cap IPOs.
There are however a number of concerns surrounding the new legislation, which essentially hinges on fears that less government oversight will lead to more investment scams. Especially as some see the new legislation as a back flip on the regulatory protection that were enacted as a result of the dot.com and Wall Street excesses, both of which led to investment scams and investment bubbles that eventually burst costing investors millions of dollars.
While there are a number of risks associated with facilitating ease of capital funding predominantly from poorly thought out and non-profitable business ideas, it is overall a huge plus for small businesses, the crowd funding industry and the U.S economy. This new legislation will make start up funding easier to obtain and create a new and dynamic funding industry creating an explosion in small business growth leading to increased economic growth and employment.