New Law Raises Funding Hopes For Startups, Worries Over Fraud

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A new law has many technology entrepreneurs excited. The Jobs Act — which passed the House earlier this week and is awaiting President Obama's signature — will make it easier for new businesses to raise money. But many are concerned it will also open the floodgates to a new wave of financial fraud.

Clint Gordon-Carroll and his buddy, Alen Peacock, say the law could have come in handy when they were launching their own startup. Their idea was to build a quicker way for computer users to back up all their files and store them on a cloud. They built a prototype and came up with a name — Space Monkey — but the one thing they didn't have was the cash to transform their idea into reality.

Peacock says that in Utah, where they live, most "investors just aren't used to the nature of high-tech startups and how those work."

According to Peacock, the few investors who were interested were generally more used to putting money into real estate or restaurants.

"They want you to have revenue and they want you to have profits and they want you to show market traction," Peacock says. "And with a technology startup, there's often this huge upfront development cost that you need to invest in before you can get to that point."

Peacock and Gordon-Carroll also had a few friends who were willing to put money in. But federal rules require that anyone who invests in a startup before it goes public and files detailed financial statements has to be a so-called accredited investor. In other words, they basically have to be rich.

"The current system is set up so that you have to have a certain amount of money in order to invest in startups," Peacock says. Regulations require that you have $1 million, excluding the value of your house.

"So for people who don't meet those minimum requirements," he says, "they're just out of the game."

Peacock and Gordon-Carroll had to turn most of their buddies away, leaving Space Monkey temporarily grounded.

A Connection That Makes 'All The Difference'

"There are great entrepreneurs with great technology and great product who are in Atlanta, Ga., or Wichita, Kan.," says Naval Ravikant, CEO and co-founder of AngelList, a social network for investors and entrepreneurs. "And we see some great companies coming to AngelList actually from remote locations."

Ravikant says the lion's share of technology investments are made in Silicon Valley; Boston; Austin, Texas; and Seattle. Outside of those technology hotspots, it can be hard to get a good idea off the ground. So one of the things his site aims to do is introduce people with good ideas to investors with money and some startup experience.

"I don't think we would be in existence if it wasn't for AngelList," Gordon-Carroll says. He and Peacock joined AngelList late last year. Gordon-Carroll says AngelList helped them meet a network of interested investors and raise almost $1 million as seed money in less than two months.

"At the end of the day, a central place where we could talk about what we're doing with potential investors made all the difference," Gordon-Carroll says.

'Wherever There's Money, There's Going To Be Fraud'

The Jobs Act would clear the way for new companies to advertise that they're looking for investors, and it would let anyone invest in privately held businesses, making it a lot easier for startups like Space Monkey to raise money and for new sites like AngelList to get off the ground.

The new law also opens the door to online crowd-funding sites where startups can strut their stuff and jockey for small investors' attention. Dozens of entrepreneurs, like Sara Hanks, see a big opportunity in that. But as a securities lawyer, Hanks is also skeptical.

"I think we can expect to see the African princes inventing cold fusion any second now," she says. "Wherever there's money, there's going to be fraud. I think we have to stipulate that up front."

Hanks is the former general counsel for the congressional oversight panel charged with keeping an eye on the federal banking bailout, so she knows a thing or two about financial shenanigans.

But that's not stopping her from launching her own online crowd-funding portal. Unlike most of her potential future competitors, her plan is to hire securities lawyers to sift through the startups that want to raise money on her site and weed out the crooks. Still, none of those companies will be a sure thing.

"Let's be clear about this, most startups are not going to get anywhere," she says, which raises a question: "Why would you invest in something that's probably going to fail?"

According to Hanks, the answer is that it's fun. As long you're investing money that you can afford to lose, helping someone take a crack at making his or her dream come true can actually feel pretty good.

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