Crowdfunding a Texas Intrastate Offering
Texas is the latest state to embrace equity crowdfunding. On October 22, 2014, the Texas State Securities Board approved proposed Rule 139.25, which exempts intrastate securities offerings using crowdfunding. Rule 139.25 will become effective in November of 2014. The new Texas exemption requires that offers and sales of an issuer’s securities be made exclusively through an Internet website operated by a Texas registered general dealer or Texas registered crowdfunding portal.
Issuers cannot conduct their own offerings under the new rule.
Issuers are allowed to raise up to $1 million in any twelve-month period if the following conditions, among others, are met:
♦ The securities must be offered and sold only to persons who are residents of Texas.
♦ The issuer must have filed a certificate of formation in Texas.
♦ The issuer must maintain its principal place of business in Texas.
♦ At least 80 percent of the issuer’s gross revenues during its most recent fiscal year must have been derived from the operation of a business in Texas.
♦ At least 80 percent of the issuer’s assets at the end of its most recent semiannual period must be located in Texas.
♦ No more than $5,000 can be accepted from a single investor unless the investor is an “accredited investor” as defined by SEC Rule 501 of Regulation D of the Securities Act of 1933, as amended.
♦ The issuer and crowdfunding portal website must provide the disclosure required by rule 139.25 (h) and (i) to investors and on the crowdfunding portal website.
♦ The issuer must use at least 80 percent of the net offering proceeds in connection with its Texas operations.
♦ Offering proceeds must be held in escrow until the issuer receives the targeted offering amount as set forth in the issuer’s disclosure documents.
♦ Crowdfunding portals must obtain an affirmative representation of Texas residency from any visitor to the portal prior to providing them with offering information.
♦ Issuers must have a reasonable basis for believing investors are Texas residents and obtain written confirmation of the foregoing.
♦ Certificates representing shares sold in the offering must be marked with a restrictive legend setting forth the restrictions on transfer imposed by Rule 147 of the Securities Act.
Rule 139.25 is only available if the issuer is an entity that has filed a certificate of formation with the Texas Secretary of State and is authorized to do business in Texas. Only certain types of business entities file a certification of formation. The most common ones are corporations, limited liability companies, and limited partnerships. A sole proprietor, general partnership, or joint venture would not be eligible to use the Texas crowdfunding exemption since those types of entities do not file a certificate of formation with the Texas Secretary of State.
Certain issuers are not permitted to use the Texas Intrastate Exemption to crowdfund their securities offering. These include issuers that are, either before or because of the offering:
♦ Engaged in or propose to engage in the business of investing, reinvesting, owning, holding, or trading in securities. Such a company would probably be an investment company;
♦ Subject to the reporting requirements of the Securities and Exchange Act of 1934, generally referred to as SEC reporting companies; or
♦ shell companies.
Disqualification Provisions for Bad Actors
An issuer cannot use the Texas intrastate exemption if the issuer, the issuer’s predecessors, any affiliated issuer, or any control person of the issuer is subject to certain disqualifications arising from past violations of the law. “Control person” in this context means an officer; director; other person having the power, directly or indirectly, to direct the management or policies of the issuer, whether by contract or otherwise; or a person that owns 20% or more of any class of the outstanding securities of the issuer.
A disqualification occurs if any of the above-identified persons or entities:
♦ Within the last five years, has filed a registration statement which is the subject of a currently effective registration stop order entered by any state securities administrator or the SEC;
♦ Within the last five years, has been convicted of any criminal offense in connection with the offer,
♦ Purchase or sale of any security, or involving fraud or deceit;
♦ Is currently subject to any state or federal administrative enforcement order or judgment, entered within the last five years, finding fraud or deceit in connection with the purchase or sale of any security; or
♦ Is currently subject to any order, judgment, or decree of any court of competent jurisdiction, entered within the last five years, temporarily, preliminarily, or permanently restraining or enjoining such party from engaging in or continuing to engage in any conduct or practice involving fraud or deceit in connection with the purchase or sale of any security.
Pre-Offering Notice Requirements
Under the new rule, a pre-offering notice filing and 21-day waiting period are required. At least 21 days before the first offer is made, the issuer must file a Crowdfunding Exemption Notice with the Texas Securities Commissioner.
During the waiting period, the issuer’s disclosure statement and offering summary must be made available online. The issuer’s information may include a video that appears on the same Internet website on which the issuer’s offering appears. To the extent that the video includes information required in the disclosure statement or the offering summary it should be treated as part of those documents and included as part of the notice filing made by the issuer with the Texas Securities Commissioner.
Texas Rule 139.25 Coordination with federal intrastate exemption.
Securities offerings made under Rule 139.25 must comply with the federal exemption for intrastate offerings in Section 3(a)(11) of the Securities Act of 1933 (15 U.S.C. §77c(a)(11)) and SEC Rule 147 (17 CFR §230.147).
The shares sold in reliance upon the Texas Intrastate Crowdfunding Exemption are restricted securities. Issuers relying upon the Texas crowdfunding exemption must comply with the holding period required by Section 3(a)(11) and Rule 147 under the Securities Act of 1933, as amended which imposes a nine month holding period unless sold to a Texas resident.
Disclosure Requirements in Texas Crowdfunded Offerings.
The issuer’s disclosure statement must be made readily available and accessible to each prospective purchaser when the offer of securities is made on the funding portal’s website. The disclosure statement must include:
♦ a general description of the issuer’s business;
♦ the history of the issuer’s operations and organization;
♦ the management of the company and principal stockholders;
♦ how the proceeds from the offering will be used;
♦ financial information about the issuer;
♦ a description of the securities being offered; and
♦ any litigation and legal proceedings.
An issuer must provide current financial statements certified by its principal executive officer to be true and complete in all material respects. If the issuer has audited or reviewed financial statements prepared within the last three years, those financial statements must be provided to investors as well.
The issuer must inform all prospective purchasers and investors of the following risks, among others:
♦ There is no ready market for the sale of the securities acquired from this offering; it may be difficult or impossible for an investor to sell or otherwise dispose of this investment. An investor may be required to hold and bear the financial risks of this investment indefinitely.
♦ The securities have not been registered under federal or state securities laws and, therefore, cannot be resold unless the securities are registered or qualify for an exemption from registration under federal and state law.
♦ In making an investment decision, investors must rely on their own examination of the issuer and the terms of the offering, including the merits and risks involved.
♦ No federal or state securities commission or regulatory authority has confirmed the accuracy or determined the adequacy of the disclosure statement or any other information on this Internet website.
♦ Written disclosures setting forth the limitations on resale of the securities contained in SEC Rule 147.
More information regarding the new rule, requirements for crowdfunding portals, and related forms, can be found here.
Companies seeking to rely upon the exemption should be cautious of its technical requirements particularly the disclosure and notice provisions required by Rule 139.25, as outlined above. Before considering an intrastate crowdfunding offering, companies should consult with qualified securities counsel to ensure compliance with both state and federal law.
For further information about this securities law blog post, please contact Brenda Hamilton, Securities Attorney at 101 Plaza Real S, Suite 202 N, Boca Raton, Florida, (561) 416-8956, by email at [email protected] or visit www.securitieslawyer101.com. This securities law blog post is provided as a general informational service to clients and friends of Hamilton & Associates Law Group and should not be construed as, and does not constitute legal advice on any specific matter, nor does this message create an attorney-client relationship. Please note that the prior results discussed herein do not guarantee similar outcomes.
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Brenda Hamilton, Securities Attorney
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Boca Raton, Florida 33432
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