How will the JOBS Act Bring Capital to Small Business and what are the Risks?

By Charley Moore | April 9, 2012

President Obama signing the JOBS Act into law on Thursday, April 5th

The JOBS Act of 2012 — signed into law by President Obama yesterday — is an encouraging example of bi-partisan cooperation between Congress and the White House.

The Jumpstart Our Business Startups Act (or JOBS Act) sailed through both houses of Congress and is intended chiefly to increase small businesses’ ability to raise capital. So, exactly how will the JOBS Act do this? And what are the risks?

Let’s turn first to Scott Gerber of Time Magazine:

The JOBS Act reduces many of the regulatory barriers that have, up to this point, made it nearly impossible for young startups to raise much-needed capital from investors. If hundreds of Members of Congress and thousands of young American entrepreneurs, myself included, are correct — and I believe we are — this historic moment is going to redefine business as we know it.

Among other capital formation measures, including the expansion of mini-IPOs, the amended JOBS Act includes an edited version of Congressman Patrick McHenry’s “crowd funding bill,” which allows startups and small businesses to raise up to $1 million annually through a number of small-dollar donations using web-based crowdfunding platforms.

So what’s “crowdfunding”? Before the JOBS Act, only “accredited investors” were allowed to invest in startups (usually in hefty sums). But now? We can all be venture capitalists. The idea is that instead of going after a few giant checks, startups can now go after hundreds and hundreds of smaller ones, raising the same amount of capital. Think of it as Kickstarter for small businesses.

And while the idea of macro-investing is certainly enticing, it’s not without it’s detractors. Here’s Andrew Ross Sorkin:

Its goal is noble: start-ups and small businesses are the lifeblood of our economy, and it is hard to argue with helping entrepreneurs build businesses and hire employees.

However, the legislation, in the name of creating jobs, dismantles some of the most basic protections for the most susceptible investors apt to be drawn into get-rich-quick scams and too-good-to-be-true investment “opportunities.

In other words, accredited investors are more capable of spotting the sort of accounting chicanery used by unscrupulous businesses and should be more equipped to separate quality investments from risky ones. While they’re not always right (Sorkin reminds us Groupon’s stock value has dipped significantly), they have the expertise and knowledge to make sound bets and the reserves recover from loses.

There’s also the worry is scammers may exploit the legislation for a quick buck:

Where there’s money, there’s fraud. Just as there will be emergent properties that help startups thanks to the JOBS Act, there will be unintended consequences. Several groups are forming up to come up with ways new crowdfunded businesses can self-regulate. This is critical, as even now the JOBS Act isn’t fully baked regarding the best ways to prevent crowdfund investors from getting bilked. There’s a 270-day regulation-writing period that starts today, during which this is all supposed to get sorted out. It won’t be easy, and it may not be possible to foresee all the clever ways scammers will be able to rip people off.

But amid these worries and risks, the fact remains that more people can invest in small businesses they believe in without the business owners themselves going into massive personal debt to get their companies moving. Even though most Americans aren’t accredited investors, everyone realizes that investing in a business is never a sure thing.

As for which businesses stand to gain, Slate’s Will Oremus says:

They’ll be startups and young businesses that have growth potential, but not on a large enough scale to attract venture capital: the environmentally friendly flip-flop maker in Seattle; the custom candy maker in Boise, Idaho…[companies] too risky a bet for the banks but perfect for small-time investors, who are willing to lose a few thousand dollars for the chance of a big return—or just to support a business they admire and might even use. In short, they’ll be the type of startups that already attract donors on crowdfunding sites such as Kickstarter—only now the money will flow more readily, because the donors stand to gain as well.

Tangible moments of bi-partisanship in Washington are like panda bears: elusive, rare, and usually beautiful. And while the JOBS Act has its risks and its detractors, the intention — to give startups and small businesses new ways to raise capital, grow their companies, and hire new employees — is one worth celebrating.