When we first began discussions at Hatch about creating a crowdfunding law just for Oregon, we didn’t know how many factors there were to consider. After researching other states’ existing laws, we realized that there are many variables – and that each affects how (or even if) the law is used by entrepreneurs. So far, the SEC rules around advertising have proven to be one of the biggest challenges.
The challenge is this: how do you enable entrepreneurs to raise local capital without onerous red tape, while also minimizing risks for investors?
State vs Federal
The answers so far have been found in a few key variables that the states actually control, such as creating individual investment caps, reporting requirements, limiting the maximum raise amount, and developing reasonable filing procedures. In Oregon, we came up with a balance of modern, workable ideas that streamlined the process and included built-in investor protections. We quickly realized, however, that everything at the state level must work within the restrictions found at the federal level.
State-based securities crowdfunding is made possible using a federal exemption – the overarching “mother ship” regulation. This exemption effectively allows companies to sell unregistered securities within a state, provided the business and the investors are all based within that state (i.e. no money crosses state lines). For companies to qualify for this exemption, they need to comply with rule 3(a)(11) and comply with the safe harbor “Rule 147”. The problem is, Rule 147 was written in the 1970s, before the internet age, and currently is one of the biggest barriers to effective state-based crowdfunding. In short: it’s outdated and it’s holding us back.
Rule 147 Update Proposals
Happily, the Securities & Exchange Commission (SEC) has plans to modernize Rule 147. A subcommittee has proposed changing some of the outdated restrictions. (In fact, one of the regulators on that committee will be here at ComCap16 to talk about it. Join us and meet Michael Pieciak, Deputy Commissioner, Vermont Securities Division!) Three main proposals aim to reduce the requirements for entrepreneurs and allow raising funds on the internet. The current requirements, and the proposals to amend them, are outlined below in plain English so that you can see for yourself some of the challenges that lie ahead.
(Please keep in mind these are heavily paraphrased, and that this is not legal advice!)
Current Requirement: Entrepreneurs using an intrastate law can only advertise to people who live in the state. Meaning, no social media or use of the internet without absurd online linguistic gymnastics.
Why It’s a Problem: Companies cannot freely announce their offer and advertise on the internet for fear of being out of compliance and losing their ability to claim the exemption.
Proposed Change: Allow advertising to flow freely onto the internet, through social media, and be seen anywhere, but maintain the requirement that all sales be made only to residents of the state in which the issuer has filed.
Outcome: Companies can announce their offering on social media and their website, and bring traffic to their site, while still only allowing in-state investments.
Current Requirement: Companies offering securities must derive at least 80% of their gross revenues from operations within the state.
Intent: To make sure that companies using the exemption are genuinely based within the state.
Why It’s a Problem: It’s confusing – how do you keep track of where all your revenues are coming from? What happens if only 78% of your income is from operations within the state?
Proposed Change: Removing this percentage threshold, and instead using alternative criteria to determine that a company is based (and does business) in the state in which they are offering securities.
Outcome: Clear and simple factors that determine whether a business can offer securities in reliance on the intrastate exemption, saving time when deciding on how to raise funds.
Current Requirement: Companies must be incorporated or organized within the state where securities are sold.
Intent: Again, to make sure that companies using the exemption are genuinely a state-based company.
Why It’s a Problem: Some companies wish to incorporate in states such as Delaware for legal and tax benefits, despite doing business solely within another state. This requirement therefore can affect the day-to-day costs of doing business, and the attractiveness to investors.
Proposed Change Eliminating the requirement that the issuer be incorporated or organized in the same state where all securities sales occur.
Outcome: Businesses could still sell securities within the state where they are based, even if they incorporate elsewhere.
What do you think? Are these changes good? Bad? Ugly? Leave a comment below and tell us what you think.
How would you design a law to balance the interests of entrepreneurs and investors?
If you want to hear what state and federal regulators think, you can hear it directly at ComCap16. Click here to see what else you can learn at ComCap16!