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Crowdsoucing Changes Everything!

March 28, 2012

While America enjoys many competitive advantages over other industrialized nations, arguably, our most strategic is America’s adventuring, entrepreneurial culture that does not punish failure and (at least so far) rewards success.

The JOBS Act that now awaits our President’s signature is about to amp-up this competitive advantage!  As it has moved through congress, we have both blogged and tweeted in support of its passage, so it may be of little surprise to our followers why we are so excited.  But with the President’s signature imminent, let’s take a look at why this is a game-changer for New Market Entrepreneurs!

First, let’s start with what makes us Entrepreneurs.  These are our two favorite definitions of entrepreneurship our readers are used to seeing:

  • Harvard Business School’s  Bill Sahlman defines entrepreneurship as “ In relentless pursuit of a market without regard to the resources required.
  • Stanford B-school’s Steve Blank’s definition:  “A startup is an organization formed to search for a repeatable and scalable business model.”

In short, we pursue our passions despite the little voice that tells us “we don’t have enough money” and “we have not yet quite figured it all out”.   Most of us are not as worried about the later as we are the former.

While America’s Venture Capital institution is the envy of the world and a key element of our country’s entrepreneurial/cultural competitive advantage, until recently, many have argued that early stage fundraising has been somewhat broken.   As VC’s funds got larger and larger, they needed to put more money to work and bypassed the seed and even subsequent round.   While the situation has been getting better in recent years with individual angels and angel groups becoming much more active– as well as a slew of startup accelerators like Y-Combinator and Techstars serving a vital role in helping entrepreneurs move their idea from a napkin to a fundable concept– the funding marketplace has been limited because only very wealthy people were allowed to invest and entrepreneurs were severely limited in their legal ability to market to them.

To address the “limited in their legal ability to market” void, very recently, we have seen a group of funding platforms arrive on the scene attempting to bring together, in an eBay-like fashion, accredited buyers (investors) and worthy sellers (people like us with big ideas in need of startup capital).  AngelList and Kickstarter are prime examples of these new-breed funding platforms– part ebay, part niche social network.

But even as the landscape for early-stage funding opportunities evolved for the better, the basic law of supply and demand was artificially influenced by government policy:  pricing (cost of money defined as the amount of equity early stage entrepreneurs had to give up) remained high because the supply of capital was limited to a small group of “accredited investors” (net worth of $1million not including home).

Enter the JOBS bill and the concept of Crowdfunding that it will enable–  the supply side just got a whole lot bigger!  Soon, anybody will be able to invest in startups.  Anybody!  As supply of investment capital becomes more plentiful, its cost should come down.   But more importantly, good ideas heretofore overlooked by the investment community (early stage consumer products, as just one example) will have a new capital resources never before available.

No doubt, there will be bad apples on both sides of the equation (companies fundraising and brokers looking to exploit unsophisticated investors) that will need to be policed and rooted out.  And no doubt that the argument “you get what you pay for” may come into play as well–  having experienced early stage investors backing you brings access to experience, advise and networks that “Joe Blow investor” wont bring.   But, net-net, the JOBS bill will be a source of new and much-needed entrepreneurial oxygen at a time when our Nation’s economy and entrepreneurial spirit most need it.

If you are a New Market Entrepreneur who has been stymied by the fundraising process, you will be well served to read up on this bill.   Here’s a great place to start, excerpted below.

The JOBS Act:

  • Increases the thresholds at which companies are required to register under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), (i) from $1 million to $10 million in total assets and (ii) from 500 to 2,000 holders of record of a class of securities, if no more than 500 holders of record are unaccredited (disregarding for each such threshold individuals holding securities pursuant to an employee compensation plan).
  • Requires the SEC to revise Rule 506 within 90 days following the enactment of the JOBS Act to eliminate the ban on general solicitation and general advertising in certain private placements that are sold only to accredited investors or qualified institutions.
  • Provides small companies with a new method of raising capital called “crowdfunding,” which has been popularized by online platforms such as Kickstarter and Profunder, by allowing issuers to raise up to $1 million within any 12-month period from investors without triggering the registration requirements of the Securities Act of 1933, as amended (the “Securities Act”), as long as the transactions are made through an SEC-approved broker or funding portal.  The crowdfunding rules also contain:
    • Annual Caps:  For an investor with annual income or net worth below $100,000, the investor’s annual investment in crowdfunded securities is capped at $2,000 or 5% of the investor’s annual income or net worth.  For an investor with annual income or net worth above $100,000, the aggregate annual investment is capped at 10% of the investor’s annual income or net worth.
    • Regulations Applicable to Funding Portals and Brokers of Crowdfunded Securities:  Funding portals and brokers of crowdfunded securities must register with the SEC and must comply with several requirements intended to reduce fraud, including: (i) protecting investor privacy; (ii) providing disclosures to investors regarding the risk of loss; (iii) requiring investors to answer questions demonstrating understanding of the risks; and (iv) obtaining background checks on the officers and directors of an issuer and anyone holding more than 20% of an issuer’s equity.
    • Restrictions on Issuers: Companies selling crowdfunded securities are prohibited from advertising their issuances outside the funding portal or broker.  In addition to periodic follow-on filings with the SEC, an issuer must provide the SEC with an initial filing that includes: (i) a description of the business and its financial condition; (ii) income tax and financial statements; and (iii) descriptions of the ownership and capital structure of the business.  Issuers will be liable for material misstatements or omissions made in the course of issuing their securities.

There are at least two ‘yeah-but’ issues we are still trying to understand.  First has to do with timing of when we can access crowdsource funding under the new, loosened terms.  From the above piece comes this buzzkill:

The crowdfunding provisions of the JOBS Act will be effectuated following a 270-day SEC rule-making period to  reconcile the practical differences between the JOBS Act and the current rules and enforcement actions of the SEC  and other regulatory bodies.

Then there is this, also from the same piece (as seen above):

Companies selling crowdfunded securities are prohibited from advertising their issuances outside the funding portal or broker.

Does this mean that we can or can not build links into our products that point to our “Crowdfunded Offering”?   Anybody know?  Pls comment.

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