It could be easier for you to launch your next great idea. Now, thanks to a provision of the recently enacted JOBS Act authorizing “crowdfunding,” instead of trying to convince big banks and Wall Street to back your business, you will soon be able to turn to Main Street. The provision, dubbed the CROWDFUND Act, brings securities laws and regulations into the Internet age. It’s designed to boost job growth by making it easier for new small businesses and entrepreneurs to raise capital from small dollar investors.
Over the last few years, musicians, writers, directors and other artists and creative types have already successfully used crowdfunding to fund thousands of independent projects. Using websites like Kickstarter and IndieGoGo and social media platforms like Facebook and Twitter, these artists have solicited millions of dollars in contributions from hundreds or thousands of people. But, because of securities laws enacted during the Great Depression, these artists have thus far only been able to accept donations and contributors have not been able to loan or invest money in the project with any expectation of profit.
The CROWDFUND Act changes the game. Friends, family members and strangers now have a chance to buy into your idea or business and have an ownership stake. The Act allows entrepreneurs to collect up to $1 million a year by posting their businesses on “funding portal” websites that are registered with the Securities and Exchange Commission (SEC). There, people can check out business ideas, evaluate the risks and decide whether to invest. People with incomes of $100,000 or less may invest up to 5 percent of their income or $2,000, whichever is greater. Those with incomes or net worth over $100,000 will be capped at 10 percent of their income or net worth, as applicable, or $10,000, whichever is greater.
Supporters say crowdfunding has the potential to not only help entrepreneurs and create jobs, but also improve local communities. For example, investors may seek to fund small ventures that align with their particular interests, like a plan to increase recycling or a project to rehabilitate a blighted neighborhood. Crowdfunding offerings also create an opportunity for entrepreneurs who have a great idea for a business but no connections to big banks, venture capitalists or hedge fund managers. New ventures also create more jobs in proportion to large corporations, so encouraging new ventures should in theory help an economy struggling with high unemployment.
Still, critics say crowdfunding removes too many investor protections and could open the floodgates to fraud. Congress attempted to alleviate this concern by requiring all crowdfunding offerings to be conducted through registered brokers or independent third party websites. These independent third party intermediaries must screen potential investors for their ability to demonstrate a basic understanding of the level of risk inherent in startups and small business, including the risk of losing an entire investment. Funding portals are also required to conduct background checks on the owners and executives of potential issuers. Funding portals are prohibited from taking an interest in any company that conducts a crowdfunding offering on their website. They also may not give investment advice to potential crowdfunding investors, and may not handle investor funds or securities. The actual exchange of money for stock, bonds, etc., in the transaction must be handled by a reputable third party such as a federally insured bank or licensed brokerage.
Critics also point to other potential problems. For instance, small businesses that are funded by angel investors usually receive much more than capital, including industry expertise, experience, market intelligence and connections that an angel investor brings to the table. A crowd of investors would offer none of these things, but could bring plenty of headaches from investor relations, communications and tax reporting, as well as an increased risk of shareholder litigation.
In all, it remains to be seen whether the CROWDFUND Act will have a meaning full impact on small businesses, jobs or the economy. Clearly, demand for crowdfunding investments exists. However, in practice crowdfunding could prove to be unworkable or too great an opportunity for fraud. But, despite the risks and pitfalls and potential for fraud, crowdfunding could also turn out to be a revolutionary mechanism for creating jobs and democratizing access to capital in the Internet age.
Nick Jensen is an attorney in the Corporate and Securities, Taxation and Real Estate practice groups at Lewis and Roca LLP, a business-focused law firm with offices in Phoenix, Tucson, Las Vegas, Reno, Albuquerque and Silicon Valley. Nick represents businesses, investors and entrepreneurs in a variety of financial, government and tax areas. Nick is also an avid investor and the founder and past president of a private investment group in Arizona. Nick holds a Master of Laws degree in Taxation from NYU School of Law and is also a certified public accountant licensed in Arizona. He can be contacted at [email protected].