Status Update: Crowdfunding

In 2012, in an effort to revive the job market, President Obama signed into law a bill known as the “JOBS Act” (Jumpstart Our Business Startups). He called it a “potential game changer” for entrepreneurs seeking financing to start or expand a business. Most notably, it allowed entrepreneurs to solicit investment online and allowed the average investor (not just the wealthy “accredited investor”) to make an investment, a concept known as “crowdfunding.” On the federal level, the Securities and Exchange Commission (“SEC”) was slow in drafting the necessary rule amendments that would allow crowdfunding to occur across state lines (interstate crowdfunding). But state agencies and lawmakers were eager to open up capital for their local businesses. They began passing crowdfunding laws and regulations which let local businesses raise money from local residents on an intrastate basis, some taking action even before the JOBS Act was signed into law.

Kansas and Georgia were the first states to move forward with intrastate crowdfunding regulations, with their “Invest Kansas Exemption” and “Invest Georgia Exemption,” respectively, both adopted in 2011. They did this by writing their new crowdfunding exemptions so that they worked within the parameters of an existing federal intrastate exemption. Although state crowdfunding exemptions cannot supersede the actions of the SEC, there is a longstanding federal exemption from registration for intrastate offerings under Section 3(a)(11) of the Securities Act of 1933, as amended, and SEC Rule 147, which is a “safe harbor” means of compliance with Section 3(a)(11).

Other states followed suit. In fact, by the end of 2015, only a handful of states had yet to propose or enact regulation. Tennessee’s crowdfunding exemption, Invest Tennessee Exemption, or “ITE,” went into effect on January 1, 2015 while specific rules relating to ITE took effect December 16, 2015. I was so pleased with Tennessee's leadership in crowdfunding that I wrote a letter of support for the proposed regulations. While the rules create an opportunity for issuers to raise equity capital, there are unique anti-fraud risks. 

State rules, regulations and/or exemptions are not without limitations, however, and there has been much written about whether they will have the desired effect. There are restrictions on the offerings that can be conducted intrastate. Most obviously, issuers can only raise money from investors in their own state. But other restrictions, which vary state to state, can also be burdensome. These include: limits on funds to be raised, limits on the amounts an investor can invest, limits on those that can be issuers, limits on transferability, increased disclosure and reporting requirements, required use of broker-dealers or crowdfunding portals, required use of internet site operators, and required use of escrow agents. In addition, in order to qualify under the state rules, regulations and/or exemptions, the offering must fall under the federal exemption from registration under Section 3(a)(11) and SEC Rule 147.

]

In October 2015, the SEC finally issued 568 pages of final rules to implement the JOBS Act, which become effective May 16, 2016. These are the parameters of the crowdfunding rules:

• Issuers can raise a maximum of $1 million in a 12-month period
• Investors whose income or net worth are less than $100,000 are limited to $2,000 or 5% of their income, whichever is greater, in aggregate crowdfunding investments over a 12-month period
• Investors whose income or net worth is greater than $100,000 may invest up to 10% of their income or net worth, not to exceed $100,000 in a 12-month period
• All crowdfunding transactions must take place on an SEC-registered intermediary (either a broker-dealer or a crowdfunding portal)
• Intermediaries must take measures to educate investors and mitigate fraud
• Issuers must provide basic financial information (the proposed rules require audited financials for offerings greater than $500,000)

Invest Tennessee Exemption Rulemaking Hearing

Last week, Cutwater Law’s founder, Bob Zeglarski, attended a public hearing regarding regulations being proposed by the Tennessee Department of Commerce and Insurance’s Securities Division pursuant to the Invest Tennessee Exemption (ITE). The hearing was held to allow the public to weigh in on the proposed regulations.

Tennessee Department of Commerce and Insurance’s Securities Division

Zeglarski appeared in support of the Divisions new rule after submitting the following letter earlier in the month (text follows):

Sent via Email

(sarah.branch@tn.gov)
Sarah Branch, Esq.
Assistant General Counsel
Securities Department of Commerce and Insurance 
500 James Robertson Parkway, 8th Floor 
Nashville, TN 37243

RE: INVEST TENNESSEE EXEMPTION
NEW RULE NUMBER 0780-04-02-.17 (“New Rule”)

Dear Ms. Branch,

Please accept this letter in support of the New Rule. I welcome the opportunity to share my viewpoint with the public at the Rulemaking Hearing on April 22, 2015. This letter represents my own views as a Tennessee securities lawyer who advises private and public emerging growth companies.

During the past 10 years, I have primarily helped businesses leverage capital to grow. In my experience, scarcity of capital is the greatest challenge faced by emerging growth companies, particularly those with total annual gross revenues of less than $10 Million. As a result, I have become an advocate for responsible deregulation of securities laws that facilitate small capital formation.

I support the New Rule because it codifies best practices for compliance with the intrastate exemption from federal securities registration requirements, a rarely utilized exemption that has numerous pitfalls. By establishing rules that require a conservative approach, issuers will be more likely to avoid such pitfalls. The New Rule will, therefore, protect our new marketplace, helping to keep transaction and capital costs low for Tennessee companies that use the Invest Tennessee Exemption to raise capital.

The Invest Tennessee Exemption will help most emerging growth companies in Tennessee access the capital they need to succeed. While late stage emerging growth companies can absorb the large transaction costs required to access capital in a national securities market, most emerging growth companies cannot. Instead, they must navigate a private marketplace that limits its sources of capital to banks, professional investors, and certain wealthy individuals that, all together, constitute only 1% of the US population. The Invest Tennessee Exemption provides smaller issuers with a new avenue to local public capital without the expense of registration. Having greater access to capital, small issuers will be better positioned for growth.

In addition to providing Tennessee companies with a new source of capital, the Invest Tennessee Exemption creates an opportunity to build a stronger local market for capital, spur local economic development, and create new jobs. One only needs to review the historical record to know that this vision is feasible. Before the passage of landmark securities legislation in the 1930s, local and regional stock markets flourished in the United States. They expanded local economies and helped create new jobs.

The Invest Tennessee Exemption contributes to a movement, particularly in the South, that will help fix certain small capital formation problems that have emerged over the last 100 years. Federal regulations have limited small issuer access to only the wealthiest investors, while virtually eliminating their access to public markets. At the same time, national marketplaces, like the New York Stock Exchange, have maximized economies of scale to drive down transaction costs, making local capital less economical. The Invest Tennessee Exemption solves the problem of access and makes small capital formation economically feasible on a local level.

The Invest Tennessee Exemption will also have a positive impact on our broader economy. The consolidation of our public markets has created a major market failure that adversely impacts our economy. By catering to the largest companies, the most lucrative clients, national securities marketplaces have dangerously narrowed the field of publicly listed companies. Today, most of our national wealth is yoked to the performance of national public capital markets that list less than 1% of all US companies, a very small group of companies that all have enormous market capitalizations. As a result, the failure of one can shock the entire system. The Invest Tennessee Exemption will help to diversify our public markets, reducing this systemic risk.

Thank you for proposing a rule that protects our local capital market, encourages local economic growth, and strengthens our national economy.

Enclosed please find my proposed revisions to the New Rule. Thank you.


Respectfully,
CUTWATER LAW PLLC
/s/Robert Zeglarski
Robert Zeglarski, Esq
Founder

cc: Daphne D. Smith, Assistant Commissioner for Securities (via email daphne.d.smith@tn.gov)

Suggested editorial changes to Chapter 0780-04-02-.17 Invest Tennessee Exemption:

1. In §3(a)(1)(i), insert “deemed to be” after “An issuer shall be...” to harmonize the language with Rule 147.
   
2. Strike §4 and replace it with the following language that is more consistent with the Securities and Exchange Commission’s Compliance and Disclosure Interpretations, released October 2, 2014:
   “(4) Use of the Internet. An issuer shall not use the Internet to offer or sell securities pursuant to this exemption unless such issuer limits communications that are offers only to those persons having Internet Protocol, or IP, addresses that originate from the state of Tennessee and prevents any offers to be made to persons having IP addresses that originate in a state other than Tennessee. The issuer shall maintain a log of all user IP addresses that have viewed issuer communications that are offers.”
   
3. With respect to the established authority set forth at the end of the New Rule, strike all references to federal regulations, which provide no source of state rulemaking authority. 
   

Robert Zeglarski

Antifraud Risk And Equity Crowdfunding In Tennessee

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 bobz@cutwaterlaw.com.  

Bob Zeglarski

The New Tennessee Equity Crowd Funding Exemption You Didn’t Know About

Article by Kelley Boothe.  Published by Southern/alpha

Have you ever looked up the Invest Tennessee Exemption?

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. 

I asked Lawyer Bob Zeglarski of Cutwater Law PLLC, to help me explain how it all works. The firm is hosting a free webinar on October 21st to go over the Invest Tennessee Exemption in detail. According to Zeglarski:

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.

2. Solicitation

You may recall last year when the SEC lifted the ban on general solicitation, allowing startups to raise money online publically.  According to Forbes’s, lifting the ban on general solicitation means you as a founder can now express that you are raising money through the following:

1. A mass newsletter/email
2. A public profile on a startup investment platform
3. A company, personal or third-party website that displays openly that a startup is fundraising
4. Public speaking engagements, such as conferences, panels, or forums
5. Social media
6. Public videos

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.

If you wish to learn more, you can register for the webinar online or via email (info@cutwaterlaw.com).

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

Webinar for Tennessee Entrepreneurs - Crowdfunding With The Invest Tennessee Exemption

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.”

The Invest Tennessee Exemption has numerous advantages over current and proposed federal regulations, including the JOBS Act of 2012:

• Neither state nor federal registration of the offering is required
• General solicitation (defined below) of Tennessee investors is permitted
• Funds may be raised from any Tennessee investor, regardless of financial means

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.

Register for the webinar online at http://www.cutwaterlaw.com/webinars or via email (info@cutwaterlaw.com).

Bob Zeglarski

About Cutwater Law

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)