Ordinary investors will soon get the chance to invest like venture capitalists, thanks to a new law intended to boost start-up companies.
But some experts say the law will help small businesses at the expense of investors. The Jumpstart Our Business Startups Act allows fledgling companies to raise up to $1 million per year by trolling the Internet for investors willing to take a flier on stock (or debt) in the business in advance of a conventional initial public offering. So-called crowd funding opens up a badly needed source of capital for start-ups. But, says Georgetown University professor James Angel, "crowd funding could easily turn into crowd fleecing" if investors can't sort legitimate opportunities from bad deals and outright scams.
Here's how the process will work: Companies will issue securities on online funding portals registered with the Securities and Exchange Commission, or through brokers. Investors will get information about the risks of the investment, the financial health of the company and how it expects to use the money raised. But you won't find a traditional prospectus -- or the level of disclosure traditionally found in one. It's up to the SEC to finalize the rules, due by the start of 2013.
Investors shouldn't jump at the chance to buy in. Only 45% of start-ups last five years, according to the Kauffman Foundation, which tracks entrepreneurship. The JOBS Act recognizes the risk by limiting the losses investors can suffer. Those with an annual income or net worth (likely excluding the value of a home) of less than $100,000 will only be able to invest the greater of $2,000 or 5% of their assets. Those above the $100,000 limit have more to lose -- their investment is capped at 10% of their income or net worth, up to $100,000. With a few exceptions, investors must hold the shares for 12 months. Expect secondary markets to crop up to trade shares.