How to Invest in Start-ups

Do you want to invest like a venture capitalist? Given the choice, would you rather wait for a company to grow to billions of dollars in market capitalization before investing? Or would you choose to take some added risk, and try your hand at crowdfunding a small business still on the "ground floor?"

If you choose to invest in the start-up, there's good news: The JOBS Act is finally the law of the land.

What is the JOBS Act and what does it do?

Passed by Congress in 2012, the Jumpstart Our Business Startups Act (JOBS Act for short) was designed to do two main things: First, make it easier for start-up businesses to attract the money they need to grow. And second, to level the playing field, and allow mom and pop investors to invest alongside large companies providing venture capital to small businesses.

Companies too small to conduct an IPO on a big stock exchange like the NYSE or Nasdaq are permitted to use "equity crowd funding" to raise up to $1 million each year by selling stock in their companies. Note that equity crowd funding is different from pure crowdfunding via websites like Indiegogo or Kickstarter. Those sites help companies raise money by selling consumers early access to the products they plan to develop, or simply asking for financial support -- but they don't let you buy an ownership stake in the company (although Indiegogo has partnered with a company that will).

In contrast, equity crowdfunding via the JOBS Act does give you a chance to buy a stake in start-ups seeking venture capital.

Who can invest in a start-up via the JOBS Act?

The JOBS Act aims to facilitate investing in such start-up companies by small investors. And when I say small, I mean really small. True venture capitalists, angel investors, and providers of seed funding generally need an annual income of $200,000 (or more), or a net worth of $1 million (or more) to be considered "accredited investors" and thus permitted to invest in an unlisted private company.

But the JOBS Act largely does away with these restrictions. As of this year:

• Anyone can invest up to $2,200 per year, spread across as many crowdfunding investments as they like.
• Those with annual income or net worth of $44,000 or more can invest more -- the lesser of 5% of either their annual income or net worth.
• Those with both annual income and net worth of $107,000 or more may invest up to 10% of the lesser of their annual income or net worth, up to but not exceeding $107,000.

For example, an investor with both the U.S. median income (the U.S. Census says that's $55,775) and median net worth ($45,000) can invest $2,250 a year in JOBS Act start-ups. Wealthier individuals -- the Financial Industry Regulatory Authority (FINRA) gives the example of an investor with $150,000 in annual income and net worth of $80,000 -- can invest up to 5% of the lesser of those two numbers (5% x $80,000 = $4,000) in any 12-month period. (Note that the JOBS Act does not let you consider your home equity as part of your net worth).

How can you invest in start-ups via the JOBS Act today?

So much for what you're allowed to do. Now -- how do you do it?

The JOBS Act only permits equity crowd funding of investments when it is conducted through an SEC-registered broker-dealer's online platform or online "funding portal" such as AngelList, MicroVentures (partnered with Indiegogo), or Crowdfunder.com. Each of these work differently, and the process isn't quite as simple as "buying a stock" at an online brokerage.

For one thing, in contrast to the thousands of companies listed on the NYSE and Nasdaq, there are only a limited number of start-ups available for investment via the JOBS Act, and these vary from site to site. Second, small investors need to jump through a series of hoops, beginning with describing their financial situation, the types of small businesses they want to invest in, and the amounts they are willing to invest. Then, after choosing an investment, investors must request access to review the company's financials. Only then can an investment be made.

How will investors invest in start-ups in the future?

The difficulties in the process suggest two possible alternatives for start-ups investing in the future: Either investors will give up on the process as too complicated, or the process will become less complicated, more user-friendly, and easier to navigate over time.

Let's hope it's the latter.

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