What the New Crowdfunding Law Means for Small Business Owners

For the past few years, crowdfunding has been a way for creative types to raise money and get their ideas produced. If you had, say, a film idea or an invention, you’d post a profile page on a crowdfunding website like Kickstarter or IndieGoGo to solicit capital in exchange for recognition, a small gift or pre-sale of the item (not shares of ownership). If you met your fundraising goal, you’d keep the pledged money. If you didn’t, you’d get nothing.

 

But small business owners who wanted to crowdfund by offering shares of their firms couldn't do so — until now.

 

The New Crowdfunding Law

In the past, small businesses couldn’t sell shares of their company through crowdfunding sites to raise money, because it violated Securities and Exchange Commission (SEC) rules. But all that changed last week when Congress passed the JOBS Act (JOBS stands for Jumpstart Our Business Startups), allowing what’s known as equity-based crowdfunding. President Barack Obama signed the law today, and it is likely to take effect over the next few months.

 

Already, a slew of new crowdfunding platforms that will take a cut for assisting small businesses — Crowdfunder.com, EarlyShares.com, and FundingLaunchPad.com, to name a few — have been announced. (I’m averaging about two such announcements in my inbox each day.)

 

How the JOBS Act Will Work

Once the law takes effect, business owners will be able to set up crowdfunding profile pages on online platforms and offer shares of their companies in exchange for cash from investors. Anyone making less than $100,000 will be allowed to invest up to $2,000 or 5 percent of their annual income or net worth (generally excluding the value of your primary residence), whichever is more. People with income or net worth exceeding $100,000 will be able to invest up to 10 percent of that amount, but no more than $100,000. Entrepreneurs will be able to raise up to $1 million annually without registering shares with the Securities and Exchange Commission; up to $2 million for companies that release audited financial statements.

 

What Some Experts Are Worried About

Although the bill passed Congress overwhelmingly, some detractors, including consumer advocates and regulatory groups, fear that the new, relaxed regulations could lead to securities fraud.

Larry Landsman, a partner at the Chicago law firm Block-Landsman, worries that selling equity could be risky for entrepreneurs who don’t understand securities laws. “Some businesses fail," he says. “The last thing you want to have happen if your business goes under is to deal with lawsuits from unhappy investors who feel they weren’t properly informed of risk.” 

How Crowdfunding Could Help You

 

So, what does all this mean for your business?

 

It’s a little early to know much, since the SEC still needs to spell out rules to entrepreneurs who want to crowdfund.

But once that happens, crowdfunding could help you find money in today’s tight credit market. (I blogged about other ways to scare up cash in an earlier post: “5 Places to Find Money for Your Small Business.”)

 

If you think you might want to use crowdfunding to grow your business, be cautious. Remember: You’ll be giving up part ownership of your company. That means that other people will have a say in what you’re doing and you'll need to set up a way for them to weigh in on matters concerning the direction and management of the company. If you offer up more than 50 percent of your business through crowdfunding, you’ll actually surrender your decision-making power.

 

Beyond that, if you sell shares through crowdfunding, you might also have a harder time attracting venture capitalists or other investors in the future, says Mark Heesen of the National Venture Capital Association. These potential funders may feel that your company has too many shareholders, which could be a headache for them.

 

Ways to Crowdfund Successfully

The key to crowdfunding successfully will be carefully valuing your business, both today and by projecting its value out for a few years. That way, you can price your crowdfunding shares accordingly. Your accountant can either help with the valuation or suggest professional business valuation experts you could hire.

 

But, please, I implore you: Do not log onto a crowdfunding platform online and start selling off shares of your company without understanding how much your company is worth as well as your short- and long-term financing needs.

 

Landsman cautions business owners planning to crowdfund to “shop around” and make sure that fees for the service are reasonable. He also says you should ask the company offering crowdfunding how it is complying with SEC rules, such as disclosures to investors.

 

Once it’s clearer exactly how equity-based crowdfunding will work, what it will cost and which sites are emerging as leaders in the field, I’ll be back with more information and advice.