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SEC Makes Intrastate Crowdfunding A Little Easier

Source: NASAA Intrastate Crowdfunding Update – October 17, 2016

The SEC just adopted rules that should make intrastate Crowdfunding easier, at least if State legislatures do their part.

To understand how the new rules help and how they don’t, start with section 3(a)(11) of the Securities Act of 1933, which has been, until now, the basis for all intrastate Crowdfunding laws. While section 5 of the Securities Act generally provides that all sales of securities must be registered with the SEC, section 3(a)(11) provides for an exemption for:

Any security which is a part of an issue offered and sold only to persons resident within a single State or Territory, where the issuer of such security is a person resident and doing business within or, if a corporation, incorporated by and doing business within, such State or Territory.

In 1974 the SEC adopted Rule 147, implementing section 3(a)(11). That was long before the Internet, and as state legislatures have enthusiastically adopted intrastate Crowdfunding laws since the JOBS Act of 2012, some aspects of Rule 147 have proven problematic. The rules just adopted by the SEC fix some of the problems of Rule 147:

  • In its original form, Rule 147 required that offers could be made only to residents of the state in question. The revised Rule 147 says it’s okay as long as the issuer has a “reasonable belief” that offers are made only to residents.
  • In its original form, Rule 147 required issuers to satisfy a multi-part test to show they were “doing business” in the state. Under the revised Rule 147, an issuer will be treated as “doing business” if it satisfies any one of several alternative tests.
  • The revised Rule 147 provides safe harbors to ensure that the intrastate offering is not “integrated” with other offerings.
  • In its original form, Rule 147 provided that securities purchased in the intrastate offering could not be sold except in the state where they were purchased for nine months following the end of the offering. The revised Rule 147 provides, instead, that securities purchased in the intrastate offering may not be sold except in the state where they were purchased, for a period of six months (not six months from the end of the offering).

Those are all good changes. But the SEC didn’t stop there. In addition to changing Rule 147 for the better, the SEC has adopted a brand new Rule 147A. Rule 147A more or less begins where Rule 147 leaves off and adds the following helpful provisions:

  • Most significantly, offers under Rule 147A may be made to anyone. That means the issuer may use general soliciting and advertising – and the Internet in particular – to broadcast its offering to the whole world. Purchasers – the investors who buy the securities – must still be residents of the state, but offers may be made to anybody.
  • The issuer doesn’t have to be incorporated in the state, as long as it has its “principal place of business” there – defined as the state “in which the officers, partners or managers of the issuer primarily direct, control and coordinate the activities of the issuer.” Thus, a Delaware limited liability company could conduct an intrastate “offering in Indiana, as long as all the officers and managers live and work in Indiana.

Why did the SEC bother to create a whole new Rule 147A to add these provisions, rather than just adding them to Rule 147?

The answer is that Rule 147 is an implementation of section 3(a)(11) of the Securities Act, and if you look at section 3(a)(11) you’ll see that the additional provisions in Rule 147A – allowing offers to everybody, allowing a non-resident issuer – are prohibited by the statutory language. To add these provisions, the SEC had no choice but to create a new Rule 147A that is entirely independent of section 3(a)(11).

And there’s the rub. Many of the existing intrastate Crowdfunding laws require the issuer to comply with Rule 147 and section 3(a)(11). Texas, for example, says:

Securities offered in reliance on the exemption provided by this section [the Texas intrastate Crowdfunding rule] must also meet the requirements of the federal exemption for intrastate offerings in the Securities Act of 1933, §3(a)(11), 15 U.S.C. §77c(a)(11), and Securities and Exchange Commission Rule 147, 17 CFR §230.147.

This means that issuers in Texas will not be allowed to conduct an offering under the more liberal provisions of Rule 147A until the Texas State Securities Board changes that sentence to read:

Securities offered in reliance on the exemption provided by this section must also meet the requirements of the federal exemption for intrastate offerings in the Securities Act of 1933, §3(a)(11), 15 U.S.C. §77c(a)(11), and Securities and Exchange Commission Rule 147, 17 CFR §230.147, or, alternatively, the requirements of the federal exemption for intrastate offerings in Securities and Exchange Commission Rule 147A, 17 CFR §230.147A.

To those who have spent the last three years pushing intrastate Crowdfunding laws through state legislatures, it might look as if the boulder has rolled back down the hill. But there might also be a silver lining. Almost all the state rules were adopted before Title III became final, and almost all include very modest offering limits. Now that Title III is working as promised, Rule 147A might present an opportunity for legislatures not just to take advantage of the more liberal provisions, but also to raise offering limits and make other adjustments, seeking to make their state rules more competitive with the Federal Title III rules.

In the big picture, the SEC has once again proven itself a fan of Crowdfunding. And that’s good.

Questions? Let me know.

Two Upcoming Events

I’m delighted to participate in two important Crowdfunding events over the next few weeks:

  • The Regulation A Bootcamp in Manhattan this Thursday, November 10th. For more information and to register, click here.
  • The CrowdInvest Summit in Los Angeles on December 7th. For more information and to register, click here. (Use prom code “MARK30” for 30% off your conference pass).

Both these events are going to be terrific, with a roster that reads like a who’s-who in the industry.

(Miss Nevada had planned to attend also, but apparently had a last-minute scheduling conflict when she learned I would be participating.)

I look forward to seeing everyone else there!

MARK

Workshop on Regulation A+

 

On March 4th I had the pleasure of co-presenting a workshop on Regulation A (Title IV Crowdfunding) in Mountain View, California, at an event organized by Crowdfund Beat. My co-presenter, Jillian Sidoti of SyndicationLawyers.com, is a terrific person, an engaging speaker, and one of the country’s leading authorities on Regulation A.

I hope you enjoy our conversation and get a sense of the real-life practicalities of preparing and filing a Regulation A offering.

CrowdFund Beat Media International is an online source of news, information, events and resources for the crowdfunding industry. Currently we cover the USA, Canada, the UK, Italy, Germany, France, and Holland, and soon we’ll be expanding to Spain, Australia, Japan and China. We think of our work as an educational and informative service to the crowdfunding community, and appreciate your suggestions.

Intrastate Crowdfunding After Title III

CF WordclouldOn one hand, the SEC just proposed several changes to Rule 147 that will make intrastate Crowdfunding easier:

  • We used to worry, at least a little, about the language in Rule 147 saying that you couldn’t offer securities to anyone outside the state. How does this work when your offers are made with the Internet, we wondered? The SEC just proposed eliminating that requirement.
  • If you were doing an intrastate offering in Texas, Rule 147 used
    to require using a Texas entity – not Delaware, for example. No more.
  • If you’re doing an intrastate offering in Texas, you have to show you’re doing business in Texas. The new proposals would make that easier.
  • The new proposals would also simplify and rationalize the rules around (1) the “integration” of offerings (combining an intrastate offering with other offerings), (2) verifying that investors are residents of the state, and (3) re-sales of securities purchased in an intrastate offering.

All that is great, and should really help the intrastate Crowdfunding market (although I take to heart Anthony Zeoli’s excellent caveat here.)

On the other hand, the SEC also proposed a $5 million cap on intrastate offerings, which seems very important in light of Title III.

Title III Crowdfunding allows any issuer anywhere to raise up to $1 million from non-accredited investors who live anywhere in the world. With Title III Crowdfunding available, why would an issuer use intrastate Crowdfunding? There are only two possible reasons:

  • You’re allowed to raise more money in the intrastate offering
  • The process of the intrastate offering is faster/cheaper/easier

Once the hi-tech folks get their hands around Title III, I think we’re going to see the process becoming faster, cheaper, and easier than it looks now, making Title III comparable (maybe even superior) to intrastate Crowdfunding from that perspective.

Then it just comes down to how much you can raise. If I am a small issuer – raising less than $1 million, for example – why would I use the intrastate law of my state when I can use Title III instead and appeal to the whole universe of investors? Case in point:  New Jersey enacted an intrastate Crowdfunding law just this week – with a $1 million limit. Why would a New Jersey business use that law, with Title III on the books and the gold and silver of Manhattan right across the Hudson River?

And if I’m a software developer wondering what kind of platform to build, isn’t the scale tipped in favor of Title III?

The scales will tip further that way when Congress increases the limit of Title III from $1 million to something higher. Although the SEC can always raise the limit for intrastate Crowdfunding as well, the future probably belongs to Title III.

Questions? Let me know.

Crowdfunding Legal Resources

I really appreciate the time you spend on my blog. To make the blog more useful, I’ve added a Legal Links button, up there to the right. To start, you’ll find links to:

I plan to add more links in the future and welcome your suggestions.

Questions? Let me know.

C Corp vs. LLC: What’s the Right Choice?

Ryan Feit, the CEO of SeedInvest, just published a great piece in Inc. Magazine about the pressure some entrepreneurs feel from venture funds to convert from a limited liability company to a C corporation. Ryan points out that the tax cost associated with a C corporation often makes the LLC the better choice.

It’s a question I’m asked all the time. And like Ryan, I normally come out on the side of the LLC for Crowdfunding companies, at least so far.

To flesh out the issue, I’ve written an online pamphlet describing the main characteristics I’m thinking about when I recommend LLC or C corporation. If you want to understand why corporate lawyers seem so isolated at social gatherings, take a look.

Choosing the Right Legal Entity Flyer

Questions? Contact Mark Roderick.

Improving Legal Documents in Crowdfunding: Capital Calls

man beggingYou raise $2 million of equity from investors to buy an apartment complex and two years later want to make $500,000 of capital improvements. Where do you get the money?

Traditionally, your Operating Agreement might give you the right to make a “capital call,” asking your existing investors for the additional $500,000. Suppose you had 20 investors, each contributing $100,000 in the beginning. Exercising your right to make capital calls, you would ask each for another $25,000 (20 x $25,000 = $500,000).

If the Operating Agreement includes a capital call feature, then it should also describe the consequences if one or more investors fail to contribute. The simplest approach, which I have seen used in Crowdfunding offerings, provides for simple dilution based on capital contributed. Let’s say 19 investors send $25,000 checks but one does not. The Operating Agreement would provide that his ownership interest is reduced by 1% (100 basis points), the percentage that his failed contribution ($25,000) bears to the total capital contributed ($2,500,000).

A few things to bear in mind using capital calls in Crowdfunding:

  • If I am the Crowdfunding investor, I do not want a capital call. Once I write my initial check, I don’t want to be asked for more money.
  • If I am the sponsor, I don’t want to be obligated to ask my existing investors for additional capital, which is just another way of saying I don’t want to give my existing investors a so-called “preemptive right.” There might be 157 existing investors. It might be much easier to get the $500,000 from a single source, or even a new Crowdfunding round. I want to leave my options open.
  • If we include a capital call, simple dilution is often not the right answer. Suppose the real estate market deteriorates and I desperately need the $500,000 to keep the project afloat. If an investor fails to make good on the capital call, a much higher rate of dilution might be appropriate, 150% or 200%, or even more. I have drafted agreements where the failure to make good on a capital call results in the wholesale forfeiture of an interest.

Crowdfunding is like traditional private placements in many ways, but in other ways it isn’t. When we draft legal documents for Crowdfunding deals we need to figure out which is which.

Questions? Contact Mark Roderick.

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