Waiting for the Crowd’s Cash

With the anniversary of the JOBS Act fast approaching, the SEC still has not released the rules that will make equity crowdfunding possible. But wh...
David RosenbaumMarch 19, 2013

When President Obama signed the Jumpstart Our Business Startups Act on April 5, 2012, he called it a “game-changing” bill.

The game needed changing. After the Great Recession, access to capital became a huge problem for small business, as the percentage of loans under $1 million that banks approved (the kind for which most new and small businesses apply) fell 10% between 2007 and 2012. According to a 2012 survey by the National Small Business Assn., “nearly half (43 percent) of small-business respondents said that, in the last four years, they needed funds and were unable to find any willing sources, be it loans, credit cards, or investors.”

The survey went on to say that almost a third of small-business respondents reported that since 2008, “their loans or lines of credit were reduced,” and “nearly 1 in 10 had their loans or lines of credit called in early.”

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“For small business, loans were not gettable,” says Jason Best, co-founder of Crowdfund Capital Advisors, who, with his partner Sherwood Neiss, worked with the White House, the Senate, the House, and the Securities and Exchange Commission to help write the crowdfunding law. “No working capital for you” was the message small business was receiving, Best says.

And, after all, wasn’t it time for a change? Rule 506, prohibiting the public solicitation or general advertising of funds for securities, was part of the Securities Act of 1933, notes Neiss. “Isn’t it crazy that those laws are still governing the way we raise capital?”

Meanwhile, the amount of money venture-capital funds were able to raise was almost halved between 2007 and 2011, according to a study by Thomson Reuters and the National Venture Capital Assn.

The JOBS Act was supposed to fix many of those problems by making it possible for small and growing companies to sell up to $1 million in shares in their company to an almost unlimited number of investors without having to go through the expensive SEC registration process. It would enable them to advertise their deals publicly (that’s Title II of the act), and allow them to sell shares to unaccredited investors earning less than $100,000 a year (that’s Title III).

Almost a year later, the SEC has still not released its guidelines. In anticipation of the act’s implementation, however, online crowdfunding platforms such as Kickstarter, Crowdcube, Indiegogo, RocketHub, Fundable, and scores of others have proliferated, marking time until they can sell stock in companies by offering actual products to small investors, or parts in crowdfunded movies, or just about anything except actual equity.

“Right now, it’s all donation-based,” says Steve Temes, co-founder and chairman of EarlyShares, one of the first crowdfunding platforms to go live. “You invent a cool watch. People go online and put up $200 and they get the watch.” In essence, they’re funding your operations but they’re not investing in your company.

They may not be investing, but “it’s a cool way to presell inventory, or test a new product line or extension,” Neiss says.

Temes is ready to get busy. “EarlyShares has 60,000 users registered and over 2,000 companies; we’re building up our database,” he says. But he’s not surprised that the SEC is still grinding away at the rules. After mentioning the leadership change at the top of the commission as a possible explanation for the SEC delay, Temes notes the many complexities the SEC must deal with before equity crowdfunding can be implemented safely.

There’s the problem of due diligence, Temes notes. “We have an 18-point checklist to prevent against fraud, to make sure that bad guys aren’t involved in a company before the deal is considered by our team, but the SEC and [the Financial Industry Regulatory Authority] will mandate those terms,” he adds.

There’s also consumer education. Buying stock is complicated. “Making investments in small companies is high-risk,” says Best. “You should use less than 10% of your investible income in small companies. It has to be considered a high-risk allocation, and that depends upon how old you are; how risk-tolerant you are.”

The fear that small, inexperienced, unaccredited investors could be fleeced was one of the major objections to Title III of the JOBS Act. But it’s a fear Neiss believes may be overstated. “We’ve just come out of one of the most difficult economic periods in our history,” he says. “There’s no proof people will deploy capital in a riskier manner than before. Chances are people won’t risk more than they can afford to lose. People are increasingly conservative.”

Neiss also believes in the wisdom of crowds. “It’s harder to get money from a crowd than a board of venture capitalists,” he says. “There are more people critiquing you. Their experience and depth can be broader than any boardroom of VCs.”

Neiss points to a Kickstarter campaign in which someone tried to fund a game using information that wasn’t theirs. “But people in the space knew it wasn’t real; it was uncovered in a comment section, and their page was taken down in 24 hours,” he says.

At EarlyShares, Temes has started EarlyShares University to educate potential investors on everything from what a common stock is to what to look for in a real estate or entertainment investment. “Education is mandated by the JOBS Act,” he says. “People have to know they could lose money.”

Once the SEC announces its guidelines (which Temes predicts will be sometime this summer), Neiss believes it will increase deal flow and “net new innovation” in how businesses are formed and funded. He advises businesses planning to go the crowdfunding route to work its social networks.

“It’s about bringing your own crowd,” he says. “Money will not rain from the sky. It’s about doing what you do every day: creating brand engagement and awareness so that when you go out to the community, your friends and customers are positively disposed to offer you the capital you need.”