While Regulation (Title III) Crowdfunding continues to get all of the attention, the overwhelming majority of states currently have some form of “intrastate” retail crowdfunding laws already in effect; many of which offer significantly more favorable terms to issuers and investors than the federal rules. The main issue with these intrastate crowdfunding options is that there is little uniformity between the intrastate crowdfunding laws of each state, making it extremely difficult to highlight the good and bad provisions of each
You probably don’t know it but currently thirty-six (36) states have enacted Intrastate crowdfunding exemptions (or have enacted amendments to their existing blue sky laws to permit some type of Intrastate crowdfunding) and another eight (8) states are in various stages of enacting/considering such legislation. That being said, as previously stated the laws vary significantly from state to state, and a discussion of the nuances between the various state laws would be well beyond the scope of this post. Luckily, for those that might be interested, I have put together, what I believe to be, the definitive comparative matrix of current Intrastate crowdfunding laws.
I had originally intended this post to be a graded comparison of the various enacted state crowdfunding laws. However, the lack of any real uniformity between these laws makes applying a grading system extremely difficult and probably of little value. Accordingly, I instead decided to analyze some of the provisions and features which, in my opinion, are integral to making intrastate crowdfunding a truly viable option for local businesses.
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Key Provisions and Features.
Each of the enacted intrastate crowdfunding laws have pros and cons (yes, even my Illinois’ law). However, certain key provisions and features can help make the intrastate crowdfunding laws more attractive and effective. These include the following:
Use of Rule 147A.
Without getting into a boring legal discussion on the topic, almost all intrastate crowdfunding laws were originally based on Section 3(a)(11) of the Securities Act of 1933 and federal Rule 147 which allow for the non-public offering of securities by companies within a state solely to residents of that state. These rules however are antiquated and often hard for companies to adhere to (e.g. they do not permit general advertising over the internet). This is why last year the SEC elected to substantially revamp these laws. The problem is how the SEC elected to actually make those changes.
While the SEC made some positive changes directly to the existing Rule 147, the real beneficial changes (including eliminating the requirement that a company actually be incorporated/organized/formed in the state in which the intrastate offering is conducted and eliminating the prohibition against advertising over the internet and other forms of general solicitation) where moved into a new federal Rule 147A.
So what does all this legal mumbo jumbo mean? Since the majority of intrastate crowdfunding laws were originally written with specific reference to the original Rule 147, a company would not be able to take advantage of the new beneficial Rule 147A provision unless the laws were changed to include it. Think of it like trying to get into a club where you are supposed to be on the VIP list, only to find out they spelled your name wrong and now you can get in …. no party for you.
Some of the state laws have been amended (or, if new, have been drafted to include) specific reference to the new federal Rule 147A. In these state, the intrastate option is much more viable. If, for no other reason, then as a result of a participating company’s ability to freely advertise their offering, over social media or any other means, so long as the securities are only sold to in state residents. This is a VERY powerful advantage and a huge improvement over what a company can do under the old Rule 147 and even under the federal Title III laws.
States that currently allow for use of new Rule 147A: Arkansas, Colorado, Georgia, Illinois, Michigan, Minnesota, Nebraska Oregon (by temporary rule expiring January 7, 2018), and Vermont
Expanded Escrowee Provisions.
Almost all of the current intrastate crowdfunding laws require investor funds to be held in escrow with a third party escrowee until the respective offering closes. However, in a noble effort to keep money within the state, many states have statutorily required that such escrowee be a bank or other financial institution which is actually chartered within the state (or, in one state, a locally registered attorney). As you can imagine, getting a local bank to understand crowdfunding, let alone be willing to take on the risk of holding investor funds, is an frustrating exercise to say the least. Resultantly, in states where such requirements exist, crowdfunding efforts have been significantly stalled, if not outright prohibited, because an authorized escrow agent cannot be found.
There are currently only a limited number of banks and other institutions who are actually willing to act as escrow agents in this space, and most are national level and/or online entities. Acknowledging this issue, many states have significantly expanded their list of permitted escrow agents to include, at a minimum, banks and other financial institutions who are authorized to do business within the state (as opposed to having to actually be physically located and/or chartered within the state). This has helped to facilitate crowdfunding in many states by allowing portals and companies to work with one of the few currently available escrow providers.
States that currently have expanded escrowee provisions: Alabama, Alaska, Colorado, Delaware, Georgia, Idaho, Illinois, Indiana, Kansas, Kentucky, Massachusetts, Minnesota, Montana, Nebraska, New Jersey, New Mexico, North Carolina, South Carolina, Tennessee and Texas.
NOTE: Certain states are silent as to eligible escrowee qualifications and those states have been excluded from the above list of states as it is unclear whether silence on this issue makes those laws as, or less, restrictive then those discussed above.
Per Offering, and NOT Annual, Investor Limitations.
The overwhelming majority of state statues set a maximum annual investment limit for non-accredited investors based on the total amount such person invests in ALL intrastate offerings during any given 12 month period. Put another way, most state statutes provide that a non-accredited investor is not permitted to invest more than $X (typically between $5-$10k) in intrastate offerings in any given 12 month period. This may seem fine at first blush but there are two distinct issues with this approach.
First, to the extent there is more than one intrastate portal in a given state, the above approach, by is nature, requires each portal to rely on the word of the investor as to how much they invested with other portals. Put simply, when there is more than one available portal this approach is inherently flawed because there is no way for a particular portal (or issuer) to keep track of how much an investor has actually invested in any given 12 month period among all available portals. As such, the investor protections which were intended by these annual investment limitations are essentially meaningless. I mean c’mon, most people would fill $0 in a box when asked the question simply to avoid the hassle of thinking about it. If the limitation is that easy to avoid then what good is it really?
The second point is a little more opaque. Given the limited number of currently available intrastate investors, imposing annual limits actually reduces the amount of available funds open to companies seeking funds later in any given year.
How so you may ask, think of it like this?
Imagine you are on the Vegas strip with your friends and your wife told you that you can’t spend more than $1,000 on gambling the whole time you are there. Under this scenario, the first one or two casinos you enter are much more likely to get your money when compared to those at the end of the strip (where you’d be lucky to still have enough money left from the $1,000 limit to play a nickel slot). Accordingly, when taking into account the currently limited available investor base for intrastate offerings, an annual limitation on intrastate investments actually hurts issuers raising money later in any given year.
A per offering investor limitation solves both of the above concerns. By per offering limitation, I mean a limitation which provides non-accredited investor would not be permitted to invest more than $X, per company (i.e. issuer), in any given 12 month period.
With respect to the first concern above, since the investor limitation is based on the amount of money given to a particular company, such company (and ultimately the portal the company is conducting its offering) should be able to easily determine whether such limitation is being complied with without having to rely on the word of the investor at all. As for the second concern, since the investor limitation would essentially reset with each offering, companies seeking to raise funds later in any given year would theoretically have the same probability of receiving investors funds as those raising money earlier in the year. Carrying the Vegas example forward, let’s assume your wife told you instead that you can’t spend more than $1,000 on gambling in any one casino. Under this new scenario, each casino on the strip would be equally likely to get some of your money (though your wife will certainly not be happy).
States that currently have per-offering investor limitations: Illinois, Iowa, Kentucky, Minnesota, New Jersey, New Mexico and North Carolina.
Now this is where I, and some of my colleague in the industry, tend to differ so feel free to form your own opinions.
The ability of a company to conduct an intrastate offerings (i.e. those under Section 3(a)(11) of the Securities Act of 1933 and federal Rule 147) is not new and in fact has been around for a long time. That being said, those statutes were rarely actually used because the wording of such statutes, and the limited guidance issued in connection therewith, was vague at best.
Generally transaction attorneys, like myself, do not like vague, untested and/or open ended statutes as they simply leave too much risk potential for clients. For you Seinfeld fans out there, think of it like that episode where George gets a project from his boss, Wilhelm, but doesn’t hear the specific instruction of what he’s supposed to do. As a result, when Steinbrenner sees the results of George’s project he has him committed to a mental hospital (and hilarity ensues).
In my opinion, the same premises applies here; when the instructions are not clear the end product is bound to be a mess (though if an intrastate offering is completed improperly, hilarity will most certainly not ensue).
For the above reasons, among others, I prefer intrastate statutes which clearly define the obligations of both portals and issuers. Some of my colleagues argue that, when it comes to investment regulation, less is more and the statues should be simplistic and open to interpretation. While that approach may sound nice in theory, those of us who advocate for the use of intrastate crowdfunding laws already have an uphill battle educating issuers, investors, regulators and attorneys alike as to the use and effectiveness of these statutes, including responding to inherent investor protection concerns.
If you are one of the advocates charging up that hill you are going to want to be able to point to a particular statute or rule when batting critics, I assure you. Moreover, clear guidelines will eventually lead to standardized forms and disclosures which will, eventually, reduce the overall cost to issuers of preforming such intrastate offerings (think laser pro loan documents vs custom loan documents).
States that currently have specific intrastate statutes and related regulations: Colorado, Illinois, Indiana, Maine, Massachusetts, Minnesota, North Carolina, Texas, Washington and Wisconsin.
The above is simply an analysis of what, in my opinion, are the key provisions and features which can help make available intrastate crowdfunding options more viable and attractive to local companies and investors. That being said, I can tell you from personal experience that inclusion of the above alone is simply not enough to get local investors and issuers to engage in intrastate crowdfunding. The key is getting local investors and companies to be aware that intrastate crowdfunding options exist and educating them on how they work.
A good example of this can be seen by comparing Illinois with Oregon. Now I wholeheartedly believe the Illinois intrastate regulations, which I drafted (and which contains each of the above, and more), create an extremely workable and viable capital raising option for Illinois companies. That being said, there has been little actual intrastate offering activity in Illinois to date due; primarily due to the lack of knowledge that this option even exists (not for lack of trying on my part by the way). On the other hand, in Oregon, whose statutes contain none of the above, significant traction has been made in educating and informing local companies and investors as to the availability of the intrastate crowdfunding option and we are seeing substantial offering activity in Oregon as a result (both thanks, in no small part to the efforts of Hatch Innovation and the like).
[clickToTweet tweet=”The key is getting local investors & companies to be aware of intrastate #crowdfunding options & educating them” quote=”The key is getting local investors & companies to be aware of intrastate #crowdfunding options & educating them”]
Many of the currently available intrastate crowdfunding regulations offer significantly more favorable terms to both issuers and investors when compared to the federal, Title III, exemption. However, states need to do a better job of promoting these available intrastate options to local companies and investors before we will see any significant offering activity in the majority of these states. That being said, as the knowledge and popularity of these intrastate options continues to grow, the importance, and resulting benefits, of including the above provisions will become readily apparent.
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Anthony Zeoli is a Senior Contributor for Crowdfund Insider. He is a Partner at the law firm of Freeborn in the Corporate Practice Group. He is an experienced transactional attorney with a national practice specializing in the areas of securities, commercial finance, real estate and general corporate law. Anthony drafted the bill to allow for an intrastate crowdfunding exemption in Illinois that eventually became law.