With the passing and enactment of Title II of the Jumpstart Our Business Startups (JOBS) Act in September, the SEC essentially changed the game for small businesses and start-ups seeking financing. Simply put, Title II lifted an 80-year ban on openly soliciting personal networks and the general public for funding. And while this is a huge shift in policy, Title II still requires that businesses disclose how they are soliciting to the SEC in more detail within 15 days of soliciting, and limits start-ups to soliciting only to those who qualify as “accredited investors.”
Those restrictions, however, will likely change again with JOBS Act Title III. Expected to be proposed by the SEC this year and passed in early 2014, Title III will allow start-ups to openly solicit non-accredited investors as well. In other words, entrepreneurial hopefuls will be able to freely tap their personal and social networks, online and offline, to help fund their business venture. For some, this could open doors to new sources of funding and capital, and will certainly have implications for the now-hot crowdfunding industry. However, there’s also legitimate concern about fraud if Title III passes, since the floodgates are opened wider.
With these changes and with any form of outside financing — whether equity, non-equity, or even reward-based — it will be more important than ever for businesses to understand the pros and cons of every option, and conduct proper due diligence.
In regard to crowdfunding specifically, there are several areas both entrepreneurial hopefuls and prospective investors need to be made aware of before jumping on board.
- Buyer beware — While the overall financial risk can be less due to the “donation” or “contribution” being smaller, crowdfunding investors are often far removed from the business they are funding and therefore may not perform due diligence in learning about the startup, the crowdfunding platform, where their money is going or how it is being spent.
- Ongoing obligation — Many crowdfunding models require the business to give something back to investors in the form of products, services, ongoing discounts or deal with the administrative and legal burden of having shareholders (Title III may complicate this further allowing non-accredited investors to buy in). And while every investment should see a return, businesses must be careful to not over extend what they can deliver, or even negate the value of the funding to cover the cost of fulfilling those obligations.
- Platform credibility — With around 450 platforms now on the crowdfunding bandwagon, due diligence has never been more important. Most do not disclose how many businesses even get funding — nor will they share how many of them continue operating after the initial cash injection is accepted. And as with any financial transaction, the rise in options can lead to an increase in potential scams. In fact, there have been some reports of instances where entrepreneurs have been unable to withdraw the capital given to them, making the donation worthless. Both businesses and investors need to carefully investigate their crowdfunding platform options to ensure it is credible and legitimate.
So, while for some early stage start-ups the JOBS Act might open viable options for funding streams, businesses and investors must be sure to conduct the type of due diligence we have come to expect in traditional financing models to make sure it is right for them.
David Nilssen is CEO and cofounder of Guidant Financial. In 2007, the Small Business Administration (SBA) named Nilssen the National Young Entrepreneur of the Year and the Puget Sound Business Journal named him one of the top 40 businesspeople under 40. David is a past president of the Seattle Entrepreneur Organization and a former Board advisor for Youth Ventures. As the premier provider of Rollovers as Business Start-ups (ROBS), Guidant Financial provides people from all walks of life the freedom to fund a new business or franchise using their existing retirement funds without taking a taxable distribution or getting a loan, in addition to offering traditional business funding options such as SBA loans and unsecured credit. For more information, visit Guidant online at guidantfinancial.com.