The Wisdom of Crowds: The JOBS Act and Equity-Based Crowdfunding

Guest post by Jumpstart Foundry mentor Laureen Kuzur.

The acronym-friendly Jumpstart Our Business Startups Act, the “JOBS Act”, was signed into law by President Obama last week. It sped through the legislative process due in large part to its bipartisan popularity as a jobs growth bill. It provides for sweeping  regulatory reform of various securities laws, the most we have seen since the Enron / Sarbanes-Oxley reforms of a decade ago.

Most media attention on the JOBS Act has been focused on the provisions relating to equity-based “crowdfunding” – raising money over the Internet in small installments from large numbers of ordinary investors in exchange for an economic interest in a company. Until now, investment in private companies in the U.S. generally has been limited to “accredited investors” – those with a net worth of at least $1 million or an annual income of $200,000. Or, companies have attracted money from unaccredited individuals through non-investment forms of crowdfunding, for example by offering gifts, offering advanced sales of products, or soliciting donations. The money being drawn into these non-investment forms of crowdfunding has been growing fast. Kickstarter, which has made its name by promoting creative endeavors, has seen the scale of its fundraisings rise rapidly. Through a campaign on Kickstarter last month, one video game developer remarkably raised more than $3.3 million pledged from 87,000 backers in exchange for t-shirts, DVDs, and access to the games being developed. But with the passage of the JOBS Act, a company will be permitted to raise up to a total of $1 million in small stake investments from large groups of unaccredited investors for more than just a t-shirt – the investor will now be able to own an equity stake in the company.     

No lemonade just yet

In case you were getting excited to go out tomorrow and raise $1 million to fund that summertime lemonade stand, note that the JOBS Act leaves it up to the  Securities and Exchange Commission (SEC) to define a set of rules that will govern the implementation of the law. The SEC has until January 1, 2013 to issue these rules and the new law is not effective until the rules are issued. Mary Schapiro, the Chairman of the SEC, has been quite critical of the JOBS Act so it is likely that the SEC will use its broad powers to put in place some hardline rules in the interest of investor protection. This should be considered a good thing, as investor protection is vital to the long-term prospects of crowdfunding. In many ways, the JOBS Act turns its back on established securities law practice, which has led to restraints on how equity can be raised in private markets. Supporters of equity crowdfunding argue that filtering out the best investments and limiting fraud will be solved by tapping the “wisdom of crowds”. Whether the crowd will be clever enough to make money through wise investing or whether harmful mob mentality will result remains to be seen.  

While we wait for the SEC to issue the implementing rules, an entrepreneur eager to take advantage of the new crowdfunding law should use this time to think carefully about how to go about working with the crowd. For example, consider how many investors you will be able to deal with (hint: raising one million dollars from one million investors is probably not a good idea!) and plan out an investor relations strategy. Also, prepare to communicate the terms of the deal clearly. You’ll want to come up with guidelines for the investment, including, among other things, how much of the company you want/need to sell, what equity interest is being offered for the investment, how the price was reached, and the effects of future rounds of financing (i.e. every time new money comes in an investor’s stake in the company will be diluted). 

National Crowdfunding Association

Also, consider which crowdfunding platform you will want to solicit your investors through. Undoubtedly, many new platforms will be popping up in the coming months to take advantage of the new law. Use this time to examine the unique terms, conditions, branding and identity that each platform will offer. It may take some time for the industry leader to emerge. Trade associations will also be created in the coming months, so resources to help you select the right platform are likely to be plentiful. In fact, a “National Crowdfunding Association” is in the process of being formed and will be holding its first conference in July.    

Overall there is great potential for the crowdfunding industry to revolutionize the way start-ups are launched. An entrepreneur interested in this funding structure will want to monitor the draft and final rules to be issued by the SEC in the coming months. Hopefully we will see the development of a regulatory framework with sensible protections and incentives that will nurture success stories for both entrepreneurs and the crowds that fund them.

Photo from Flickr by: Roger’s Wife

Posted on April 12, 2012

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Categories: Blog
Tags: Crowdfunding, JOBS Act, Kickstarter, Laureen Kuzur, National Crowdfunding Association