Jumpstart Our Business Startups Act a powerful new tool for raising capital—crowd funding

Here is an article in the WSJ that discusses the Obama Administration’s new “Jumpstart” program for small business financing.

When was the last time you ever saw a government program that actually worked for small business?

The Wall Street Journal – Business

THE MONEY GAME

Doing Equity Crowd Funding Right

Small businesses are getting a powerful new financing tool. But there are plenty of pitfalls.
By
Javier Espinoza
Updated May 18, 2012 1:59 p.m. ET

Small businesses are about to get a powerful new tool for raising capital—crowd funding.

Under the recently passed Jumpstart Our Business Startups Act, small firms will be allowed to sell equity stakes online to large numbers of investors, just as some companies now solicit funds on platforms like Kickstarter.com. And businesses won’t face the usual rules and red tape that come with larger equity offerings. (Read the text of the act at http://www.gpo.gov/fdsys/pkg/BILLS-112hr3606enr/pdf/BILLS-112hr3606enr.pdf.)

Even though the process will be simpler, there are a lot of nuances and potential pitfalls companies will need to keep in mind. We asked experts for their best advice and biggest caveats.

Choosing a Platform

The easiest way to offer stock online will be to use an existing platform like Kickstarter, experts say. A few sites have even handled crowd-based equity sales using different methods, such as permitting only sophisticated investors to buy shares.

But after the JOBS Act takes effect later this year or in 2013, many new sites will likely enter the market. How can you tell what’s the best choice?

David Millard of law firm Barnes & Thornburg LLP in Indianapolis recommends carrying out extreme diligence on any site you might use. “You want to make sure that the platforms are not fly by night, they satisfy the legal obligations” imposed by the Securities and Exchange Commission, he explains.

Of course, he says, just because a site has a good pedigree doesn’t mean it will take hold as the industry standard: “In the tech world, the tried, true and established can become irrelevant and passé overnight.”

Valuing the Company

Under the new rules, businesses will be able raise up to $1 million annually, and most small investors can give up to $2,000 total. But how do you decide what your company is worth? And how big of a stake should you sell?

A common mistake that small-business owners make, experts say, is to give away too much of their equity when they are at their initial stages of raising capital.

“You started your business to keep as much equity as you could, so you should work hard to do that,” says Dave Lavinsky, president of Growthink Inc, a business-planning firm and investment bank.

Michael Bush, a small-business adviser in San Francisco, recommends offering less than 10% of equity. As for valuation, he offers a rule of thumb: Figure out how much annual revenue you expect your company to bring in two years after raising the capital. Then value the business at one to two times that number.

The First Donors

One of the biggest changes in the new rules is removing limits on who can invest. Unlike regular stock offerings, crowd offerings are open to people of any wealth level, and companies can reach out to them directly through social networks and other venues. But that doesn’t remove a very basic hurdle: Lots of people won’t want to be the first on board.

“Anyone who considers funding you knows exactly how much you raised already,” says Mr. Lavinsky. If investors “go to the site, and you have zero dollars raised, [they] are going to be skeptical.”

One solution is to tap your existing customer base. “Nurture your customer base and have loyal customers,” Mr. Lavinsky says. “When it comes to crowd funding, you will already have an existing relationship with those people.”

Companies might also consider turning to suppliers as potential stockholders. Still, some experts recommend caution, since investors will have access to the financial statement a company files with the SEC.

“Business owners should think about whether or not they want their suppliers and vendors to have access to sensitive information like margins and earnings,” says John M. Torrens, a professor of entrepreneurial practice at Syracuse University’s Martin J. Whitman School of Management.

Informing Investors

Under the new rules, small businesses don’t have many reporting obligations.

Before they sell stock, they must file financial statements with the SEC and disclose any risks related to the offering, says Mr. Lavinsky. They also need to make available to potential investors their income-tax returns for the most recent year, as well as certified financial statements. Aside from some other rules aimed at very large investors, that’s essentially it.

Still, experts advise that it’s a good idea to go beyond those basics. For one thing, says Mr. Bush, small companies should be specific about how they plan to use the funds that they raise from investors.

“If someone asks you how you’re going to use the money, you should be able to be very specific and provide a lot of details,” Mr. Bush says. “You don’t want to say general things like, ‘to buy new equipment.’ ”

Experts also think that it’s a good idea to give investors regular updates every three months or so, perhaps in the form of a webcast or an email newsletter.

“Let them know how the business is doing, where you’ve been having some trouble, what you’re going to do to mitigate that trouble” and other important points, says Mr. Bush.

It’s also important to spell out those ground rules early on. “Let them know that you will be providing updates this way prior to getting the money,” Mr. Bush says. “You will not be returning phone calls because you need to focus on your business.”

Mr. Espinoza is a London-based staff reporter for The Wall Street Journal Europe. He can be reached at javier.espinoza@wsj.com.

GOOD LUCK !!!

Doing Equity Crowd Funding Right? – Doubtful