Thanks to Title II of the Jumpstart Our Business Startups Act, which went into effect in September, private businesses can now solicit the public for seed investments.
Before the law’s passage and because of the Securities Act of 1933, businesses were prohibited from asking the public for money.
“It was an 80-year-old securities law that was really outdated and was meant to protect the little old lady from the bad man trying to sell fake stock certificates,” said Ruth Hedges, CEO of Unismart Capital Software Inc. and Crowdfunding Roadmap, which held its second annual crowdfunding conference at M Resort on Oct. 14-16.
Effective immediately, crowdfunding is open to businesses as a means of netting investors and raising equity. Previously, it could be used only to collect donations and donors could only be rewarded with gifts, not equity.
Though crowdfunding is now legal, the U.S. Securities and Exchange Commission still has work to do, said Justin McVay, director of the Startup Center at the University of Nevada, Las Vegas.
The center is a free community resource, financed by the Small Business Association, that is headquartered at UNLV but has satellite offices around town. Since it began in April, it has helped about 90 clients raise nearly $3 million in capital.
Previously investors had to be certified by the SEC as having a net worth of more than $1 million, a trust of more than $5 million, or making a single income of $200,000 for the past two years or a combined income of $300,000 for the same time period.
The requirement is meant to protect investors from themselves, McVay said. The SEC doesn’t want people putting their life savings into a bad investment when the reality is that 80 to 90 percent of startups fail and after the initial startup period, 50 percent of small businesses fail.
Since crowdfunding relies on small donations, sometime totaling $5 or $10 or $20 dollars, the rules for investing will have to be adjusted to allow for a lower threshold, perhaps a subset of an accredited investor that is authorized only to invest in crowdfunding.
Startups and small businesses often have trouble landing traditional bank financing because they haven’t been around long enough, don’t have proof of income and have no collateral to offer banks.
For these people, crowdfunding can be a good option.
On the flip side of crowdfunding is peer-to-peer lending.
“This is another way of crowdsourcing, but for debt not equity,” McVay said.
Lending Club and Prosper are two of the best-known sites, which allow people to lend to other people but collect interest rates that are better than what banks offer. Both allow loans of up to $35,000.
Debtors on Lending Club reveal their credit scores and specify what interest rate they promise to repay over a specified period of time. The website has facilitated $2.7 billion in loans since its inception in 2007.
As with any other loan, default occurs, so McVay said an investor’s best bet is to minimize risk by lending small amounts of money to several businesses, rather than a large amount to one.
Peer-to-peer lending groups are typically backed by banks that will take over the loans in case the websites fail, and use the same collection methods as traditional money lending.
With these new sources of income available, McVay stresses how important it is to have a solid product or service before seeking capital.
“Getting access to capital is one of the most important aspects of starting a new business,” McVay said, “But there are a lot of things you have to do before you are ready to talk to someone about money.”
Entrepreneurs still have to explain their product or service and the need for it. Business ideas should identify a problem and fix it.
Above all, talking to customers is key to developing a minimum viable product, the most basic form of the product that can be launched and improved on over time.