The JOBS Act offers a new opportunity for businesses looking for funding; rather than needing to apply for a loan or look for credentialed investors, businesses can look to the crowd for financing. The model was pioneered by such sites as Kickstarter, which allows artists and other individuals to post projects and ask interested parties to donate money, often in small amounts, to cover a set amount of costs. But where Kickstarter has helped fund very specific, usually short-term creative projects, the JOBS Act opens up opportunities for sustainable business ventures.
SEE: Valuing Startup Ventures
Cutting the Red Tape
In a way, this legislation will make it possible for startups to receive money from public investors from the day the business starts. As long as a company is raising less than $1 million per year, much of the red tape of either qualifying for an exemption and selling only to accredited investors, or completing mountains of paperwork, will be erased.
However, there are some requirements, including a public announcement, registration with the SEC, background checks on issuers and other paperwork. There are also constraints on investors, including a limit on how much money a single investor can invest in a given year through crowdfunding, and investing must take place through a broker or portal that can educate the investor on potential risks.
Crowdfunding offers a new potential point of entry for investors, especially those who may not have enough funds to take large positions later on in a startup's growth. But even though a startup may seek well below the million dollar cap, these investments will likely come with a higher level of risk. There may also be scenarios in which crowdfunded companies don't offer quite the return of other investments.
Tim Schafer is the founder of Double Fine Productions, a game maker who raised $3.3 million for a new game and a documentary through Kickstarter. Schafer told the San Francisco Chronicle that he doesn't see a need to sell shares to raise equity. "We raised three times that giving away lunches and T-shirts ... People taking chunks of our equity is something we are trying to get away from."
The new legislation does mean that there is an opportunity to fund smaller businesses, targeting niches that might otherwise be financially difficult to work in. An example is consumer products; for a business wanting to produce and sell consumer products needing less than $10 million, there just aren't a lot of sources of startup capital. Private equity firms typically invest in larger companies, but consumer products easily appeal to individuals likely to participate in crowdfunding projects. It's easier for someone to understand the benefits of creating a better mousetrap than a better financial instrument. That may be the secret to Kickstarter's success: funders are interested in projects that offer products and incentives that they personally want.
There are concerns that crowdfunding will open up opportunities for fraud, that the less experienced investors likely to be interested in crowdfunding projects may be opening themselves up to more risk than they can really afford. There are also dangers for the companies seeking funding - they may be less savvy business owners without the experience to manage the process correctly, making it harder to get future funding.
The Bottom Line
The concept is still new and evolving; as companies begin to consider crowdfunding and the SEC creates rules to cover the process, these concerns are likely to be addressed. Crowdfunding may very well offer different opportunities for investors and bring new and innovative products to the market that otherwise might not have been possible with the old rules.