The Jump-Start Our Business Start-Ups (or JOBS) Act of 2012 was supposed to mean great opportunities for small business owners to raise capital and grow family-controlled businesses. At the time President Barack Obama called it "a potential game-changer" that would give them "access to a big, new pool of potential investors—namely, the American people."
The law was intended to allow small operations to raise money through crowdfunding, pretty much the same way people raise money with a GoFundMe type campaign or how companies use Kickstarter for specific projects.
Except, things didn't work out quite that way for either small businesses or small-time investors. New rules, called Reg CF (for crowdfunding), from the Securities and Exchange Commission were supposed to fix problems that had made the concept pretty much unworkable. But nine years after the law was passed, it has ended up favoring larger enterprises while strengthening the hold on business financing of Wall Street banks, Silicon Valley venture capitalists and other large financial players.
The law was a response to the Great Recession. Banks, after years of reckless practices, tightened lending standards even as they accepted taxpayer bailouts. The Federal Reserve noted in 2010 that many small businesses said they couldn't get credit even if they seemed credit-worthy.
"This was a bill that originated in a Republican-controlled House and it was designed to be a law that made access to capital easier," said Roger Royse, a corporate and securities lawyer in Palo Alto, Calif.
Then the bill hit the Democratic-controlled Senate."It changed from an ease-of-capital-raising bill to an investor protection bill," Royse added. After all, the government has to make sure that investors don't lose their savings to a risky small business, or at least so said the Senate Democrats who worked the bill over.
The practice is long-established. Going back to the 1934 creation of the SEC under President Franklin D. Roosevelt, a double focus on capital and investor protection has been standard.
Small Business Hurting
Even though the worst of the Great Recession had passed, the needs for business funding are eternal. The Federal Reserve in a 2019 report found while 48% of small businesses either had or obtained sufficient financing, 23% had a financing shortfall, and 29% might have unmet financing needs. Also,80% of small business owners wanted their enterprise to grow.
Regular investors sought good returns. Taking a flyer on small businesses was also more appealing as interest rates fell, making the return on fixed-income investments like safe corporate bonds and Treasury notes hardly enough for a cup of coffee. Meanwhile, big institutions and wealthy people kept gaining major profits from investments in hot companies.
The initial SEC regulations for the JOBS Act fell short. Companies could raise at most a tad more than $1 million. That wasn't enough money "to justify the cost" of complying with the rules, Royse said. Complying with the regulations was expensive.
There was also a $100,000 limit on the amount of capital an individual, no matter how well-heeled or savvy, could invest in a year. The same limit applied to institutions. That greatly reduced the total pool of money that might be available for small businesses.
The new regs increase the amount a business can raise to $5 million. That helps rationalize the company's costs. But it really doesn't fix the problems.
"The regs weren't necessarily designed for your brick-and-mortar mom-and-pop business to go out and raise capital," said Nick Mathews, CEO of Mainvest, one of the platforms that companies crowdfunding under the regulations might use.
No, they don't, but that is what the 2012 law was intended to do.
The regulations require detailed disclosures, not the kind most small businesses can explain in plain English. The accepted and generally tortured legalese the SEC prefers "requires an infrastructure comprised of financial, accounting, and legal professionals," said David Bissinger, a securities litigator and partner with Bissinger, Oshman & Williams in Houston. The lawyers, auditors, and other staff to check everything favors firms raising at least close to the $5 million limit under the JOBS Act.
"I just become skeptical," that companies with a valuation under $100 million can adequately perform the compliance and "whether that securities offering makes sense for anybody," Bissinger told DCReport.
The terms of getting capital are also challenging.
"Reg CF is designed for something like scalable businesses," Royse said, meaning companies that can grow fast and get big, with a large potential payoff for investors.
"They don't have to be Silicon Valley unicorns," he added, referring to hose firms valued at a billion dollars before they even sell stock to the public."But I think they have to be something with opportunities for growth."
Under the crowdfunding scenario, the company looking for money has to give something in return. It may be equity—a significant slice of the business. Equity financing often means that big and savvy institutions demand that the people who came up with the idea surrender control of their baby business and a huge share of future riches. That tends to keep wealth concentrated in the hands of the already rich.
That is in part what the JOBS act was intended to address – entrepreneurs not earning big financial rewards because of lack of access to capital to grow their business without giving up confiscatory amounts of ownership to venture capitalists.
Another approach substituted royalty financing or shared earnings arrangements, where investors get a cut of future profits, instead of providing equity ownership. "There are a lot of those out there, now," said Royse. "It's like really expensive debt."
According to Matthews, Small Business Administration-backed bank debt runs in the range of 7% annual interest. The more complicated sharing arrangements effectively translate into a 10% to 20% interest rate on the amount loaned, a steep expense when Treasurys pay a bit more than 1%, home mortgages go for as little as 1.75% and many people with good credit scores can pay under 10% on credit card debt.
In a down year when revenues shrink, the JOBS Act theory was that owners would pay out less in royalties or shared earnings, helping level out the often-volatile finances of small companies so they endure until better times return. In a good year, though, the payout gets much larger.
All this means that the system of raising money for new businesses remains heavily weighted in favor of the venture capitalists, the big Wall Street stock and bond writers and other big boys of finance. The big winners are institutional investors—pension funds, hedge funds, and private equity firms—that can get the investments they want and do their own form of crowdfunding. That is, crowding out the little people so they still keep the best investments for themselves.