April 3, 2012

The Risks of the JOBS Act

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Cornell’s Entrepreneurial community has been thriving; between talks of an impending co-working space in the works, the tech campus extravaganza and Entrepreneurship@Cornell’s Celebration events, the future startup CEOs of the Ithaca community are seeing opportunities that haven’t existed before. And now, a new bill might add to the excitement surrounding the Cornell community.President Obama is expected to sign the JOBS act, a bill that would seriously loosen up regulation for startups, SME’s (Small to Medium sized Enterprises) and companies with under $1 billion in annual revenue. Some of the stipulations in the bill allow companies earning under $1 billion to IPO without completely complying with SEC mandates for five years. Furthermore, it allows companies to raise capital from up to 1,000 investors, rather than the previously stipulated 500, without going public. The bill also states that companies can solicit for investors, something that they were not previously allowed to do — and something that may compromise the information they disseminate to individuals who might invest. And perhaps the most disputed consequence of the bill allows unaccredited investors to contribute up to $10,000 or 10 percent of their annual income to startups as angel investments.But what does this mean? Is it a good thing or bad thing? Well for job growth it makes sense — it allows companies to raise capital more easily and helps make America a more attractive place to start a company. While corporate tax rates are still far too high, it is now a place where starting a company is becoming a matter of finding enough individuals who are willing to invest a few thousand dollars in an entrepreneur who they think might become the next Dell, Zuckerberg or Gates. It also makes it easier for companies to go public, something that has been advocated for years. It is a bit unreasonable that companies with a $2 billion market cap have had to follow the same laws as those with a market cap over $400 billion. But this is also a scary law, one that leaves uneducated investors incredibly vulnerable, especially those whom are excited to invest in startups. Why might a startup turn to crowdfunding (raising money from a bunch of unaccredited investors rather than one or two venture capitalists)? Is it because that startup wasn’t successful in raising money from an established firm? Was it because that startup simply couldn’t convince a group of professionals with ample industry experience that its business model would eventually lead to scalable profitability? Possibly, and even likely.The best startups, the next Zuckerbergs, would not turn to crowdfunding because it makes more sense to raise money from a venture capitalist or an established angel. Not all investments are equal, and with an investment, a venture capitalist also brings experience, connections and strong advice. A crowdfunding model doesn’t provide that. Further, it is always harder to deal with a large number of investors than it is with a small group who also sits on the board. This means that most startups that do turn to crowdfunding will do so as a last resort, meaning they will likely have questionable track records. These new, unaccredited investors, excited to have the opportunity to now invest, won’t get access to the best deals — these small investments, despite being under $10,000, might really become a waste of money temporarily paying the salaries of unproven entrepreneurs.The JOBS act is going to create jobs — it will also have its success stories. In all likelihood a new company will eventually IPO or make a strong exit as a result of raising capital from a new, alternative route. In fact, many startups who have raised seed funding are having a much harder time raising a series A round, and these will be the companies in the best position to find a new means of raising capital. But for every success story there will likely be pitfalls and major losses incurred by inexperienced investors who will ultimately feel used. The JOBS act — while interesting and exciting — is also scary.

Ali Hamed is a sophomore in the college of Agriculture and Life Sciences. He may be reached at abh68@cornell.edu. Guest Room appears periodically this semester.

Original Author: Ali Hamed