Thoughts on the JOBS Act (or, Coming Soon: More Liquidity In The Private Markets)

Written by Paul on June 15th, 2012

The JOBS Act is a hefty bill with a number of key points but, for the purposes of early stage tech startups, there are two material items that will drive the increased liquidity of the private markets:

  1. The JOBS Act legalizes crowdfunding. This means that the average person will now be able to invest up to 10% of their yearly income or $10,000 (whichever is less) in exchange for an equity stake. Startups can raise up to $1M per year (or $2M per year if they release audited financials) — this is more than enough for most internet startups today. Overall, this gives early stage startups access to more potential funding sources (but will likely cause the market to become crowded with startups that might not ordinarily pass the bar for experienced angels and VCs).
  2. The JOBS Act raises the cap on private shareholders from 500 to 2,000. In the past, fast growing tech companies sometimes found themselves up against the 500 private shareholder limit which put them in the position of going to the public markets early instead of dealing with the  (expensive and time consuming) alternatives. This gives the founders breathing room they might need to mature the company a bit further, if they want it.

By lifting the cap on the private shareholder limit, we’ll certainly see private secondary markets (such as SecondMarket) benefit. The less obvious part is that crowdfunders and “superangel” funds (such as 500 Startups) may benefit as well.

Consider the scenario where a company has raised $100K from crowdfunders roughly six months ago and now approaches an early-stage VC. In this new round, it may make sense for some of the crowdfunders to sell their positions to the new VC (or other investors) in the new round — particularly if the crowdfunders don’t plan to make follow-on investments and/or want liquidity a little earlier. The crowdfunder gets to make some upside on their money, the new investor can take a slightly larger stake and the founder doesn’t have to dilute any more than necessary for the new round.

Now let’s suppose that a few years have passed and the company wants to raise an even larger round (for the sake of this example, let’s assume the company’s doing OK and the prospects look good). The existing investors (again, crowdfunders and some early stage VCs) may be open to selling some portion of their positions to the new investors, presumably later-stage VCs that may also have a newer fund (read: they can afford to wait longer for the company’s exit. The reason for this is a separate and longer conversation but, in the case of venture funds, there’s sometimes a risk/reward calculation that might justify selling assets sooner rather than later. Read up on IRR to learn a little more.).

Summary: the JOBS Act will increase the liquidity of the private markets. And this probably is a good thing.

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