Q&A: Crowdfunding your small business or startup: What you need to know
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A federal law promising an easier process for raising capital has energized entrepreneurs and investors, but many experts are pointing to the caveats.
The provision was part of last year’s bipartisan Jumpstart Our Business Startups (JOBS) Act, which was designed to help businesses grow and hire.
One facet of the JOBS Act, in particular, was created to make it easier for startups and small businesses to gather small amounts of money from nonaccredited investors through online funding portals, a process known as crowdfunding. In return, business owners give the investors small equity stakes in the company.
Previously, businesses could only take on “accredited investors,” who, under the law, had a certain net worth, income or personal relationship to the entrepreneur.
And if they went the crowdfunding route, using services such as KickStarter and Indiegogo, a business owner couldn’t give investors equity in the company, only a product — such as a copy of a movie, if that was the project.
Some critics worry the new rules could cause small, inexperienced investors to lose money or be exposed to fraud. That’s why the Securities and Exchange Commission recently released nearly 600 pages of rules dictating the new provisions, open for public comment for about another two months.
Can the crowdfunding legislation work for your small business or startup venture? The Charlotte Observer spoke with attorney Benjamin Baldwin, who specializes in equity investments and capital structures, with the Charlotte, N.C., firm Robinson, Bradshaw & Hinson.
Baldwin, who has written in North Carolina business and law publications about the impact of the Jobs Act on the state, said that while the new federal legislation doesn’t directly address jobs or employment, growth in the state’s small-business ecosystem could lead to more jobs. And if small businesses are able to raise capital more easily, that growth might happen faster.
Baldwin explains how investments would work and why many businesses should consider hiring a securities lawyer to walk them through the process. Comments have been edited for clarity and brevity.
QUESTION: Who is affected by the JOBS Act’s new crowdfunding legislation?
ANSWER: The Internet has long been used for charitable purchases, disaster relief, that sort of thing. Now, if the SEC finalizes its regulation, it will be expanded to a corporate capital-raising context. Basically, it’s available for companies that don’t want to raise more than $1 million for a 12-month period.
Q: Who can invest?
A: There is a sliding scale, depending on the net worth or the amount of money that investor makes. That’s so people don’t get taken advantage of. If the investor has a net worth of less than $100,000, then the amount sold to that investor could not be more than the greater of $2,000 or 5 percent of their annual income or net worth.
If their net worth is over $100,000, then the limit is 10 percent of their annual income or net worth, with a hard cap of $100,000 per investor.
Q: What if an owner of a successful brick-and-mortar small business, like a cafe, wants to use crowdfunding to raise money for another location. Would it work?
A: If they are very patient and are willing to hire a good securities lawyer who can walk them through the process. You don’t want to … wind up on the wrong side of securities (laws).
Q: What are some of the drawbacks?
A: One of the biggest drawbacks is (the law) will require a company to produce audited financial statements if they’re trying to raise more than $500,000. It’s an intrusive and expensive process, like going to the doctor and having an unpleasant procedure done every year.