Intrastate crowdfunding: Nice, but not a game changer

In recent months, a lot of excitement has built up surrounding the enactment and use of intrastate crowdfunding exemptions as an alternative to waiting for the SEC to finalize Regulation Crowdfunding at the federal level.  Presently, at least thirteen states have introduced or enacted some form of exemption from state regulation for intrastate crowdfunding offerings.  These exemptions allow companies to sell securities in offerings exempt from SEC registration through making notice filings with their respective state securities commissions rather than following the standard intrastate practice of “qualifying” the offering with state regulators.  The exemptions vary in some ways, but common features include limitations on the amounts offered to investors, caps on individual investor contributions, disclosure requirements, disqualification of Bad Actors, and affirmation of state and federal securities fraud liability.

However, there are impediments to intrastate crowdfunding.  As noted industry observers point out, very few companies have successfully raised funds as a result of the exemption.  There have been some notable successes.  Back in October of last year, SparkMarket led the way with its intrastate offering in Georgia for Bohemian Guitars.  More recently, Tecumseh Brewing Company used the intrastate exemption in Michigan to raise $175,000.

These successes demonstrate the utility of intrastate crowdfunding—it is a great way for small, community-based companies to raise funds locally.  What it is not is a revolutionary way for high-growth-potential startups with national footprints to access capital markets.

Most of the intrastate exemptions adopted so far are based on Section 3(a)(11) of the Securities Act. This exemption from registration at the federal level requires the entire offering to be intrastate. The SEC has provided guidance and a safeharbor for companies relying on Section 3(a)(11) in Securities Act Rule 147.  Rule 147 outlines the requirements for the company offering securities, the status of all offerees, and restrictions on the resale of those securities.  For instance:

  •  The company must be organized and doing business within a single state (e.g., no Delaware corporations doing business in Michigan);
    • Doing business within a single state means at least 80 percent of its gross revenues, at least 80 percent of its assets, and at least 80 percent of the net proceeds from the raise are used within the state (e.g., a North Carolina company that receives 30 percent of its revenues from Virginia would not qualify);
  • The offerees of the securities must all be in the same state (as the SEC made clear in April, that eliminates the ability to use unrestricted solicitations through social media);
  • Additionally, the securities sold in an intrastate offering are restricted for at least nine months, and even after that may only be resold to persons in the same state as the original sale.

Companies using intrastate crowdfunding exemptions will also need to take care to ensure that the intrastate offerings are not “integrated” with any other offering that may result in the loss of the exemption.  For example, if a company immediately follows up an intrastate crowdfunding raise with a raise using general solicitation under Rule 506(c), the offerings could be deemed to be integrated and the unrestricted general solicitation for the Rule 506(c) offering will result in the loss of the exemption relied on for the intrastate offering.  As a result, the company will have violated Section 5 of the Securities Act and would be deemed a Bad Actor prohibited from relying on various exemptions from registration under the Securities Act in the future.

Two states, Maine and California, have decided to draft their intrastate crowdfunding exemptions around a different federal exemption from registration, Securities Act Rule 504.  Rule 504 poses different compliance challenges than Section 3(a)(11), but does open more avenues for companies to reach investors, be organized and operating in more than one state, and have securities that can be resold without restrictions with dollar limits substantially similar to the intrastate crowdfunding provisions based on Section 3(a)(11).  In the long-term, we may see more states adopting this approach to their intrastate crowdfunding because of the increased flexibility for growth-potential companies.

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