A key piece of federal legislation that would open up equity crowdfunding to everyday Americans, helping small business owners obtain financing and potentially creating new jobs, is moving closer to fruition.
The Securities and Exchange Commission (SEC) plans to take final action on Title III of the JOBS Act by October 2015, nearly three years after the act was signed into law by President Barack Obama, according to the Office of Information and Regulatory Affairs.
What does this mean for small business owners? Well, once Title III is finalized, it means anyone — not just accredited or wealthy investors — will be able to invest in privately owned businesses via equity crowdfunding.
Right now, small businesses can raise money through crowdfunding sites such as Kickstarter and Indiegogo in exchange for rewards or gifts, but under Title III, they’ll be allowed to crowdfund up to $1 million per year in exchange for equity ownership.
NerdWallet interviewed several business professors to get their thoughts on what the new rules could mean for small business owners. Here’s what they had to say.
‘It might not make economic sense, even if they are eligible’
Dan Olszewski, director of the Weinert Center for Entrepreneurship at the Wisconsin School of Business
While some think Title III will radically change entrepreneurship, Olszewski says he thinks the impact on small business owners will likely be minor, as many of them will not be willing to give up ownership in their company.“Small business owners may appreciate the additional funding options, but it is also true that the thought of having additional co-owners and potentially a good number of them will be very unattractive to the typical small business owner,” says Olszewski.
Small business owners, he says, typically prefer to use personal savings, credit cards or loans to finance their business, which allows them to potentially keep 100% equity. “This is important to most small business owners and will likely minimize the attractiveness of the new crowdfunding options.”
If a business is raising over $500,000, it must supply audited financials to investors, and if it is raising over $100,000, it must supply financials that have been reviewed by an accountant, as Olszewski points out.
“Many small business owners don’t want to spend the money to get their financials audited by an accountant, and given the legal cost of an SEC filing and accounting fees, it might not make economic sense, even if they are eligible,” he says.
Another aspect to consider is that non-accredited investors may not understand the risk involved in these types of investments, which are far riskier than more traditional options, Olszewski says.
“It is very important that the investor only limits their investment size to an amount they are prepared to lose if the idea doesn’t result in a successful business,” he says.
‘It’s not free money by any stretch’
Dr. Douglas Lyon, professor of engineering entrepreneurship at Fairfield University
Heavy regulation will turn off many small business owners and entrepreneurs to equity crowdfunding, says Lyon.
“You will still not only be beholden to your investors, but you will be beholden to a regulatory requirement,” says Lyon. “And that regulation on crowdfunding will be onerous because of the amount of reporting that will be needed. So it’s not free money by any stretch. And yet, it’s very nice to have another financing option than, you know, friends, family and fools.”
Lyon says entrepreneurs should be careful before raising money via equity crowdfunding, and recommends seeking professional help before making any decisions.
“When I look at Title III, I see a 585-page document that few people have read cover to cover, including me, and that tells me there’s nothing simple about the SEC regulations in this matter,” says Lyon. “Whenever the government gets involved with all this regulation, your average entrepreneur really doesn’t understand what they’re getting into. They need to have professional help, or they can get themselves into serious trouble. It worries me a little bit.
“I really don’t see how this is going to be easy money for anybody — I get worried that some mom-and-pop is going to lose their savings, and I think that’s why there’s all this regulation coming down the pipe,” Lyon says.
The legislation ‘needs to take steps to protect investors’
Dr. Victor Perotti, professor at the Saunders College of Business at the Rochester Institute of Technology
While Perotti says he feels the implementation of Title III will change the small business financing landscape, he says the key element for Title III’s success will be how it protects investors.
“I think at the outset we will see a lot of participation by non-accredited investors,” says Perotti. “The long-term success of this provision will be judged based on how smoothly these investments are handled, and especially how complaints and challenges are handled.
“While no system will eliminate fraud, this legislation does need to take steps to protect and create recourse for investors who are not treated fairly — this is the biggest risk of all,” Perotti says.
For more information about how to start and run a business, visit NerdWallet’s Small Business Guide. For free, personalized answers to questions about starting and financing your business, visit the Small Business section of NerdWallet’s Ask an Advisor page.
Top image via iStock. Images of professors courtesy of the subjects.