Crowdfunding: Politicians Love the JOBS Act, Why Investors May Not

Despite political contention over the influence of corporate America in shaping the American Dream, our nation’s leaders tend to unite in their respect of small business. Lawmakers ‘walked the walk’ last week, as the Senate passed an amended version of the Jumpstart Our Business Startups Act (or the JOBS Act) with broad, bipartisan support.

The House passed the bill the previous week, which means the JOBS Act faces little obstacles as it is finalized into law.

The concept is relatively simple: The act decreases regulations for small companies in obtaining startup funds. The practice is autological: small companies can proceed in organizing direct, small investment campaign with individuals, akin to a large group ‘pooling’ their money. The bill allows a company to raise up to $2 million. One investment will typically value between $1,000 and $30,000, depending on the site and investor qualification.

Until the JOBS Act, the law had clearly defined crowdfunding as acceptable for projects and donations, not businesses. ‘Financiers’ could receive complimentary rewards in return for investments, however equity crowdfunding – expecting a payback on an investment – had been illegal. Logically, the SEC still regarded these investments as sales of securities, which thus required the use of registered brokers.

This Act can be considered both a proactive and reactive response to the power of the internet and social networking. Microfinancing has of course existed since this country’s inception, but, surprisingly not on the internet until recently. Still, there exist several case studies of successful crowdfunding initiatives.

Crowdfunding is popular among nonprofits (and appeals to celebrities, like actor Ed Norton’s Crowdrise site) and it has also succeeded in the music/film/entertainment space, both in funding a particular project as well as record labels and media companies. The second tech boom has benefited from crowdfunding, both in building websites and in developing hardware and accessories. Some sites, like MicroVentures and Xpert Financial, are registered brokers, and thus create investment opportunities and secondary markets for the startup private sector.

The JOBS Act gained favor in the political realm because it encouraged entrepreneurship, increased employment and manufacturing. Now, with the lightened regulatory rules, small and startup companies can lead more aggressive campaigns across with more lofty goals. The deregulation may entice more traditional industries and sectors to consider crowdfunding a viable option. Further, this Act is thought to give a new socio-economic group the power to invest and own. Idealistically, this concept stimulates the American Dream, but more tangibly, proactive investing stimulates the economy.

Still, there exists sizable opposition to the act, critics who argue both the implementation issues and the fundamental threats to the economy. With less polished sites that do not employ traditional financial advisory (investor questionnaires, risk disclosure, etc.), will investors properly understand the magnitude of their financial decisions? How easy will scamming be, and who is responsible for retribution?

In reality, this Act may be a “relief package” for public companies that can dodge disclosure rules and investor protection mandates previously outlined in Sarbanes-Oxley, according to Bloomberg. A new class of emerging growth companies, with millions in revenue, can gain the capital to immediately go public, yet be given the freedom to operate up to five years without an independent test of their internal operations, according to the opinion piece. Further, what regulations are in place to prevent ‘pump and dump’ PR operations and analysts from misleading investors? Can clearly biased analysis be masked as independent analysis or sell-side research?

These questions address a major philosophical issue of fundraising and investment. Can naivety coupled with low-risk lead in fact lead to an unstable and dangerous investment environment?

High net-worth investors do not expect immediate returns on investments, and perform countless methods of due diligence before making decisions. They rely on reputation of other investors and management, a privileged network of individuals they trust, analyzed and re-analyzed market trends, experience as an insider and years of success in the space. The JOBS Act now introduces a new group to investment opportunities without providing the authoritative framework that advisors and placement agents bring. Will the ‘low-risk’ investors act intelligently, and more importantly, will the companies act responsibly?

Does a privileged group of high-net worth, high-risk investors inherently lead to stability? Does this stability require third-party underwriters and analysts to ensure growth?

Stay tuned for Part II: How Crowdfunding Can Affect the Healthcare Market, and Your Wallet, appearing in next week’s OneMedSentinel.

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