Everything You Need to Know About the JOBS Act and Crowdfunding

Everything You Need to Know About the JOBS Act and Crowdfunding

The Jumpstart Our Business Startups Act (JOBS Act), signed into law by President Obama on April 5th 2012, aims to open up the door for budding entrepreneurs and startups by increasing their ability to raise capital and reducing various securities regulations.

The JOBS Act represents one of the most radical changes to securities laws since the 1930’s. These changes grew out of an ‘IPO Task Force’ of capital markets experts, assembled by the U.S. Department of the Treasury in March 2011 to address declining IPO activity. For much of the last decade, the IPO market has been underutilized as a means of liquidity and capital fundraising because of the expense and regulatory burden. IPO exits were effectively closed for all but the largest companies. The IPO Task Force recommended specific policy changes to improve smaller businesses’ access to capital markets.

The 2008 recession brought its own set of problems for startups and small businesses. Research findings by The Kauffman Foundation, the world’s largest foundation devoted to entrepreneurship, suggests that since the recession:

• the number of startups has dropped from 500,000-600,000 a year to around 400,000;
• the five year survival rate for new companies has fallen by 5 percentage points; and
• the average number of employees in start-ups has dropped from seven to five people.

At the same time, capital constraints by community banks have led to a growing disconnect between the financing needed by startups and the loans that fit a typical bank commercial lending portfolio. Many accredited investors, who are entrepreneurs themselves, want to invest in smaller ventures if mechanisms were available for doing so in a relatively efficient and reasonably safe manner. The American JOBS Act may finally present this opportunity, bringing successful entrepreneurs together to invest millions.

Provisions under the JOBS Act
Under the small JOBS Act, emerging growth companies can now, amongst other things:
• be exempt from compliance with certain Sarbanes-Oxley Act accounting requirements if their annual revenues remain under $1 billion;
• raise up to $50 million in funding before having to disclose periodic reports to shareholders (previously $5 million);
• raise the cap on private shareholders from 500 to 2,000;
• fast track the IPO process by confidentially filing preliminary registration documents, going public within two years of audited financials instead of three, and receiving analyst coverage immediately after going public.

Equity Model Crowdfunding
One of the most talked about components of the JOBS bill is the legalization of equity model crowdfunding. Unlike other forms of crowdfunding, which involve donations in return for small rewards, equity model crowdfunding involves the sale of securities (stock, bonds, convertible notes). Investors will be able to make small investments of up to $10,000 a year in return for an interest in the profits of the business. Previously, non-accredited investors had little or no access to investing in early stage private companies, but with equity model crowdfunding, a large number of ‘ordinary’ people will now be able to participate. The American Jobs Act also permits the use of registered online ‘funding portfolios,’ like IndieGoGo and Kickstarter, to facilitate the fundraising process. Collectively, these provisions will make funding more accessible for startups, helping to drive the development of new companies.

Reactions to the JOBS Act
Reactions to Obama’s Jobs Act have been mixed. There are those that fear it will dismantle some of the most basic protections for susceptible investors. Inexperienced investors may be drawn to get-rich-quick schemes that only have to provide minimal financial disclosure, leading to more money-losing IPO’s like Groupon. Despite these concerns, many prominent corporate and tech leaders, such as Steve Case (co-founder of AOL), Mitch Kapor (founder of Lotus), Jim Newton (founder of TechShop), Google and the National Venture Capital Association, have actively backed the JOBS legislation.

Steve Case was one of the biggest behind-the-scenes advocates for the small JOBS Act, which he says is crucial to help small businesses that have been stifled by the Sarbanes-Oxley Act of 2002 and other rules that have restrained IPO’s. Rory Eakin, founder of CircleUp, suggests that the JOBS bill will help foster entrepreneurial development, which is the key to drive job creation. Currently less than one percent of U.S. small businesses receive Angel investments. “By opening up restrictions around general solicitation and introducing crowdfunding…these investments [can] create up to six jobs per investment,” he said.

Preparing for the JOBS Act
The SEC now has until 31 December, 2012 to determine the rules that govern how companies can use equity model crowdfunding to raise capital from investors and set out the responsibilities of intermediaries. These rules will include what must be disclosed to prospective investors before they decide to participate. Emerging growth companies are not permitted to use equity model crowdfunding until these rules are defined. In the meantime, they can prepare for these regulatory changes by following 7 Key Steps.