New business startups have traditionally been the fount of job creation in the dynamic and often turbulent U.S. economy. Over the past decade, however, the rate of new business creation has faltered thanks in part to two vital factors: over-regulation (the subject of numerous past and future missives in this space), and lack of access to capital. In addressing the latter, Congress sanctioned an experimental conduit outside the cumbersome public offering process through which investment capital can be channeled to entrepreneurs seeking funds to expand.
Photo — Please put this mug shot of Chris Hopkins of Barnett & Co. in our system to use every other Wednesday when it will run with his column.This week, the U.S. Securities and Exchange Commission issued final guidelines allowing small businesses to offer stock to the public through a mechanism known as crowdfunding. Enterprising capitalists have been soliciting funds on the Internet for years, turning to a passel of sites like Kickstarter to aggregate small commitments from like-minded individuals on behalf of a new idea or worthy cause. Industry sources estimate that $16 billion was raised through crowdfunding in 2014, expected to grow to $34 billion this year. That figure would exceed the entire annual average venture capital investment of $30 billion.
Previous efforts, however, precluded the actual sale of shares without registration. The recent SEC rules elevate crowdfunding to a new level by sanctioning the sale of equity and debt securities to the public without satisfying the expensive and cumbersome IPO requirements, subject to certain limits.
In 2012, Congress passed the Jumpstart Our Business Startups or JOBS Act, aimed at addressing the notable decline in new business creation. One important aspect of the JOBS Act was the relaxation of certain regulatory strictures regarding the issuance of securities (stocks and bonds) by small enterprises. The legislation directed the Securities and Exchange Commission to promulgate rules necessary to implement the program consistent with its mandate of protecting individual investors from fraud. The final version of the rules was unveiled this week.
It is perhaps illustrative of the fundamental problem that the SEC needed over three years and 685 pages of regulations to accomplish its task of simplifying the process. And the implementation will not be complete until late January of 2016. Still, compared to the existing registration process, the new rules should allow many smaller startups to access the capital markets affordably.
Previously, entrepreneurs could offer unlisted shares in their companies only to so-called accredited investors with liquid net worth in excess of $1 million. Furthermore, they were prohibited from soliciting investment via media outlets including print, TV or the Internet.
The JOBS Act allows small companies to advertise for investors and to sell shares to non-accredited members of the general public. There are still some restrictions based upon income and net worth, but even the smallest investor may commit up to $2,000 per year. Individuals are limited to $100,000 regardless of net worth, and firms may raise a maximum of $1 million annually under the plan.
Other provisions include a relaxation of the requirement for expensive and time-consuming audits of the financial statements and a waiver of the audit requirement for first-time crowdfunders. Taken together, these new rules should allow more startup businesses to access the growing pool of small investors anxious to share the risks and potential rewards attendant to new enterprises.
The main criticism of the new SEC rules is that they are still too restrictive and complex, so much so that the object of the JOBS Act will be smothered in red tape. Still, by any objective measure, the new simplified offering regime opens the way for more startups to reach out successfully to more investors and in the process to create more jobs.
Christopher A. Hopkins, CFA, is a vice president and portfolio manager for Barnett & Co.