The JOBS Act may have been passed in 2012, but Title III - one of the sections with the biggest impact - goes into effect on Monday.
Beginning May 16th, regular investors will be able to buy shares of small businesses using crowdfunding portals. Until now, only wealthy investors (so called accredited investors who earned more than $200,000 a year or had a net worth of over $1 million) were able to invest in private companies.
Regulators have kept small companies from raising capital until now as an attempt to protect investors. Small company investments are often higher risk and have less transparency than larger companies that are available on public stock markets. But it is small companies that are the growth engine of the American economy and many small business have had problems raising money to stay afloat.
Title III allows companies to raise up to $1 million a year from regular investors with some additional reporting requirements. Investors have limits on how much they can invest. Individuals with income or net worth less than $100,000 can invest the greater of $2000 or 5% of their annual income or net worth (whichever is lower).
Portals will be created to help match the companies with investors. These portals are required to be registered broker-dealers with FINRA and the SEC.
Several existing companies are hoping to position themselves as portals under the new regulation.
AngelList has previously helped connect wealthy investors with companies. They plan to partner with Republic.co to enable regular investors to partner alongside wealthy investors in small companies.
Kickstarter is one of the most popular is "rewards-based" crowdfunding. Investors don't own equity in return for their investment, but usually get the product or other benefits from the company. A company spokesman said they don't currently plan to add securities to its offerings.
Royalty Exchange has allowed individual investors to buy cash income streams from musicians or holders of intellectual property. They currently use an auction format to sell royalties from artists like the Eurythmics or classic photos of Marilyn Monroe, but intend to use some of the recent crowdfunding regulations to allow investors to buy smaller portions of the royalty streams.
Supporters are expecting adoption of Title III to be slow. Portals are still in the process of being approved and small businesses will have to adjust to higher costs and reporting requirements. They will be required to publicly file annual financial statements that have been reviewed by an independent accountant, or in some cases, audited.
Investors who are used to buying and selling stocks on public exchanges need to be aware that the holding periods will likely be much longer for small companies seeking to grow. Although some investors may be looking for the next Facebook, they need to be aware that there is risk the companies are more speculative and may not generate cash flow.
Intelligent speculation may be right for those willing to lose their investment. But several investors have started turning to royalties as a means to find high yielding cash flow. These are investments that generate cash each and every year. Practical investment advice about buying at the right price holds true, but sites like Royalty Exchange provide historical payment information for investors to make estimates of future cash flows. [To see the current auctions, click here.]
While Title III may bring headlines next week, adoption will take some time. It's intent is to serve an important gap for entrepreneurs to fund the growth their businesses. Yet, it will take some time for entrepreneurs, investors and portals to build the trust that investors will have the transparency and success compared to alternative investments.