How the JOBS Act Levels the Playing Field for Small Businesses

In Silicon Valley, startups are often synonymous with venture capital. We hear a lot about new businesses with no revenue — certainly no profits to speak of — raising millions of dollars from millionaire and billionaire investors. But tech companies are not the only kinds of startups that need capital — main street small businesses need investment, too, if they are to achieve their dreams of building lasting businesses that create jobs.

Until this year, only the wealthiest in America could invest in private companies, creating an unlevel playing field for small businesses that could benefit from smaller cash infusions to grow their businesses. Why the disparity?

The Securities and Exchange Commission (“SEC”) has always been wary of unscrupulous companies taking advantage of investors who lack the information or the resources to weather the volatility inherent in equity investments. After the stock market crash of 1929, the SEC decided that everyday Americans needed protection from bad investments and enacted laws that have, to this day, effectively prevented all but the top 3% of our country’s population from investing in private equity.

While well-intentioned, SEC’s rules closed off the private market to all but the already-wealthy. This meant that many small business owners who sold parts of their company to their friends and family were breaking the law. In poor minority communities such as the Bayview, this meant that business owners have severely limited options for capitalizing their businesses, relying on their own meager savings and taking on personal debt at high interest rates — if they could even convince a bank to lend to them. Given their economically disadvantaged starting point, these options often fall short of providing an adequate infusion of capital necessary for even a modest small business to scale. For example, while $10,000 is needed for restaurant to buy a walk-in freezer, ensuring that it has enough inventory to meet customer demand and providing substantial savings on shopping costs, that amount is out of reach for most aspiring poor and minority business owners.

In a move that will begin to help level the playing field for disadvantaged business owners, Title III of the JOBS Act would enable small business owners to raise up to $1 million in securities from anyone — not just accredited investors — over a twelve month period through a website called a funding portal in amounts anywhere from $2,000 to $100,000 over that same period, subject to the investor’s annual incomes and net worth. While initially not favorable to this or any type of crowdfunding because of the risk of fraud, the SEC has seen that crowdfunding vehicles have created minimal instances of fraud, leading them to finally come around to promulgate rules under Title III that will allow businesses to start raising capital via funding portals as of May 16, 2016.

While Silicon Valley is not the target audience for Title III, small businesses stand to gain the most from such financing. Unlike raising money from accredited investors, which requires either pre-existing connections with the top 3% or compelling in-person pitch to that audience, Title III crowdfunding is conducted through a funding portal, meaning, a company can sell its shares to anyone who has access to an internet connection. In addition, while a potential investor hearing a company’s in-person pitch may make investment decisions based on unconscious or implicit biases about the company’s founders, Title III crowdfunding places the focus on the business, rather than the business owner.

To get initial interest from potential investors for Title III crowdfunding, a business owner must establish strong connections with its community. In communities that are insular and tight-knit, many existing businesses will have a ready pool of potential investors before they offer a single security to the public. These pre-existing connections may be critical to the success of a crowdfunding campaign. Women, who like minorities, have historically been less likely to receive funding from venture capitalists and angels — the so-called “accredited investors” — have been more successful than men at crowdfunding campaigns because they have tighter knit networks and are more likely to appeal to investors on an emotional level. Small businesses may find success under Title III for the same reasons.

Accredited investors may not find it interesting to invest merely $2,000 to $100,000, but even a small initial investment can amount to a large amount of money over time. In 1998, Andy Bechtolsheim invested $100,000 in Google. He is now worth $3.5 billion, much of that money from his initial investment in Google. Even if he invested only $2,000, his net worth would still be in the billion-dollar range. Although most companies will not be the new Google, for the first time ever, anyone can invest in a company at the stage where growth can be the most exponential.

Onki Kwan is a business and securities lawyer and the co-founder of neighborcapital.org, which explores equity-based crowdfunding for socially-minded companies in San Francisco. She is also the Community Development Director at Bayview/Hunters Point Community Legal, a legal aid nonprofit in San Francisco which helps businesses in its service areas raise capital.