It will help more start-ups get out of the gate, but after that it's going to be messy.
Yesterday the House passed the Jumpstart our Business Start-ups (or JOBS) Act, in a rare demonstration of bipartisan good feeling. The bill’s wide support (it passed 390 to 23) indicates just how well-loved start-ups are now in the popular imagination.
The idea’s time has come, it seems: Some sort of crowdfunding bill also seems certain to pass the Senate, and President Obama, who called for removing regulatory barriers to capital access for small businesses in his State of the Union Address, is all but certain to sign it into law.
What does the House bill actually do for you?
Basically, it will make it a lot easier for start-ups to raise money and will lower the cost of going public. To get into the specifics:
It allows you to advertise for equity investors on a crowdfunding site, something you can’t do now without running afoul of a bunch of securities laws.
You can raise up to $1 million this way from investors putting in no more than $10,000 each, or no more than 10% of their income, whichever is less.
You can raise up to $2 million if you supply your "crowd" investors with audited financial statements.
You don’t have to disclose your company’s financial statements until you have more than 1,000 shareholders. Currently, SEC disclosure rules kick in once you hit 500 shareholders.
It allows you to raise up to $50 million in an iPO without having to comply with the SEC’s full regulatory structure and related fees.
Is all that a good idea?
It’s hard to argue with a law that makes money more available to entrepreneurs. Massachusetts Sen. Scott Brown, who is pushing a similar bill in his chamber, says:
Imagine that the next Steve Jobs being held back by rules from the age of the typewriter. When are we going to give the tools and resources to our job creators? [Crowdfunding] is an innovative way to look outside the box and get up with the times to open up capital markets to new businesses and existing small businesses. It has the potential to be a powerful venture capital model.
But let’s keep things in perspective. Crowdfunding may be innovative and cool, but it’s not necessarily the answer to every start-up’s dream.
Think of it: Partnering with hundreds of unsophisticated small shareholders is a pretty inefficient way to fund a company. It could be an administrative nightmare to qualify all those strangers (are you sure that you’re investing no more than 10% of your income, ma’am?) and keep in touch with them, and as equity investors they do have rights. Their potentially chaotic effect on governance and control might scare off the serious VCs you’ll need to attract in future funding rounds.
And while the democratization of capital formation sounds good as a theory, it will likely be messy in practice. Start-ups won’t be less risky because money is more available—quite the contrary—and so more than a few mom-and-pop investors are going to lose their shirts in crowdfunded start-ups. And let’s face it, not all entrepreneurs raising money from unsophisticated investors are going to use it to elevate humanity. Some percentage are going to use it to elevate their lifestyle before absconding to Belarus.
And if enough small crowdfunders have a bad experience, it won’t be good for anyone—especially entrepreneurs.
Will the act create jobs and help more start-ups succeed?
Probably eventually, but the way there is likely to be messy, too. As Eric Reis and Steve Blank of the Lean Start-up movement have pointed out, and as Cindy Padnos of Illuminate Ventures echoes in her column and Bo Burlingham in his, easy access to capital can sometimes be a start-up’s worst enemy. It can skew incentives and weaken the discipline required to get a company to experiment, fail quickly and discover a winning idea.
Most of all, it will not increase the number of great ideas, or great entrepreneurs. VCs like Mark Suster have long argued that the market’s worst problem right now is not too little cash but too much cash chasing too few good ideas. Adding more dumb money to the market won’t fix that.
ERIC SCHURENBERG is the editor-in-chief of Inc. Before joining Inc, Eric was the editor of CBS MoneyWatch.com and BNET.com and managing editor of Money Magazine. As a writer, he is a winner of a Loeb and a National Magazine Award. @EricSchurenberg