Can Your Small Biz Use Crowdsourcing With the JOBS Act?

Recently, the Jumpstart Our Business Startups Act (JOBS Act) passed amid much hoopla about how this legislation would be the stimulus that jumpstarts the economy and enables people like you and me to invest in all of these startups without becoming accredited investors, as was previously required by the Securities and Exchange Commission.

Now if you’re a small business owner, the floodgates will open, and you’ll be able to raise tons of money to accelerate your business, right? Probably not. While the SEC is still in its evaluation stage and the actual regulations have not been written, some things are already clear from the text of the JOBS Act bill itself. First, you will only be able to raise a total of $1 million in the course of 12 months, and individual investors will only be able to contribute the greater of $2,000 or 5% of net income if they make less than $100,000 per year or have a net worth of less than $100,000, and they will only be able to contribute the greater of 10% of the net income or net worth of the investor if the investor makes or is worth more than $100,000 and not to exceed $100,000 (see Section 302(a) of the text of the bill for details). So, raising $1,000,000 will require either at least 10 high income/net worth investors or at least 500 lower net worth investors, and probably many more than that.

Furthermore, the SEC will only allow you to raise money if you raise it through an approved platform. Given that sites like Kiva.org, Lendingclub.com, and Kickstarter.com are already available on the market for fundraising purposes, I would expect a similar platform to be created for the small business crowdfunding market.

Before you decide to raise money through crowdfunding, consider the following things first:

1) It’s better if you can give rewards rather than equity. While equity is cheap, if you achieve the success you envision through the raising of capital, then it will be expensive in the future. Let’s say that you give away 10% of your company in exchange for graphic design services or getting a website up and running. These exchanges won’t cost you any cash out of your pocket, but if you sell your company for $2 million later, that’s $200,000 which is not in your hands. You’ll lose out on the upside from the equity you gave away. It’s better to give credit and make these clients VIP customers or do something special which rewards their contribution but allows you to keep ownership.

2) Do you have a compelling story? I expect the requestors of funds to outnumber the sources of funds, at least in the beginning. For every 5 people with a dream, there will only be one person who can fund the dream. Therefore, your story has to REALLY stand out to get funding. One good way to create participation desire is to have original and interactive rewards. Take a look at these projects and see what sort of nifty rewards the founders offered their backers.

3) Don’t use this source of funds to pay off bills or to cash out. The money you’re raising has to go to something which is going to dramatically improve both top line and bottom line results in your business.

4) Do you have a track record of success? Are you making a profit yet and have clients and sales established? If you said yes, and you can make for the case that crowdfunding will only accelerate the process that you would have taken anyway, you probably have a chance of receiving funding.

5) Is there a perception of overnight success in what you’re offering? A lot of people will throw $10 or $20 at projects that they think will be the next Facebook which often causes them to disregard the fundamentals in the process. There has to be just as much sizzle as steak for your small business, as many of the investors will be, by and large, uninformed and uneducated ones who are hoping to be able to tell their friends that they invested in the next Google or Facebook despite their lack of knowledge about how to properly judge a business plan.

Overall, the criteria for successful fundraising through crowdfunding will be the same as what is used to raise money through venture capital and private equity markets now – do you have a sustainable model which projects a high level of growth without an unrealistic hockey stick profit projection? If so, then crowdfunding might be a very viable alternative because of the paucity of VCs and the high cost of going to them if you are successful later.

If you want a great guide for how to launch a successful crowdfunding project, check out Natalie Sisson’s great study on it. These projects succeeded because, as I mentioned above, they told compelling stories, were moving and impactful projects as a whole, and had founders that were able to reach and connect with a large audience.

About the Author: Jason Hull is a candidate for CFP Board’s certification and passed the CFP(R) exam in March 2012. He is a Series 65 securities license holder. He is the owner of Hull Financial Planning.