Well, it’s the beginning of 2015 and the Securities and Exchange Commission still has not finalized long-awaited federal crowdfunding rules.
The SEC is now nearly two full years past the congressionally mandated deadline to provide final enabling rules for the online crowdfunding provisions of Title III of the JOBS act passed in 2012.
Unfortunately, the size of the states that have enacted intrastate crowdfunding over the heads of the SEC have been relatively small, geographically and demographically, thereby constraining the effectiveness of intrastate online crowdfunding, that is, until now.
For those not familiar with Title III of the JOBS Act, it is a law enacted nearly three years ago that will allow companies for the first time to use online crowdfunding to raise capital and fund projects, ventures, and other enterprises by selling stock, secured debt and other securities. This type of crowdfunding is often referred to as “equity-based crowdfunding” in contract to “gift-based” crowdfunding of the type transacted on sites like Kickstarter (Kick-Starter.com) and Indiegogo (IndieGogo.com). Gift-based crowdfunding sites have been around for years and have been used to successfully provide capital to thousands of businesses and projects. Occulus Rift, the virtual reality goggle company, was one such gift-based crowdfunding start up that was sold for $2 billion to Facebook a year and a half after its first crowdfunding campaign.
But because gift-based crowdfunding sites are prohibited from selling stock or other interests in companies, they provide a means only to donate and not invest money. No one donating to a gift-based crowdfunded project obtains a piece of the company in exchange for their monetary donation. In contrast, crowdfunding under Title III of the JOBS Act will allow companies to both market and sell stock over the Internet to potentially hundreds of millions of ordinary people around the world. By doing so, many believe that implementation of Title III might well revolutionize the process of procuring investment capital by enabling companies to tap into very large and heretofore untapped sources of capital. Most banking experts agree that the amount of capital that can be raised via equity-based crowdfunding will quickly dwarf what is currently being raised through gift-based crowdfunding. This view is borne out by a recent World Bank report indicating that global crowdfunding will soon reach $95 billion annually.
The only thing keeping federally authorized equity-based crowdfunding from becoming a reality in this country is, unfortunately, the federal agency tasked with its implementation, the SEC. Unfortunately, the SEC seems to be on a mission to subvert Congressional will and weaken, if not destroy, Title III crowdfunding by over-regulation and delay. The proposed rules published for comment by the SEC in late 2013 are almost 600 pages long. And now more than a year later, when pressed by members of Congress and legions of interested parties demanding that the SEC move with greater alacrity to promulgate final crowdfunding rules, the SEC has announced that it would again delay issuance of final rules to October 2015. This means that if the SEC finally does publish the rules they would be nearly four years overdue and not likely to go into effect any earlier than January 2016.
To me, the SEC’s delay and unresponsiveness to its statutory mandate to promulgate crowdfunding rules by the end of 2012 epitomizes both the arrogance and the incompetence of our federal government today. It demonstrates clearly that in our nation’s capital the words “democracy” and “will of the people” have all but lost their meaning.
Fortunately, there is something that SEC cannot control when it comes to crowdfunding: the states. Because of an exemption in the securities law that has existed since the 1930s, the states are allowed to regulate securities transactions occurring entirely within their borders. So, frustrated by the arrogant intransigence and intractability of the SEC, 13 states have elected to utilize that federal securities law exemption and pass their own crowdfunding laws authorizing intrastate crowdfunding.
The list of states that have legalized equity crowdfunding to date are Alabama, Colorado, Georgia, Idaho, Indiana, Kansas, Maine, Maryland, Michigan, Tennessee, Washington, Wisconsin and, most recently, Texas.
While it is always good to see anything that functions as a check on the extremely dangerous accumulation of power that now exists in Washington, the accelerating movement by the states to clearly stick it to the SEC is, for me at least, quite personally satisfying. Unfortunately, the size of the states that have enacted intrastate crowdfunding over the heads of the SEC have been relatively small, geographically and demographically, thereby constraining the effectiveness of intrastate online crowdfunding, that is, until now.
Enter Texas, our nation’s second most populous state and the 13th to authorize intrastate crowdfunding. With a state gross domestic product second only to California and approximately one tenth of the whole U.S., when Texas joined the states authorizing intrastate crowdfunding, it did so in a typical big-Texas way. If Texas was its own country (as many Texans seem to believe it is) it would have the 12th largest economy in the world.
The enactment of intrastate crowdfunding by Texas is, therefore, in my opinion, a game-changer for equity crowdfunding in this country. Because of the size of the Texas economy and population base, for the first time, the promise of equity-based crowdfunding, and the potential to provide small companies access to significant economic sources and amounts of new funding otherwise unavailable to them, can at last be realized.
But what is even better than the fact that Texas has passed an equity-based crowdfunding law, in my opinion, is the way it has done so. Rather than the SEC’s proposed reams of burdensome and costly regulations that could potentially eviscerate the benefits of crowdfunding, Texas enacted a simple and streamlined set of regulations for both companies that wish to raise money via crowdfunding and for those that wish to establish crowdfunding portals through which Texas crowdfunding campaigns will be conducted.
Here are a few highlighted provisions of Texas’ new crowdfunding regulations:
1) Investors may contribute up to $5,000 per offering. (This is more than double the $2,000 limitation for crowdfunding under Title III of the JOBS Act.)
2) Companies may raise up to $1 million within each 12-month period without the requirement of filing expensive audited or reviewed financials. (Title III of the JOBS Act requires reviewed or audited financial statements for crowdfunding in excess of $100, 000 to the statutory limit of $1 million.)
3) Crowdfunding portal registration is greatly simplified compared with Title III requirements. To be eligible for registration as a Texas Crowdfunding Portal (TCP), the applicant must:
- (i) be a Texas entity incorporated or organized under the laws of Texas, authorized to do business in Texas, and engaged exclusively in intrastate offers and sales of securities in Texas
- (ii) limit its activities to operating an Internet website utilized to offer and sell securities exempt from registration pursuant to Rule 139.25 (the Texas Intrastate Crowdfunding Exemption); and
- (iii) not operate or facilitate a secondary market in securities.
Neither the applicant for registration as a TCP nor its agents are required to pass examinations, and they are eligible for a full waiver of Texas’ securities dealer examination requirements. There are certain company residency requirements and, of course, all crowdfunding activities under the Texas crowdfunding law must be wholly within the state. But even considering these limitations, imposed by necessity for Texas to take advantage of the intrastate exemption to federal securities regulation, the sheer size of the Texas economy provides equity-based crowdfunding opportunities to companies that are simply unprecedented. Moreover, the new crowdfunding law is viewed by the state’s popular chief executive, Gov. Rick Perry, and many state legislators, along with its zero income tax policy, as an integral part of the state’s efforts to attract technology start-ups and become the “Silicon Valley of the South.”
So, unlike crowdfunding at the federal level, mired in a bureaucracy hostile to its implementation, Texas has clearly embraced crowdfunding with open arms.
Hopefully, it will also be a mind-changer for the frozen-brain folks in Washington that are preventing this nation’s entrepreneurs from using what may well be this century’s most innovative and effective new means of raising capital.
If you are interested in crowdfunding a project in Texas or in setting up a registered crowdfunding portal in Texas or any of the other states that authorize intrastate crowdfunding please feel free to contact our office for more information.
This article is for educational purposes only and nothing in this article is intended to be, or should be considered to be, legal advice. If you have a legal question or other matter related to the any of the topics discussed in this article, I invite you to contact our office at the number below.
Gregory A. Piccionelli is an entertainment attorney with over 20 years experience specializing in Internet matters. He can be reached at Piccionelli & Sarno at (818) 201-3955 or greg@piccionellisarno.com.
