In an era of oversight, regulations are being reigned in to help startups obtain funding. The JOBS Act, signed into law in 2012, increases investment opportunities. Specifically, the Act permits “crowdfunding” through a provision allowing sales of certain unregistered securities in small amounts. Effective crowdfunding depends on a startup company’s ability to target the right investors, as it can radically help startups raise capital. However, the provision has been met with skepticism. Advertising for investment from individuals poses a number of risks, including fraud. Ultimately, the provision will be defined by rules the SEC has yet to release.
Potential Benefits
Loosening certain regulations will allow businesses 1) to increase their access to capital and 2) to target the proper investors.
Increased Capital
The crowdfunding provision increases companies’ access to capital.1 Crowdfunding allows entrepreneurs to attract investors to reach their funding targets. Rather than working through an intermediary, the entrepreneurial businesses can obtain funds directly. 2 This makes crowdfunding investment relatively easier for individuals and can attract people who might otherwise not invest. 3 This provides added investment opportunity and another avenue to acquire capital. 4 However, while crowdfunding has been successful, the existing regulations did not allow businesses to offer equity. 5 Rather, crowdfunding sites relied on rewards or discounts to attract investors. 6 Allowing equity offerings would expand on that success by allowing another avenue for investment.
Previously, companies could only sell securities through a middleman. 7 This individual had a legal duty to act in the investor’s best interest, which provided an effective safeguard. While this protective function is important, it also presents a barrier to capital and investment. The new provision removes this hindrance. The act also allows businesses to direct funding efforts at the right target audience.
Targeting the Right Audience
The JOBS Act allows direct advertisement to potential investors. 8 The economy is still recovering from a terrible recession and an influx of capital would be beneficial. Although small businesses have accounted for 65% of new jobs over the last 17 years, their access to capital is limited. 9 Because of the Jobs Act, companies can individually target those likely to be interested in the venture, which increases their chances of accessing much needed capital.
The act may allow the use of Twitter and Facebook, along with other forums, to inexpensively attract capital. 10 Additionally, a number of successful crowdfunding websites already exist. A company utilizing such and directly marketing to its target audience is more likely to receive the capital it needs; using newly available tools can thus help startups gather required capital. With the average initial cost of a startup around $80,000, securing capital investment is crucial. 11 Of course, the act has its detractors.
Potential Problems
Opponents of the provision raise valid concerns. First, investing requires some level of specialized knowledge that many individuals do not possess. Second, direct advertisement of securities creates the potential for fraud. 12 Whether investors are savvy enough to maneuver this opportunity is questionable.
Opponents argue the complexity involved in investment requires more oversight. They believe the act deteriorates important investor protections. 13 Directly soliciting capital from individuals may pull the untrained individual or inexperienced investor into an endeavor they do not fully understand. An SEC registered middleman, however, can provide a necessary safeguard. 14 Without such a safeguard, individual investors run the risk of losing large amounts of money. Ignorance coupled with greed almost ensures such outcomes.
The potential for fraud in this context is great. As noted, the JOBS Act allows direct solicitation from investors and promises of large returns may lure people to make unwise decisions. 15
Without proper rules, deceptive ads could threaten positive aspects of the bill. The SEC has historically banned ads directed at individuals, and for good reason. The nation’s recent experience with securities fraud exposes why. Recently, regulators have been trying to prevent the fraud critics claim the JOBS Act may enable. The validity of this concern depends on the rules the SEC is in the process of creating.
Unanswered Questions
Whether the JOBS Act will increase capital for small businesses is still in question. Ideally, the SEC will keep this objective of the bill in mind when crafting rules. Opening these new avenues of investment is risky, but it can provide a huge benefit to startups. The risk involved should encourage rules that will not stifle the purpose of the Act. Ultimately, the rules the SEC provides will be decisive. Rules that are too stringent will temper positive aspects of the bill. Conversely, investors may be taken advantage of without adequate regulations. The goal should be to create a happy medium. Although optimistic about the Act’s capacity to help raise capital, I’m skeptical our political process will facilitate creation of a regulatory framework that protects the purpose of the bill.
Knox Proctor, Update on the Jumpstart Our Business Startups (‘JOBS’) Act, WRAL Techwire Editor’s Blog (Aug. 28, 2013, 7:32 AM), http://wraltechwire.com/update-on-the-jumpstart-our-business-startups-jobs-act/12825252/. ↩
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Kay Koplovitz, Funds Are Gearing Up for General Solicitation of Accredited Investors – Are You Ready?, Huff Post, Sept. 14, 2013, http://www.huffingtonpost.com/kay-koplovitz/funds-are-gearing-up_b_3780702. ↩
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Jamie Farrell, The JOBS Act: What Startups and Small Businesses Need to Know [Infographic], Forbes, September 21, 2012, www.forbes.com/sites/work-in-progess/2012/09/21/the-jobs-act-what-startups-and-small-businesses-need-to-know-infographic/. ↩
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Tanya Prive, Inside The JOBS Act: Equity Crowdfunding, Forbes, Nov. 16, 2012, http://www.forbes.com/sites/tanyaprive/2012/11/06/inside-the-jobs-act-equity-crowdfunding-2/. ↩
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D. Daxton White, Could Jobs At Advertising Rules Make Securities Fraud Easier?, Wall St. Cheat Sheet, Sept. 14, 2013, http://wallstcheatsheet.com/stocks/could-jobs-act-advertising-rules-make-securities-fraud-easier.html/?a-viewall. ↩
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Frank Weil, The ‘JOBS Act’ Is a Fraud on America, Huff Post, Sept. 14, 2013, http://www.huffingtonpost.com/frank-a-weil/jobs-act_b_1404208.html. ↩