A new law comes into effect in 2015 that swings open the doors to equity crowdfunding in Tennessee. While it may sound tempting to use, the Invest Tennessee Exemption only offers a new path to crowdfunding for entrepreneurs with a high tolerance for risk.
Crowdfunding comes in several differing forms (e.g., donations, loans, the sale of company stock). While donation based crowdfunding took off in 2009 with the founding of Kickstarter, very few companies have found an efficient and legal means to sell business interests to investors online, a fundraising strategy referred to as “equity crowdfunding.”
Even in states that have adopted similar legislation, such as Georgia, equity crowdfunding remains on the fringe. Some attribute this unfortunate result to the legal complexities that govern investment offerings. However, one major risk repels most entrepreneurs: Antifraud liability.
There are a multitude of antifraud rules with varying standards of application that may be triggered by written or oral statements construed as misleading or simply omitted. Additionally, the crowdfunder, not the investor, carries the burden of proof in establishing that the offering was properly made to the investor.
While the Invest Tennessee Exemption removes expensive regulatory barriers to equity crowdfunding, legitimate entrepreneurs are urged to seek the advice of experienced legal counsel before soliciting investors.
For questions regarding the Invest Tennessee Exemption, please contact Bob Zeglarski at Cutwater Law PLLC via telephone at 615-933-3545 or email at firstname.lastname@example.org.
If you haven’t, you should, especially if you plan to raise money through angel investments or crowd funding in 2015. Bills can be confusing and TL;DR so I’m going to do my best to relay the main points of the bill in layman’s terms so you can crowd fund your startup efficiently in the new year.
Essentially, the exemption allows equity crowd funding.
Generally all securities offered for sale must be registered with the Securities and Exchange Commission (SEC) and a state regulatory authority (in this case TN Securities Division). A company registers its securities by filing a “registration statement” with SEC and/or TNSD before it offers its securities for sale to investors. A registration statement is a set of documents, including a prospectus, that describes the investment opportunity and most often must include audited financial statements ($$$). In most cases, the SEC and/or the TNSD can require modifications or deny approval of the registration.
While registration is the rule, there are exceptions.
If a company meets such an exception, it is said to be “exempt from registration.” (i.e., it does not need to register its securities by filing a registration statement). Caveat—there are numerous rules that must be followed to qualify for any exemption.
One such exemption is found in Section 3(a)(11) of the Securities Act of 1933. It states that a company is exempt from registration with the SEC if it meets certain conditions (e.g., a company located within a particular state offers its securities for sale to investors within the same state–only one of many conditions). This exemption from Federal registration is called the Intrastate Offering Exemption.
Today, even if a company qualifies for the Intrastate Offering Exemption, it must register its securities with the TNSD. Upon its effectiveness in 2015, The Invest Tennessee Exemption (ITE) removes this TN registration requirement. In other words, if a Tennessee company qualifies for the Federal Intrastate Exemption, it will qualify for the ITE, allowing it to forego the registration process.
Where It Gets Interesting
If you qualify for the Intrastate Offering Exemption (and the ITE), you can use general solicitation methods (television/radio/print/internet) to attract investors. And according to ITE you can sell investments to anyone, regardless of financial means (with certain limitations).
The Invest Tennessee Exemption has numerous advantages over current and proposed federal regulations (including the JOBS Act of 2012).
Main Points of the Exemption:
• Neither state nor federal registration of the offering is required.
• General solicitation of Tennessee investors is permitted.
• Funds may be raised from any Tennessee investor, regardless of financial means.
1. State/Federal Registration
A company raising money under the Invest Tennessee Exemption does not need to be approved by federal or state regulators via a registration process. However, the offering must qualify by meeting certain conditions. For example, only Tennessee companies can sell their securities using this exemption, and they can only sell their securities to investors that are residents of Tennessee.
A company, personal or third-party website that displays openly that a startup is fundraising
Public speaking engagements, such as conferences, panels, or forums
According to the SEC, general solicitation means offers made pursuant to “advertisements published in newspapers and magazines, public websites, communications broadcasted over television and radio, and seminars where attendees have been invited by general solicitation or general advertising. In addition, the use of an unrestricted, and therefore publicly available, website constitutes general solicitation. The solicitation must be an “offer” of securities, but solicitations that condition the market for an offering of securities may be considered to be offers.”
The Invest Tennessee Exemption will allow Tennessee businesses to solicit investments from Tennessee residents using all forms of mass media. Currently, crowd funding is limited to websites like Kickstarter that only allow entrepreneurs to solicit donations to fund business opportunities. Starting in 2015, you can generally solicit for securities online.
3. Funding From Unaccredited Investors
“The Invest Tennessee Exemption provides entrepreneurs with a new alternative to bank loans and money supplied by angel and venture capital investors,” said Bob Zeglarski, Founder of Cutwater Law, “For their part, crowd funding investors living in Tennessee will actually have an opportunity to realize a financial return.”
The bill states that “the issuer (Founder, Cofounder, whoever is leading the funding round) may not accept more than $10,000 from an investor unless the investor is an accredited investor pursuant to federal regulations,” meaning that if you as a founder want to add unaccredited investors, they can offer up to 10,000 dollars to a startup starting in 2015.
Things to Consider:
1. Keep in mind that the unaccredited investor can only invest up to 10,000 per startup.
2. As a founder, you should note that the unaccredited investor is investing for equity, not donation.
3. According to the law, there is nothing that limits unaccredited investors from investing the max (10,000) in as many startups as they’d like as long as they qualify under the exemption.
4. Investors must be Tennessee residents.
“While companies will need to hire a lawyer to do these kinds of offerings, they won’t spend the kind of money required for a successful registration. [The exemption creates] greater access to capital at a lower cost (even lower than what is being proposed under the JOBS Act),” Zeglarski said.
Companies wishing to utilize the Invest Tennessee Exemption will need to follow strict rules set by state and federal regulators that aim to curb fraud.
Cutwater Law PLLC, a Tennessee business law firm, will host a webinar on October 21, 2014 to help local entrepreneurs prepare for the Invest Tennessee Exemption. The new crowd funding law will take effect January 1, 2015.
Southern/alpha is an online news property that tells the story of Southern startups. It provides the startup and technology communities with news and information to ease their navigation of their respective and communal ecosystems. Bob Zeglarski
Cutwater Law PLLC, a Tennessee business law firm, will host a webinar on October 21, 2014 to help local entrepreneurs prepare for the Invest Tennessee Exemption, a new crowdfunding law that will take effect in 2015.
The Invest Tennessee Exemption will allow Tennessee businesses to solicit investments from Tennessee residents using all forms of mass media, including the Internet. Currently, online crowdfunding is limited to websites like Kickstarter that only allow entrepreneurs to solicit donations to fund business opportunities.
“The Invest Tennessee Exemption provides entrepreneurs with a new alternative to bank loans and money supplied by angel and venture capital investors,” said Bob Zeglarski, Founder of Cutwater Law, “For their part, crowdfunding investors living in Tennessee will actually have an opportunity to realize a financial return.”
Experience drives every Cutwater Law engagement. That’s important when it comes to learning a new client’s business and delivering legal services with efficiency. Cutwater Law provides legal input to business owners, entrepreneurs, and creatives to help them achieve business results. ____________
Glossary of Terms
General Solicitation - Offers made pursuant to "advertisements published in newspapers and magazines, public websites, communications broadcasted over television and radio, and seminars where attendees have been invited by general solicitation or general advertising. In addition, the use of an unrestricted, and therefore publicly available, website constitutes general solicitation. The solicitation must be an “offer” of securities, but solicitations that condition the market for an offering of securities may be considered to be offers." (From the Securities and Exchange Commission's Website)
In the new crowdfunding ecosystem, there will no doubt be wolves among us. It is up to investors to protect themselves from fraud. Here are some “red flags” to look for when investing in a company on Spring Street:
1. High Compensation with Little or No Revenue – We all need to make a living, but there is no reason why the CEO of a crowdfunded company should be making excessive compensation, particularly when the company is generating no revenue.
2. Expensive Money or Contracts – Look out for big commissions payable to management or third parties who assist the company in raising money. Be suspicious of “consultants” or “finders” who have contracts with the company entitling them to a percentage of any funds they raise. If a company is making regular cash payments to a third party for any kind of service, you should understand what the payments are for. Also, find out if there is common ownership between the company and any vendor. It is possible that management is simply funneling cash to themselves through a vendor they own.
3. Related Party Transactions – Is management involved in any contract or transaction with the company that would benefit him or her personally? Is the company buying its primary asset from the company’s CEO? If so, find out the terms of the deal and how it was or will be approved. Legitimate management will go to extraordinary lengths to mitigate conflicts of interest.
4. Accounting Issues – Has the company ever had an accountant jump ship? If so, find out why. Read all letters written by the company’s accountant in connection with the offering. They may reveal something questionable about the company or the offering.
5. Assets Unrelated to Business – Incredibly, people will invest in a company that owns assets only tangentially related to its line of business. This could be a clue that management intends to take the business in a completely different direction, after taking your money.
6. Confidential or Secret Information – Be suspicious of information provided on a confidential basis or “off the record”. Sometimes secret information is offered to give the perception of value. Other times it is offered to avoid leaving a paper trail.
7. Black Boxes – If a company claims to own proprietary technology or a trade secret that give them a marketplace advantage, demand full disclosure. A company that is not willing to share proof pursuant to a confidentiality agreement may be blowing smoke.
8. Familiar Names – You should raise an eyebrow if a company uses names similar to names of successful companies, products or people. Scour the internet for information about everyone involved (e.g., management, lawyers, accountants, consultants, vendors, and advisers). If you read something negative online, conduct more research on the matter.
9. Fast Money – Companies that use crowdfunding to raise capital are high-risk ventures. Good investments are long-term. Do not be persuaded by projections that promise high returns over a short period of time, often 6 to 24 months.
10. Guaranteed Returns – No investment can provide a guaranteed return, otherwise the owners would simply get a bank loan to capitalize the venture. Be skeptical of a company that claims that downplays the risks associated with an investment. Don’t invest in opportunities that are de-risked or enhanced by exotic financial products, complex corporate structures or insurance products. Protect yourself from the smartest guys in the room.