Crowd funding and the new Jumpstart Our Business Startups law
Although the website is mostly about commercial lending as a source of financing for business and commercial real estate, I wanted to discuss a different source of financing for businesses. Last week on April 5th, President Obama signed the Jumpstart Our Business Startups (JOBS) law. From the point of view of business financing, the law does seem to have a lot of promise. However, the Devil will be in the details of its implementation.
The new law makes it easier for new firms to raise capital from the public by allowing businesses to raise up to a million dollars from the public without going through the regular IPO process. The big change that the law is implementing is the amount of disclosure that you need to do in order to raise money from the public. The idea of creating a more democratically initial public offering process is not new. While it has usually been a requirement that you needed to be an accredited investor (wealthy and knowledgeable), there have been notable exceptions that allowed the regular public to be part of the process.
The most remarkable of those exceptions was the OpenIPO initiative. In fact, back in 2004 I took part in the Google IPO by using them. One of the best investments of my life, I only wish I had held on to those shares a bit longer. However, the Google IPO was not a regular offering. The founders could have gone to any investment banker to get their public offering going. This new law is going to open the doors to a whole lot of small business owners, and a lot of more unsophisticated investors. And here is where things can get tricky.
Although there is a perception that the IPO business is down because of regulation, the truth is that not that many companies are interested in going public because of the turmoil in the market. Regulations are there for a reason, I see a potential for unscrupulous people to take advantage of people.
It is easy to see that investors run a risk by participating in these investments. If there is no qualifying thresholds, there will be a lot of novices backing up ideas that might sound good but have little or no chance of succeeding. Furthermore, not everyone has the ability to perform their own due diligence. I can only imagine how difficult it would be to do an assessment with less information than what is offered in a prospectus.
The other side of the coin is how risky this might be for the business owner looking for funding. I foresee a lot of people setting up practices to take advantage of the new law, and start their own “crowd funding” operation. Will they be charging the business owner an upfront fee? Will we find out in a couple of years, that only 1 in 50 of those businesses getting charged the fees, will eventually get funded?
What could probably make the difference between success and failure would be if big players were to get into this new “low cost, low paperwork IPO industry”. It would bring legitimacy to the process. The OpenIPO people have a jump start on the race. However, the size of the new transactions will necessitate a new more retail oriented approach. In other words, forget about million dollar underwriting fees, and start thinking more about fees under $50,000. More of a packaging fee.
It will be interesting to see how things develop in a few months once the rules are in place.