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Crowdfunding for Small Businesses

The Jumpstart Our Business Startups (JOBS) Act passed Congress and was signed by the White House in 2012. The Act legalizes a new form of crowdfunding – it allows small, unsophisticated investors to buy shares or debt privately from small or startup companies. We are still waiting on the SEC to move forward with the final rule. The JOBS Act allows small private companies to raise up to $1M a year through crowdfunding if they provide audited financial reports and without undergoing the expense of an Initial Public Offering (IPO). An individual with earnings or net worth under $100,000 can invest five percent, up to a $2,000 cap. The percentage rises to ten percent and the cap increases to $100,000 for wealthier investors. The technique, called "business crowdfunding", has its roots in an earlier form of crowdfunding that was based on donations. Donation crowdfunding websites such as Kickstarter facilitate the matching of donors with creative projects. The payoff for the donor is usually some sort of merchandise associated with the project, like an autographed copy of a book. This model works well for small projects. Business crowdfunding does not involve donations, but rather investments. One gets involved in this activity hoping to make a return. Marketing Crowdfunding Offerings The JOBS Act introduced a new kind of SEC-regulated website with unique responsibilities, called a funding portal. Expect these portals to proliferate sometime in 2013. However, we are still waiting. An interesting article by David Rosenbaum details the history and status of the Act. The funding portals will have to follow SEC Rule 10b-5, which bans fraud relating to the sale of any security. Funding portals must see to it that a client's annual fundraising via equity crowdfunding does not go above the legal restrictions ($1 million, or $2 million if the client provides audited financials). Note that funding portals can't directly seek offers to buy private shares nor proffer investment recommendations or advice – these activities must be coordinated by a third party. Portals may not retain any of the cash received via crowdfunding. What's the hold-up? Economists are divided on the benefits of the legislation. It should make more capital available to entrepreneurs without a lot of costly regulation. However, few economists believe it will create many jobs, and many warn that shady operators will defraud unsuspecting small-fry investors. Jay Ritter, an IPO expert at the University of Florida, claims: "It will have minimal impact on jobs". John Coates, a Harvard law professor, warns that private stock trading, where there are fewer consumer protections, will increase. He warned: "It will increase legitimate companies' cost of capital". Startups relying on crowd funding have five years before they have to furnish audited financials, plenty of time, in the eyes of many, to make a lot of mischief. And legitimate companies that eventually go public after successful crowd funding may be of lower quality due to the Act's loosening of regulations. Nay saying economists, however, see a rise in fraud and bankruptcy on the horizon. Further reading: 4 Tips for a Successful Crowd-funding Campaign