JOBS Act Turns Spotlight on Crowdfunding

The new law blesses a new financing option for start-ups — but the blessing comes with many caveats.
Sarah JohnsonApril 5, 2012

President Obama signed the Jumpstart Our Business Startups Act, also known as the JOBS Act, into law today. Introduced December 8 in the House, the bill sped through Congress this year, garnering bipartisan support and raising the eyebrows of investor advocates.

Investors have expressed concern that some of the act’s regulatory rollbacks will lead to fraud and not to a rise in jobs, the key benefit its proponents claim the law will provide. For their part, supporters have contended that the law should lead to an influx of businesses wanting to list on U.S. public exchanges, which have seen their listed companies wane in recent years.

The act gives so-called emerging growth companies (defined as companies with less than $1 billion in annual revenue or $75 million in market cap) a five-year reprieve on several Securities and Exchange Commission regulations. These companies, for example, will have to provide only two years’ worth of audited financial statements rather than the three years that larger companies have in which to file with the SEC during the pre-initial-public-offering process.

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The provisions related to IPOs will likely encourage more companies to go public and make their first few years as listed companies easier than those of their predecessors, according to Thomas J. Murphy, a partner at law firm McDermott Will & Emery. At least two of his firm’s clients that have been on track toward going public recently accelerated their efforts in anticipation of the law’s signing, he says. On the flip side, some companies may actually delay their move to go public under the new law, since it raises the threshold for the number of shareholders privately held companies can have before they’re forced to go public, from 500 to 2,000.

Another section of the law, however, will not be as freeing to young businesses as some of them had hoped — and investor advocates had feared — under the initial version of the bill. The section on crowdsourcing — an increasingly popular yet, until now, unregulated way for entrepreneurs to raise capital in the United States — puts many caveats on entrepreneurs that want to trade equity for financing. The Senate added new rules, including new documentation that the intermediaries, or brokers, of these deals and the start-ups looking for capital will have to provide.

Some companies that want to use online resources to solicit investments without having to register their shares with the SEC — which they can do if they raise less than $1 million a year — may decide it’s not worth the trouble.

Under the law, the person selling the shares must register as a broker with the SEC and provide a background check on every executive, director, and person who owns more than 20% of the company behind the equity. Such a requirement does not exist in other securities laws, according to Murphy. The new rules make crowdfunding “far less popular than a lot of people believe,” he adds. The broker must also provide assurance that the investors understand their risks associated with investing in fledgling businesses. The SEC has 270 days to come up with related rules to make the change effective.

Still, the industry is excited at the prospect that equity-based crowdfunding will be allowed in this country. Earlier this week, for example, 50 companies established the National Crowdfunding Assn., which plans to set up best practices and host a conference this summer.

Until now, entrepreneurs in this country have been largely limited to trading charity donations, movie tickets, T-shirts, and the like for informal financing through social media. Now they can advertise on websites (also called funding portals) to nonaccredited investors under the premise of more lucrative returns. “It’s a step in the right direction, but hopefully in the future the boundaries will increase a little bit,” says Kevin Berg Grell, a program director at Crowdsourcing.org, which is creating a set of standards for crowdfunding platforms. The standards will help small companies choose which platforms to work with based on several factors, including the security of their systems.