The crowdfunding component of The Jumpstart Our Business Startups Act (JOBS) is designed to help startup and emerging growth companies raise capital through new securities exemptions.
“It’s a promising platform for companies that are already doing small-dollar raises of capital,” says Jeff Roberts, a director at Kegler, Brown, Hill & Ritter. “With the high cost of capital from venture and angel funds and the general unavailability of bank funding, small businesses, startups and emerging growth companies are looking for different ways to raise funds, so they are very excited about the possibility of crowdfunding. It’s worth the hype because currently, raising capital is expensive and investors are hard to locate.”
Smart Business spoke with Roberts about how to benefit from crowdfunding.
What is crowdfunding?
Crowdfunding concepts have been in the market for quite some time with companies like Kickstarter providing a platform for businesses to raise money through donations. With the passage of the new JOBS Act, businesses will soon be permitted to issue equity to investors based upon a securities exemption that allows companies to raise up to $1 million annually from non-accredited, small-dollar investors such as friends and family, and those who want to place their money somewhere other than the stock market. Funds will be raised through regulated online crowdfunding intermediaries.
Investors will be limited in the amount of money they can invest. According to the JOBS Act, investors with an annual income or net worth of at least $100,000 can invest up to 10 percent of their annual income or net worth. Those with a net worth of less than $100,000 can invest the greater of $2,000 or up to 5 percent of their income or net worth. The dollar amounts at risk on the front side are small, which helps alleviate the fear of some skeptics who think some investors may spend their life’s savings on a fraudulent venture.
What kinds of companies should consider crowdfunding to raise capital?
Local restaurants (or other small businesses with dedicated customer followings) that need to make certain capital improvements can go out and raise the money for those projects through these online intermediaries. Any startup company that doesn’t generate a lot of income up front could also take advantage of the crowdfunding platform, though such companies may have more difficulty in generating a buzz.
The financial disclosure requirement for raising $100,000 or less is not as great as raising between $100,000 and $500,000. In the latter case, you have to provide reviewed financials, and in raising more than $500,000, companies have to provide audited financials. The cost of providing those financials has been a roadblock for some small startups. When their accounting bill can be $10,000 to $20,000 before they raise a dime, it can be prohibitive to their market access. Given the cost profile, companies with less than $100,000 in financial needs may be best served by this new platform.
What are the potential legal risks associated with crowdfunding?
Companies seeking to raise funds though this exemption need to be more concerned about compliance with state laws that govern corporations, limited liability companies and other entities because, given the relaxed federal regulation, greater emphasis will likely be placed on state law fiduciary duties.
If Ohio can come up with some sort of regulatory scheme that makes it efficient to raise capital this way, then it could become the Delaware of crowdfunding. A lot of the governmental bodies and politicians like that idea and are behind it, but it’s still early. And since federal regulations will trump state law, how this will be regulated between states is still up in the air.
What could change about crowdfunding regulations?
Crowdfunding won’t become a reality until the end of the year because the SEC has 270 days from the date of enactment to put its regulations in place. While some specifics are included in the JOBS Act, there are still some open questions and equity cannot be raised through the crowdfunding securities exception until the regulations are released. What worries me is that the SEC, in an attempt to hurry up and get something out there, might throw out proposed regulations that are not really well thought out, which may create additional road blocks that effectively eviscerate the purpose of the JOBS Act, which is to make it easier and cheaper to access money.
What can companies do now?
Put it on your radar as an opportunity. Some companies considering doing raises in the next six months are operating under the old SEC rules and might put off those investments until they can see what happens with crowdfunding. But otherwise, not much can be done until we know what that landscape looks like.
If a company is interested in crowdfunding, where should it start?
Seek out legal counsel because this is such an unknown area. Issuers of crowdfunding equity are going to have questions about which intermediary to use. Should they go through a licensed broker/dealer instead of a crowdfunding intermediary? How much money should they raise? What are they going to have to provide in the way of financial disclosures? Hopefully, as the market develops, the process will become more efficient and well defined and the cost of fundraising will decrease.
The ability to go to nonaccredited investors online and the ability to reduce transaction costs by not expending substantial amounts of money on securities compliance is a step in the right direction, but time will tell how successfully crowdfunding can be implemented and what type of demand it generate.
Jeff Roberts is a director with Kegler, Brown, Hill & Ritter Co., L.P.A. Reach him at (614) 462-5465 or [email protected].
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