After my post on the JOBS Act last night, I got an email from a friend with a good question. As I composed an answer, I realized it might be of general interest, so I’m putting it here.

My Friend Asks:

I’ve been sort of following the JOBS act over the past few months, and just saw your post. I’m trying to figure out how this will impact [redacted], and how to best align ourselves to benefit from the new law. One of David S. Rose‘s comments concerned me. He stated that several investors are of the opinion that going the crowdfunding route might make it harder to raise more traditional angel/VC money down the road, but he didn’t explain why. You know what he’s talking about?

The reason I ask is that when things are ready to actually push on [redacted], we’re likely going to need to raise $2-5M worth of investor money. However, being able to raise $50-150k in the near-term might make it a lot easier for us to get to that point (and also increase the odds that we’ll survive the ups-and-downs of the bootstrapping process). David’s a smart guy with a heck of a lot of experience, so if he’s making warnings like that I’d like to try and understand why he’s concerned, not just brush it off.

My Answer:

Looking at history, Rose is right. Traditionally, venture capitalists don’t want to invest in a company whose capital structure is cluttered up with a bunch of small individual investors. Having to get shareholder approval from dozens of Common stock shareholders is time-consuming and complicated.

But.

The passage of the JOBS Act means that thousands of startups are asking the same question you’re asking. I believe that norms will have to change.

I’m not a lawyer, but I think there’s a middle ground that would make both sides happy. Once the JOBS Act provisions take effect, round up the $50K-150K from individuals (including those who would not have passed the SEC’s “qualified investor” test). Take all of their investments and collect them into a single LLC with a single manager (not a company employee or close relative!) that everyone can trust. Move forward with building your business.

When the time comes to raise a Series A, the capital structure remains clean: founders, employees, and one LLC holding Common stock. You only need the signature of that LLC manager to issue new shares of Series A. I don’t think that’s going to turn away any venture investor who you’d want to have in your deal.

[Standard disclaimer about how this doesn't constitute legal advice and you should pay a good securities lawyer to set this up correctly.]

Now, you’ll have to protect those Common shareholders against cramdown and unnecessary dilution, but that’s not a new problem. And, again, as the JOBS Act ripples through the startup funding ecosystem, I hope that those norms change as well. VCs won’t ever grant full anti-dilution to these early Common investors, but I hope that some sort of reloading occurs… maybe something similar to what employees get, although perhaps at a lower ratio. There’s no sense in killing the geese that lay the golden eggs.

At the end of the day, the best way to prepare [redacted] for venture investment is to build great products and delight your customers. If that involves taking small individual investments… take the money.

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I was asked to write “a few sentences” about the JOBS Act for another website. Since I found myself with over 500 words, I decided to post it here.

In today’s political climate, it’s hard to believe that a major bipartisan reform has passed both houses of Congress and — as I type this on Wednesday night — is scheduled to be signed by the President tomorrow. The JOBS (Jumpstart Our Business Startups) Act is one of the first victories of a new class of politically-active entrepreneurs, angel investors, and venture capitalists. And, although no bill is perfect, the JOBS Act should lead to expansion opportunities for many small businesses… and, yes, to more jobs.

U.S. securities regulations are written for big companies. For successful ones, like GE and Apple. And for failed ones, like Enron and Worldcom. But little companies have to play by the same rules. That makes it incredibly difficult for small companies to raise capital, to reward their employees with equity instead of salary, and to build their businesses in the early years. The Kauffman Foundation has shown that all net new job growth since 1980 has come from companies less than five years old. The JOBS Act is aimed at helping precisely these companies.

Part of the act loosens some of the complex disclosure requirements which can be difficult for a fast-growing company to maintain when it exceeds 500 employees. It makes it legal for an entrepreneur to stand on stage and say “I’m trying to raise money” without violating SEC rules. These are good changes. It’s not appropriate to regulate a tiny company the same way we regulate GE.

Most controversially, the JOBS Act enables “crowdfunding.” Today, unless you meet the SEC’s “millionaire threshold,” you are forbidden to invest in private companies — that is, those companies who do not have their shares listed on a stock exchange like Nasdaq. Tomorrow, that will change. You will be able to invest up to 5 or 10% of your annual income (depending on income), up to $100,000/year, into a small private company.

And that doesn’t necessarily have to be a Georgia Tech startup creating a hot Internet security technology. It can be in your cousin’s landscaping business, or in the struggling Cuban restaurant down the street. The laws prohibiting these investments date back to 1933. It’s time to adapt them to current reality.

Will some people lose their investments? Absolutely. Will there be fraud? As surely as the sun rises in the east. But markets always involve risk (and, sadly, markets have always attracted a small number of fraudsters). I have a lot more faith in free markets that I do in SEC regulators trying to apply thousands of pages of regulations to small businesses that can’t afford platoons of lawyers on retainer.

Silicon Valley investors have played a big part in lobbying for the JOBS Act… but I think it will eventually have more of an impact on those of us who are happy to live in the rest of America. A startup in Silicon Valley can, eventually, always find money. That’s not true for a startup in Atlanta… or Albuquerque, or Alaska. Loosening the constraints and letting more Americans get involved in investment decisions will be a good step towards making more growth capital — and more growth — available to everyone.

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Earlier this week, I attended a set of company pitches by startups trying to raise venture capital money. I was wearing my investor hat, not my Georgia Tech hat.

The organizer asked for my feedback. I gave it to her. I figured it was worth sharing here, with the identifiable details REDACTED to protect the guilty:

The [COMPANY REDACTED] pitch was just atrocious. A parody of everything that an investor pitch is NOT supposed to be. I assume the CEO does a better job of pitching than the CFO. When you discovered the CEO wasn’t available, you should have scrubbed the company from the agenda and gone with your first alternate.

You’re welcome to share the remainder of this with [NAME REDACTED]; I don’t care enough to email him directly:

Don’t insult my intelligence by starting with two pages of “forward looking” and “safe harbor” disclaimers and saying “My lawyers say I have to do this.” If your lawyers say that, fire them and get better lawyers. You do NOT have to start with that.

You paid a graphic designer good money for your logo. Let them take a run at your charts. Endless endless boring pages of print too small to read, with information that’s more appropriate to a third or fourth meeting, not an introductory pitch.

You finally got to a compelling statement about seven slides and fifteen minutes into your pitch: [TAGLINE REDACTED]. Hey, it’s not bad. But you stepped on the tagline, barely pronounced it, then hurried on to more deadly dull corporate droning.

Didn’t you notice how everyone had pulled out iPhones/Blackberrys by that point? Or were congregating by the bar and talking to each other, not listening to you? Were you just not paying attention to your audience at all?

You brought props — yay! — but didn’t bring them out for half an hour, and then didn’t pass them around the audience? What was the point?

And then finding out you had a flight in 75 minutes, but you just had to give two more painful boring slides? Idiotic. Especially because you didn’t use those last two slides to ask for the sale. Are you raising a round? How big? How much is already spoken for? Who else is in? What sort of terms?

You went way over the time allocated, may have missed your flight, and allowed zero time for questions? Do you really expect someone to engage with you after such an insulting use of our time?

I think there’s a pony under all this horsepoop, but you did your best to conceal it. If [COMPANY REDACTED] were my company, I’d never let you speak in public again, and I’d never use that presentation deck again. As it was, you did a great job of convincing me to NOT take the next step in asking for a meeting, since I’m afraid I’d have to see the same presentation inflicted on my partners. No way!

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Panel competing with beluga whales at Venture Atlanta.

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Friday afternoon at ATDC. Ten pizzas evaporated in 20 minutes!

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