The recently enacted JOBS Act (Jumpstart Our Business Startups) is a either terrific boost for small businesses looking to raise money, or an invitation to investor fraud, depending on whom you ask about it. To learn more about the potential upside of this legislation, I interviewed small-business attorney Garrett Sutton. He is a Rich Dad adviser, founder of CorporateDirect.com, and the author of five books, including his most recent title, Start Your Own Corporation. (Disclosure: Garrett and I are co-authors of the e-book Business Credit Success: Get on the Financing Fast Track.) Here is an edited excerpt from our interview:
Gerri: Can you fill me in on what the JOBS Act means for entrepreneurs who are looking to raise money for their companies?
Garrett: The JOBS Act is a significant development in fundraising for entrepreneurs. Basically what it does is it loosens the previously very tight restrictions on fundraising in several important ways.
In the past, you may have tried to raise money with a Regulation-D, Rule-506 offering. That’s a private placement where you don’t have to register with the federal government or your state government, so it’s a fairly flexible way to raise money. But you were hamstrung by the fact you couldn’t advertise this offering. It could only go to people that you knew, people you had a pre-existing relationship with such as friends, family or colleagues. So you really couldn’t get the offering out there to a large number of people.
Well, what the JOBS Act does is allow accredited investors, which I’ll define in a second, to to receive advertisements for these private placement offerings. That’s great because previously, these accredited investors couldn’t be reached by any sort of advertising.
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An accredited investor is someone who has either $1 million in net worth exclusive of their home, so $1 million on top of the price of their home. Or, they’ve earned $200,000 a year for the past 3 years, or $300,000 a year if they’re married.
So if you a have $1 million in net worth, or you’re earning a significant amount of income, the Securities and Exchange Commission says look, these people are sophisticated, they can take care of themselves. Our job is to protect widows and orphans. If someone has $1 million in net worth and a high-level of income, they can make their own decisions.
Gerri: Some of the criticisms I’ve seen about this particular act in this area was that it would open the door to a lot of fraud for unsophisticated investors.
Garrett: Yes, we’re going to talk about crowdfunding next, and there is that risk on the crowdfunding side, because with crowdfunding, anyone can invest. You don’t have to be an accredited investor. And so there is sort of a fraud issue that you have to worry about there, but they’re putting in some restrictions that hopefully will minimize that. (Crowdfunding allows companies to raise money from a large number of people over the Internet.) So on the Rule-506 side, you can raise as much money as you want, and you can advertise the offering but it has to come from accredited investors.
Gerri: What do you think is going to happen, in terms of those small businesses who want to raise money? Are they going to have to find companies to advertise for them to these accredited investors? Wouldn’t it be hard to find them yourself?
Garrett: Yes, and the SEC has 90 days to come out with rules on how the Rule-506 side is going to work. On the crowdfunding side, you can raise up to $1 million from anyone and you can advertise it on the Internet. But, you have to go through certain SEC-approved portals and the job of these portals is to make sure that the people offering the securities over the Internet are not fraudsters.
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Now, will some bad apples slip through? Absolutely. I don’t know how you’re going to stop that. Most commentators I’ve talked to have said, “Look, we need to have capital formation. We need to allow people to be able to invest in these startups. We’re going to give up a little bit of, there’s going to be some fraud in the system because of this, because we’re loosening it up. Some fraudsters are going to slip through. But in order to get capital formation and job creation going, we’re willing to let a little of that in to help entrepreneurs get their projects funded.”
Gerri: So, if you’re someone with a small business or starting a small business, when can you reasonably expect this option to be available?
Garrett: On the crowdfunding side the SEC has nine months to put it together and I’m certain they could get extensions if it’s not quite right. But, the industry is moving pretty quickly to work with the SEC to establish these portals. They’re going to be establishing protocols for who can invest, what type of information has to be provided and that sort of thing. So, I would say in the next year, Gerri, you’re going to be seeing this crowdfunding starting to happen.
Gerri: So 2013 is probably the year of crowdfunding. Do you see this replacing the need to establish business credit?
Garrett: No, actually I think it’s going to accelerate the need for business credit if people are able to go out and raise money. They still need to have good business credit as they continue with their business. So, this may help some businesses get off the ground but at the same time, they’re still going to need to establish business credit as they move forward in their entrepreneurial ventures.