JOBS Act Makes it Easier for Small Businesses to Raise Money

Monday, April 09, 2012 - 12:23 PM

Last Thursday, President Obama signed the Jumpstart Our Business Startups Act, or JOBS Act, which included many policies intended to help small and emerging businesses grow into larger, more successful companies.

One provision that generated much discussion in Congress and the media was regarding the loosening rules of "crowdfunding." Supporters argue this will enable small businesses to quickly raise funds to grow their business larger. Detractors are concerned that deregulating this market will legalize fraud and swindling of ordinary investors. Another provision allows companies to stay private much longer. Under the old rules once a company had 500 private investors it needed to start filing with the SEC. Now a company does not need to file with the SEC until there are 2000 private investors, which no longer includes company employees. There is much excitement in the venture capital and start up world with this Act.

The President and Congress are constantly trying to develop policies that will enable small businesses to thrive and, hopefully, turn into big businesses. One of the biggest impediments to business growth is a lack of credit. Capital is needed to acquire the supplies, real estate, employees, and technology to run a business. When a business owner is just starting or fairly young, she usually does not have much capital and it can be difficult to convince a bank to give loans. Frequently people in this position will take loans against their home. But given the dramatic decline of property values this has not been a viable option for the past several years. President Obama and Congress created the JOBS Act to help business owners raise capital more easily. Mostly they have done this by exempting them from regulations and reporting requirements. This comes with some risk though. Without regulation it will be easier for crooks to raise money fraudulently.

For a company to raise money they can borrow it from a bank or individual. Usually they are required to post some sort of collateral and will pay interest back to the lender in addition to the loan principal. Given the tightness of lending standards this option has not always been available. Another option is for the business to sell an interest, or share, in the company to an investor. Under the old rules, once a company hit 500 private investors they would have to begin filing their financial statements to the Securities and Exchange commission. Companies would rather keep their financial information closed from public scrutiny. Probably because they do not want others to see how successful they have been and how much they are spending on compensation. Also, preparing the paperwork can be quite time consuming and expensive. Mistakes will be identified and embarrassing for company management. The imminence of crossing the 500 investor threshold became a catalyst for companies (see Facebook) to list themselves publicly. The JOBS Act now increases the number of private investors a company may have up to 2000. This will enable companies to remain private much longer and avoid having to file the complicated paperwork until they have grown larger.

The JOBS Act also makes it easier for companies to find private investors. Under the old rules business owners could not solicit funding. That is allowed now. And the policy change which has received the most attention is "crowdfunding." This will allow business owners to list their idea on the internet in hopes of soliciting investment from the public at large. Think of it like Kickstarter for small business. The company will be required to file a simplified financial disclosure with the SEC. Not nearly as involved, or expensive, as getting permission to list on a public exchange like the NYSE or NASDAQ.

Why should emerging and small business be subject to the same regulation as major corporate America? This seems to be the main driving force behind the policies of the JOBS Act. Complying with SEC auditing and accounting standards to be able to raise money from more than 500 private investors or to solicit funds on the internet is expensive. The government is hoping that by lowering the barriers to raising money for small businesses entrepreneurs will be better able to capitalize and invest in their business and those businesses will become more successful. The only problem with removing the transparency of, and penalties for false, SEC filings is that it invites FRAUD. It will be more difficult for an investor, especially a not sophisticated investor like me, to accurately assess the financial state of a business. Investors will be duped into sham investments. SEC regulation goes a long way to stopping swindlers. Granted there is always going to be fraud out there. And nobody is forcing anybody to invest in these emerging and small businesses. As always, it is buyer beware.

Will the JOBS Act lead to more jobs? I am skeptical. Small business is the backbone of the country. But most small businesses fail. These policies seem to be directed at small businesses that are already pretty successful and are probably ready to make the leap to "big business." Now they will be able to maintain their small business stature for much longer. Regardless of whether they are characterized as small or big, I imagine their employment numbers will remain fairly consistent. That being said, it will allow businesses to raise money more easily and quickly. When businesses have money they can buy better equipment or hire additional employees. Either is a net positive for the economy. So in that sense, the JOBS Act should have a positive effect. Note, as an investor, I will not be investing in any of these businesses unless I know the business really well and can accurately assess it's viability.

 

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