Crowdfunding for Private Companies – Crowdfunding Lawyers
Sometimes, a company seeking to raise capital may not want to spend the time and expense of an initial public or direct public offering. In such circumstances, the company should consider an exempt offering. Even though the SEC has not created the final rules for equity crowdfunding, intrastate and accredited crowdfunding provide manageable capital raising options for companies. Companies should remember that the intrastate and accredited crowdfunding exemptions do not exempt the issuer from the antifraud provisions or broker dealer registration provisions of the federal securities laws.
This means that a company can be liable for false or misleading statements, whether oral or written in connection with its offering even if the offering is exempt from registration. Violations could result in criminal, civil, and administrative proceedings, as well as private litigation and rescission rights.
Even offerings that are exempt under the federal securities laws may still be subject to the notice and filing obligations of various state regulators. As a result, the issuer should consult with a qualified securities attorney before proceeding with an exempt securities offering.
Intrastate Crowdfunding – the Intrastate Offering Exemption
Section 3(a)(9) of the Securities Exchange Act is generally known as the “intrastate offering exemption.” Section 3(a)(9) is also the basis for the Intrastate Crowdfunding exemption. As of December 2014, thirteen states adopted Intrastate Crowdfunding exemptions.
The 3(a)(9) exemption was create to stimulate the financing of local businesses within a particular state. The Intrastate Crowdfunding exemption is consistent with this goal. To qualify for the intrastate crowdfunding exemption, a company must comply with the federal Section 3(a)(9) exemption and relevant state exemption where it conducts its offering. State requirements vary from jurisdiction to jurisdiction. The federal exemption requires that the company:
- be incorporated in the state where it is offering the securities;
- carry out a significant amount of its business in that state; and
- make offers and sales only to residents of that particular state.
Section 3(a)(9) act does not limit the size of the offering or the number of purchasers; however each state adopting Intrastate Crowdfunding exemptions has limited the aggregate offering amounts that company’s may raise.
To rely upon the exemption, a company must determine the residence of each investor. If any of the securities are offered or sold to even one out-of-state person, the exemption may be unavailable and the company could be in violation of the Securities Act registration requirements.
Securities sold in reliance upon the Section 3(a)(9) exemption are restricted securities.
The SEC has stated that an established internet presence to issue information about specific investment opportunities would likely involve offers to residents outside the state in which the issuer does business. The SEC provided guidance for issuer’s using the internet for their intrastate offerings in an update to Question 141.05 published in April of 2014.
Issuers in Intrastate crowdfunded offerings should:
- limit offers to persons whose IP address originates from a particular state or territory; and
- take steps to prevent offers and sales to persons whose IP address originates in other states.
Issuers should also use legends that conspicuously state that the offering is limited to residents of the issuer’s state under applicable law.
It is difficult for a company to conduct a successful offering in reliance upon Intrastate Crowdfunding unless it knows the purchasers and the sale is directly negotiated with them. If an issuer has significant assets outside the state, or derives a substantial portion of its revenues outside the state where it proposes to conduct its offering, it will likely have a difficult time qualifying for the exemption.
Regulation D – Accredited Crowdfunding
The JOBS Act created a new offering exemption under Rule 506 (c) which is known as “Accredited Crowdfunding.” While Rule 506(c) is still referred to as a private placement, offering, it is a public offering.
An issuer can raise unlimited funder under Rule 506(c) using general solicitation and advertising so long as sales are only made to investors whose status as accredited investors has been verified by the issuer or a third party. Rule 506(c) offerings can be widely advertised by the use of any media including the internet, billboards and television.
Issuers may still rely on Rule 506(b) to conduct an offering without the use of general solicitation and advertising and sell to up to 35 non‐accredited investors. In Rule 506(b) offerings, no accredited investor verification is required. The verification requirements can be found here.
Accredited Investor Verification
Generally, an accredited investor is an investor with a net worth (excluding their primary residence) of $1 million, income of $200,000 a year (or $300,000 with their spouse), officers and directors of the issuer and certain institutions that have more than $5 million in assets.
The SEC has specified four specific non-exclusive methods of verifying accredited investor status that satisfy the verification requirements of Rule 506(c). These methods will not be deemed to satisfy the verification requirement, however, if the issuer or its agent has actual knowledge that the purchaser is not an accredited investor. These methods of verification are set forth in Rule 506(c)(2)(ii).
Bad Actor Disqualification
Rule 506(d) of Regulation D contains the bad actor disqualification rule. Under Rule 506(c) Covered Persons are generally: the issuer; each affiliated issuer and each predecessor to the issuer, each remunerated solicitor; the general partner, managing member or investment advisor (in the case of a pooled investment fund issuer) of the issuer and each such person or entity; each officer participating in the offering, executive officer and director of all of the foregoing; each holder of 20 percent or greater voting equity of the issuer; and each promoter connected in any capacity with the issuer at the time of sale.
Disqualifying events include:
- Criminal convictions; injunctions; restraining, final, disciplinary, cease and desist, stop, suspension and false representation orders indicative of fraud, deception, misrepresentation or non-compliance with federal or state laws, regulations or agency rules regulating securities, financial institution, insurance, and commodities futures trading activities; related misrepresentations to the US Postal Service; and
- Suspensions and expulsions from membership in, and suspensions and bars from association with, members of certain securities industry self-regulatory organizations, such as FINRA.
The National Securities Markets Improvement Act (“NSMIA”)
New Rule 506(c) offerings are considered covered securities under NSMIA. However, issuers must look to each state where they offer or sell their securities to determine any applicable notice filing requirements. Issuers should also be aware that the anti-fraud provisions of both federal and state laws still apply to covered securities.
For more information about crowdfunding please contact Brenda Hamilton, securities attorney at [email protected]. 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 and compliance 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.
Hamilton & Associates | Securities Lawyers
Brenda Hamilton, Securities Attorney
101 Plaza Real South, Suite 202 North
Boca Raton, Florida 33432
Telephone: (561) 416-8956
Facsimile: (561) 416-2855