Industry Market Trends

Crowdfunding Bill to Reshape Small-Biz Financing

Mar 29, 2012

New federal legislation will eliminate certain restrictions on raising capital, which could open up vast new channels of financial support for entrepreneurs and small businesses.

A bill approved by Congress this week will institute sweeping changes to small business financing and capital investment by loosening regulations that restrict funding opportunities for entrepreneurs. The legislation is intended to spur job creation by infusing money into the small-business sector, which is a key driver of employment in the United States.

Known as the Jumpstart Our Business Startups (JOBS) Act, the bill was approved by the U.S. House of Representatives and passed through the Senate this week with widespread bipartisan support, and is now awaiting President Obama's signature. The JOBS Act includes six measures to help small firms and start-ups raise funding, make it easier for them to go public and to boost their competitiveness.

One of the measures, named the Entrepreneur Access to Capital Act, will remove specific Securities Exchange Commission (SEC) regulations that have prevented small businesses from engaging in crowdfunding, the practice of generating financing through the Internet. This method will enable entrepreneurs to raise equity capital from larger pools of relatively small investors.

"At its core, crowd-funding is a way for people anywhere ('the crowd') to use the Internet to find and finance endeavors they believe in," the New York Times' You're the Boss small-business blog explains. "But the opportunities could be even greater. Thus far, crowd-funding sites have only been able to accept donations, because securities laws prevent them from accepting investment capital. But that could change."

Until now,  crowdfunding has been used primarily for raising money for non-profit organizations, microfinancing in developing markets, artistic or creative projects and campaign donations. Small businesses have been unable to take advantage of crowdfunding due to regulations in the Securities Act of 1933 that place restrictions who can invest and limits how many investors a smaller firm can have before it becomes regulated like a public company.

The JOBS Act will eliminate many of these restrictions and will enable small businesses to raise up to $1 million a year through crowdfunding, or $2 million if the company provides prospective investors with audited financial statements. Investor qualifications have also been loosened, meaning that those with incomes or net worth of less than $100,000 can invest up to $2,000 or 5 percent of their annual income into a company, while those worth more than $100,000 can invest up to 10 percent. The present-day cap on the number of shareholders a private company can have will also increase from 500 to 1,000.

"To put it simply, crowdfunding will enable small businesses to more easily get funding. Right now, entrepreneurs must try for a small business loan or some type of grant - which they may not qualify for or may not prefer relative to equity investments - or try to solicit capital from accredited investors like venture capital funds," economics blog Seeking Alpha explains. "If crowdfunding is allowed to flourish, in time it will enable more capital to go to small businesses. This means more investments, more production, more small businesses and more jobs."

Opening up these new financing opportunities to entrepreneurs could have significant long-term effects. If the crowdfunding market proves successful, it could attract a fresh wave of foreign investors to the U.S. economy. Raising the cap on shareholders could also encourage more companies to remain private firms for longer, avoiding many of the costs and regulatory restrictions on publicly held businesses and strengthening the growth stage that many small businesses need to develop and mature.

In addition, crowdfunding could have a disruptive impact on traditional financing methods, as small businesses would need to rely less on the major banks and Wall Street investment firms as they shift toward funding from pools of smaller investors.

However, there are concerns about loosening longstanding federal finance guidelines, and "critics say that the changes would allow firms to avoid disclosing crucial financial information and elude government oversight, opening the door to fraud and investor abuse," the Washington Post's 2chambers blog reports.

Other provisions in the JOBS Act include a measure to raise the capital ceiling for companies exempt from going public from $5 million to $50 million, promoting more investment in these firms and creating more jobs; a measure to reduce the final cost of going public and introduce the category of "Emerging Growth Companies," which would allow firms to avoid the majority of SEC regulations and fees in the first few years after going public; and a measure to allow companies to use advertisements to solicit investors, which was formerly banned under an SEC regulation.

"In many important ways, the JOBS Act turns its back on several decades of established securities law practice, which has led to significant restraints on how equity can be raised in the private markets," notes. "Whether the boost to economic growth will outweigh the risk of defrauded investors remains to be seen."