How Crowdfunding Will Change The World, Part 2: What Is The JOBS Act And What Does It Do?

I’ve become a very active investor and advisor to start-ups over the past two years, and I firmly believe one piece of legislation is going to fundamentally change business, investing, and entrepreneurship. In fact, I think it might actually unleash a torrent of changes that impacts the whole world in a very positive way. This piece is part 2 of a 5 part series about Crowdfunding, the JOBS Act, and what all of this means to you. Part 1 is here.

What Is The JOBS Act?

In short, the JOBS Act is legislation passed by Congress that allows companies to publicly state that they are raising money, and then take that money from anyone in exchange for equity. As of this moment, it is currently only legal for a company to privately solicit investments from what are called “accredited investors,” which are defined as people who make more than 200k a year, or have more than 1 million in assets. Basically, only rich people are currently allowed in invest in start-ups, and the JOBS Act gives everyone that chance. This is the legislation that made equity crowdfunding legal.

I Don’t Get It, Isn’t This Just Like Kickstarter or IndieGogo?

No. On those platforms, you are giving a company or person money, and they are promising to either give you a product (like a watch), or do something (like make a movie). It is not a legally binding agreement, and you have no legal recourse against them if they just take the money and run.

Equity crowdfunding is completely different. You are giving a company money, and they are giving you ownership (equity) in return. These deals are run through licensed broker/dealers, and the company now has fiduciary responsibilities to you as an investor, and you have a legal claim on them. Think of it as similar to buying stock (it’s NOT the same thing, but close enough for this explanation).

For example, if you backed the Pebble watch or “Veronica Mars” movie on Kickstarter, at best you get whatever prize they promised you (and if they don’t deliver, all you can do it write a harshly worded review on your Tumblr and thats it). You don’t get to share in the profits either endeavor makes.

But if you invest in a start-up like Hinge on a platform like Angellist, and they end up blowing up and becoming the next big thing, you get to profit right along with them. Not only that, but they can’t just not give you your money if they get bought or start paying dividends of whatever. The full force of American financial regulations are behind you.

There are three basic types of crowd funding platforms; rewards (like Kickstarter), equity (like Angellist) and lending (like Kiva), and they are very different. In Part 5 I’ll cover all the different type of platforms, but understand that allowing people to buy equity in an early stage company this is a major and fundamental shift in the way that capital is allocated in the world financial system. This is a BIG DEAL (and I explain why in parts 3 & 4).

So The JOBS Act Gives Me The Chance To Get In Early On The Next Facebook or Instagram?

Yes. For the past 80 years, the only people who had the chance to invest in start-ups and early stage companies were the wealthy or the well-connected. The JOBS Act makes it possible for anyone to get the same access to early stage investing.

Of course, the company has to make themselves open to equity crowd investment, which not all will. But the JOBS Act gives them the chance to do that, whereas they were legally barred from both publicly telling people they were raising money, and from taking money from non-rich people.

How Much Can I Invest?

The JOBS Act lets you invest a percentage of your income or assets per year. You can split it any way you want though; it could all go to one company, or spread across a bunch of companies. Here’s how it works:

Anyone can invest at least $2,000/year.

If an investor makes less than $100,000/year or has less than $100,000 in assets, they can invest 5% of that each year. For example, if I make $60,000/year, I will be able to invest $3,000/year in startups.

If an investor makes less than $200,000/year or has less than $200,000 in assets, they can invest 10% of that each year. For example, if I make $120,000/year, I can invest $12,000/year in startups.

If an investor makes more than $200,000/year or has more than $1 million in assets, they are considered an “accredited investor,” and can basically invest as much as they want. (NOTE: These people can currently invest as much as they want anyway, the JOBS Act doesn’t change this).

How Do They Know What My Salary Is? Can I Just Lie And Say Whatever?

Yeah probably, at least right now. As of today, the regulations for accrediting investors are pretty much just asking you (it’s literally called “self-certifying”). When I signed up for all the various platforms that let accredited investors put money in start-ups (Angellist, WeFunder, etc), they just had me check some boxes and digitally sign things (a few of the platforms called me).

But the JOBS Act is changing all of that, and making the standard much higher for accrediting investors, even the new types. But in the typical way that Congress write legislation, they don’t actually say what the new standards are, they leave it up to the SEC to figure out. And the SEC basically said, “We don’t know precisely what to do, so we’ll just make it way harder to cover our asses.” Seriously.

I wouldn’t worry too much about it though, when the crowd funding platforms open up to the general public, I think they’ll all have some pretty good solutions in place.

When Can I Start Investing?

No one is precisely sure. I know, right? How the fuck can I not be sure when LEGISLATION takes effect?

Well, though Congress mandated that the SEC implement the JOBS Act compliance regulations by January 2013, the SEC did not, because its a bureaucracy and bureaucracy don’t give a fuck about you or me. So as of right now, no one knows when the JOBS Act will fully take effect, but most educated guesses have it as the summer of 2014. I do know that in a few weeks, September 24th, companies will be able to start general solicitation for raising money. They just can only take money from accredited investors. Stupid I know, welcome to government.

Where Can I Invest?

There are a bunch of equity crowd funding platforms that already exist for accredited investors, and most of those will open up to the general public as soon as they can. I will cover all of these platforms in depth in Part 5.

How Do I Know My Money Is Safe? What About Fraud?

First off, you are thinking about investing in a goddamn start-up company, this is an inherently risky endeavor. Know that.

But yes, fraud is something totally different, and in my opinion, the JOBS Act does a pretty good job in trying to reduce fraud (to the extent that it actually goes too far and makes it a little too hard to invest). Whatever, the point is: yes, there will be fraud, just like there is in pretty much all aspects of human financial endeavors, but I think it should be pretty small and limited.

Here’s a great rule of thumb for avoiding fraud in the crowd funding space: Stick to the platforms that have been around for a long time, are well established, and that everyone knows and uses. Avoid all other places that crowd fund. And definitely ignore all things that are obviously too good to be true. If you do that, you won’t get swindled.

Why? Here’s why: The large established platforms will not only have a track record of successful operation, and the owners will be known and vetted, but the way the equity crowd funding system works, setting up large scale frauds doesn’t pay. The platforms don’t make much money based off fees they take from you when you put money in–they make real money by being the actual investor in the start-up (they pool all the crowdfunders and operate the invest as an LLC, explained here).

In short: They make their money on their ability to not only create trust from investors and start-ups, but by sticking around until the start-ups get really big and cash out (either via IPO, or acquisition, or other larger public offering). Platforms like WeFunder only make money when you make money. Fraud doesn’t pay for them.

BUT, if you invest through the little places that create a really high churn rate and don’t properly vet start-ups, and take either a percentage of the raise or even worse–are brand new and unestablished–then you are exposing yourself to fraud.

NOTE: The worst frauds will be the spammers who claim to be operating under the JOBS Act, but are just straight up stealing money from you. Like the Nigerian 419 scams (“I am a Prince and I need your bank account number to help hide my wealth” type stuff). If you fall victim to those types of totally obvious, too-good-to-be-true scams, then that’s your problem as a person, and no regulations on earth will save you from your greed and stupidity.

That’s It? Surely Its More Complicated, Right?

Of course. Understand this is a super brief description, and that a full and complete discussion of all the aspects and intricacies of the JOBS Act would put you right the fuck to sleep. There is a reason I never went to Corporations of Financial Accounting Law classes in law school–this shit is BORING. Here’s a summary of the legislation written by Congressional Research Service.

This is Part 2 of 5. Once I finish this series, intend to compile it all, revise it, and turn it into a long post for other media outlets. Any comments, corrections, ideas or arguments are welcome: