Next Year, Anyone Can Invest in a Startup. Is That Good or Bad?

Libby Kane
Posted

Imagine: Had you invested in Instagram when it first launched, you would be riding high after their $1 billion buyout from Facebook this week.

While you missed your opportunity to cash in, in 2013, you may be able to profit from the next big thing.

Currently, a maze of rules around the funding of startups has created two problems: Startups can’t get cash from everyday Jane Does, and everyday Jane Does can’t invest in the startups they love.

In recent years, crowdsourcing has revolutionized funding for all sorts of projects and causes—knowledge (Wikipedia), charity (Kiva.org), journalism (Spot.us), arts projects (Kickstarter), and even tuition (such as startup Sofi, which allows college alumni to loan money to students who need help paying tuition). The idea appeals to both parties: those who can contribute only a little, and those who need a lot.

And now a new law taking effect next year will bring crowdfunding to entrepreneurship by allowing the masses to fund startups.

Sounds like an investment opportunity, right? Well, hold on. Find out below how it could affect you—whether you’re an investor or an entrepreneur.

First, Details on the New Law

The Jumpstart Our Business Startups (JOBS) Act, just signed into law by President Obama, will, among other things, allow some new companies to raise funding from individual shareholders without extensive paperwork. Previously, laws limited the investor pool available to sources like banks and wealthy individuals who were required to file their investments with the SEC.

Which companies will benefit? Those known as “emerging growth companies,” which have under $1 billion in revenue. They’ll be able to raise $1 million annually from average Americans through approved, online crowdfunding platforms without any kind of SEC registration or filing.

Individual investors like you will be able to invest up to $10,000 per year, similarly exempt from SEC filings. To put that in perspective, and to show how it could help fledgling companies, Connie Evans writes in The Huffington Post: “According to data from the U. S. Census’ Survey of Business Owners in 2007, over 43% of women-owned businesses were started or acquired with less than $10,000 in capital.”

The JOBS act also lets companies sell nearly twice as many shares, enabling them to raise more money before filing with the SEC, and acquire more shareholders than they’re currently allowed–again, bringing in more money.

What It Means for Entrepreneurs

The act isn’t meant for large companies whose assets total more than $1 billion, those already pursuing an IPO (like Facebook), or for the mom and pop shop down the street. It’s for companies like tech startups, or any other firm that is growing quickly and clamoring to raise funding fast, perhaps with hopes for an IPO.

For entrepreneurs, the act is largely regarded as a good thing. Obviously, any money helps, and expanding their available resources means more money and more progress, but companies (especially small banks, for whom the regulations are also loosened but slightly different) are also expected to save money on “compliance costs”—those costs that go along with registering with the SEC. Now that the new companies don’t have to register until they accumulate $50 million in assets, they’re not paying the bureaucratic fees and costs beforehand.

What the Act Means for the Average Investor

It sounds great, right? The opportunity to get in on today’s most promising startups, before their meteoric rise to billions? Well, maybe.

If this was a Hollywood movie, you would invest in the next Instagram or Facebook using only your year-end bonus and end up bringing home a profit when the company goes public (like Groupon) or is bought out for millions (billions?) of dollars.

But here in real life, you could hand your money over to what seems like a legit, awesome startup via the website that will launch once the JOBS Act takes effect. A few months down the road, after your entire office and extended family have forked over their funds as well, the company raises $50 million and the SEC regulations finally kick in. At that point, you find out that the company wasn’t conducting itself as it should have been, and none of you will see your money again. Yipes.

(For the record, we at LearnVest don’t recommend investing in individual stocks, or in this case, individual companies. We prefer mutual funds, which are a collection of securities, making it less risky to invest in them. For more on investing and mutual funds, check out our course on investing. )

Much of the trepidation about and criticism of the act isn’t related to the businesses who might benefit—it’s concern for the individuals who might invest. Critics point to the act as a classic measure of business deregulation that could give shady companies more time to exploit loopholes and engage in fraud. It’s been said that the respite granted by the SEC (not registering until reaching the $50 million mark) is bad news for investors, who need more regulations, not fewer, to keep informed about where exactly their money is going. Along the same lines, critics worry that the SEC doesn’t have the bandwidth to effectively monitor the platform.

The law hasn’t yet gone into effect, the site isn’t up and the average American hasn’t started giving her money to startups, but the act holds potential for small businesses and investors alike. We’ll continue to keep you informed as the story progresses.

More From LearnVest

Socially responsible investing? We’ll explain.
Do pickles hold the key to economic prosperity? Find out.
Get an A-Z look at your finances with our free Take Control Bootcamp!