Policies shift dramatically in the wake of an economic disaster. Four years after the stock market crash of 1929, regulations were enacted which barred privately owned companies from publicly seeking investment. This ban on general solicitation essentially decreed that all fundraising had to occur behind closed doors.
Then, in 2012 — once again, roughly four years following the onset of recession — President Obama instituted the Jumpstart Our Business Startup Act, better known as the JOBS Act. This bill was set in place to get small businesses moving again, and it featured seven main provisions, notably a drop of the general solicitations ban. As of September 23, 2013, it became legal for companies to advertise to potential investors for the first time in nearly 80 years.
For many startups, this is a big deal. Suddenly, they have the ability to seek out investors in ways they can actually afford — social media, TV or newspaper ads, crowdsourcing, human billboards, skywriting, or whatever else they dream up. Essentially, the end of the general solicitation ban means that small businesses now have the opportunity to seek a wider range of investors more easily and secure funding more readily, and they can do so without paying large fees to investment banks or registered broker dealers.
But there are a number of benefits that lie outside the realm of basic fundraising.
- Marketing: When a company advertises its fundraising efforts, it not only gets its name and product out to potential investors, but to potential customers at the same time. Even if a person can’t invest, he might be interested in patronizing your business.
- Traction: Oftentimes, an investment firm wants to see that a company has produced some traction before it will even consider a large investment. If a company can gather what it needs to get off the ground from public sources, investment firms are more likely to open their doors when they see the company is already moving forward.
- Champions: If you’re able to collect a lot of investors, then you’ll find yourself with an established word-of-mouth network that will pull in both investors and customers.
- Support for small businesses: It’s no secret that small businesses play a key role in the U.S. economy, and the end of the general solicitation ban will help grow this important sector. This will lead to an overall boost to the economy as new jobs are created and people gain the opportunity to spend and invest more.
- More investments broken into small amounts: In the past, if you wanted to raise $1 million, it would have been difficult to find 200 people willing to invest $5,000 each; all too often, you would have ended up looking for one or two big investors with enough capital to finance your whole operation. Now, a business has a much better chance at gathering funding in smaller chunks, minimizing the likelihood that it will end up dealing with the pressure leveraged by big-fish investors.
- New investor opportunities: Investors will now have access to a wider range of deals.
While the end of the general solicitation ban opens a lot of new doors, it isn’t devoid of downsides.
- Verifying accredited investors: One important part of the new general solicitation option involves the rule that only accredited investors are allowed to participate. While there are a variety of institutions that fall under this distinction, individuals must either have a net worth in excess of $1 million (excluding the value of their primary residences), or possess a yearly income exceeding $200,000. Under the new rules, it’s up to the issuer of stock to verify a potential investor’s accreditation. This can be done through a number of means, such as reviewing an investor’s tax information and bank and brokerage statements. It does involve a great deal of effort on the part of the issuer.
- Costs: While a small business does avoid paying hefty fees to an investment firm, general solicitation does come with costs, particularly legal ones, as you’ll want to be sure that all documentation is straight and that all investors are properly checked for accreditation.
- Giving up stock: There are clear benefits to selling parts of your company, but there can also be downsides. Remember — you do have to answer to your shareholders. And the more shareholders you have, the more meetings, votes, and work you take on.
- Exit strategy: Smart investors will often ask about your exit strategy, and saying that you hope to be acquired by Google might not go over well. There’s a possibility that shareholders will want to go public. Consider your options carefully.
- Scams: The biggest criticism leveled at the law has been centered on its potential to lead to a lot of scams as companies may not have to undergo as much due diligence. Much of that task has been placed upon the investor. This is why it will be very important for investors to gather as much information about a company seeking funds as possible.
In the end, what we’re left with is a huge opportunity for small businesses, accompanied by equally massive responsibilities and liabilities. But when it comes right down to it, isn’t the risk of opportunity always partnered with the troublesome burden of obligation? Isn’t that part of what makes business so exciting?
Nicolas Gremion is the CEO of Free-eBooks, the Internet’s #1 online source for free eBook downloads, resources, and authors. Nicolas is a culturally curious traveler and entrepreneur who lives in Costa Rica with his wife and his dog, Frankie.