The Jumpstart Our Business Startups Act (JOBS Act) was passed by Congress and signed into law by the president earlier this year with the hope of leveraging the economy and finally moving the recovery out of recession.  One of the star provisions of the JOBS Act is the usage of crowdfunding techniques to help small businesses find the funding they need at a time when banks have pretty much stopped lending money to those who need it most, and as Bill Clark of Mircoventures wrote,  “Participants can raise as much as $1 million a year without having to do a public offering – a step requiring state-by-state registrations that can cost thousands of dollars.”

Cutting through the red tape

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In August, Forbes Magazine took a look at crowdfunding and the fact that the JOBS Act “will be lost in the purgatory of SEC review for some time now, but increasingly, that seems like a moot point.  Crowdfunding for startups is already here.” Through websites like Kickstarter, the idea of crowdfunding has been brought into the mainstream though Kickstarter, although you have to maneuver your company into one of the 13 available categories in order to benefit from the funding.

JJ Colao of Forbes also notes that, “For startups, aside from an out and out grant, this is the absolute best source of capital around… The stodgy, share-hungry crowdfunding platforms legalized by the JOBS Act seem like a mess of regulation and dubious value in comparison.  Why would anyone give up equity – and deal with the whims of swarms of amateurish investors – when better options are increasingly available?”

Who’s regulating?

Rip Empson points out that the JOBS Act really is going to force the crowdfunding industry to “develop effective self-regulation, best practices, and investor protection.”  The JOBS Act “requires all crowdfunding sites to be members of a national securities association,” creating a new leadership group with the goal of including “members of the crowdfunding industry, who will be working in collaboration with legal, securities, and SEC experts.” As fantastic as this newly forming governing body is, Jason Best and Sherwood Neiss of VentureBeat quickly brought the excitement back down to ground level with the news that the SEC is now using the JOBS Act to set up new roadblocks for crowdfunding.

The SEC, which has several more months of deliberations before final rules and regulations are released, has indicated that “rather than lifting the ban on general solicitation in order to make it possible for more people to invest in American startups, the SEC proposed rules that would establish various different classes of investors, each perhaps with its own regulations,” making the process of putting out ones company or start-up for crowdfunding possibly more expensive and difficult.  The road that the SEC must build for the future of crowdfunding is very important, but in their efforts to clear up and open up the field, there is the risk of muddying it, damaging the good that the president was hoping to create.

Regardless, a significant amount of red-tape has been cut, “as the act provides businesses and investors with exceptions to the Securities Act of 1933,” even if that still means that start-ups and businesses now have a free pass to raise money as they wish online.  The JOBS Act will by its very nature create new regulation that will make it more difficult in the short term until the new rules and regulations are learned, but before the JOBS Act, “only donation-based crowdfunding projects had been allowed by federal regulation.  And while businesses have used sites such as Kickstarter and Indiegogo to gather capital, they have generally offered pre-sales or other swag, not equity, to raise funds.”

Tips for crowdsourcing

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While this new source of funding for small businesses is a potential gold mine for startups that otherwise would be left in the dark, Bill Clark offers seven important tips for businesses who are considering this route.

First, consider prior raises, if your company has raised more than $1 million in the last 12 months, your organization won’t be eligible for the exemption, but if you wait for the next 12-month period, you can use it in the future.

Next, have a communication plan, which will allow you to effectively keep your numerous investors in the loop in regards to the startup or business.  The more organized your communication plan, the better idea your investors will have about the nature and state of your start-up or business, and the better you are able to answer their questions or concerns.

Then, keep your secret sauce in check, if your start up is dealing with something sensitive, that requires the signing of a non-disclosure agreement, this probably is not the manner of funding you would want.  You need to “give potential investors enough information to make a good decision,” and there are certain bits of information an investor needs to “do their due diligence: company name, address, bios of the officers and Board of Directors, a business plan and description of the business and how you intend to use the funds raised.”

Next up, show them the money.  Again, if you don’t want your potential competitors to see what kind of volume you’re doing, or how much money you’ve made, crowdfunding likely is not the avenue for you and your organization.  Yet, depending upon the amount of revenue raised through crowdfunding there are different levels of financial information that you need to provide, from providing tax returns and having your CEO certify the financial statements to providing investors with detailed financials which have been reviewed by a CPA.

Obviously, you must lawyer up, but not only to protect the nature of the business and ensure that it’s legally sound.   “The investments you receive through crowdfunding will be for equity in your company, so you will need to have a lawyer structure the deal and set up the necessary funding documents.”

Look up front costs, meaning, you need to have a fair amount of bank ($10-15,000) for all of the costs associated with starting shop before you even raise your first dollar.  Unfortunately, audited financials, legal fees, and paying to hold money in escrow add up fast, and start-ups might not have the liquid assets needed to set up crowdfunding.

Lastly, every start-up and business needs to have a Plan B.  “The SEC has 270 days to implement the regulation, startups will not be able to use the crowdfunding portion until early 2013.”

Conclusion

The JOBS Act was passed with the hope of creating more jobs, and giving small businesses and start-ups the ability to raise the funds that they need while cutting the red tape to do so.  While there are certainly significant areas of concern, particularly relating to the SEC, for many small businesses and start-ups there should be many more positives than negatives in the long-term.