By Tom Sharbaugh, partner, and Randy Barr W’10, associate, in the Business & Finance Practice Group of Morgan Lewis & Bockius LLP
The new crowdfunding provisions in the “JOBS Act of 2012” have received a lot of attention. The Act exempts certain crowdfundings from the registration requirements of the federal securities laws (the Federal CF Exemption), and the SEC proposed regulations in October 2013 to implement the exemption (the Proposed CF Regulations). The SEC received numerous comments related to the significant costs imposed by the proposed requirements, and the Federal CF Exemption will not be effective until the SEC issues its final regulations. However, many states have found a way to go ahead with crowdfunding—by adopting their own intrastate crowdfunding exemptions.
The state exemptions cannot supersede the SEC, but there is a longstanding federal exemption from registration for intrastate offerings. States have generally designed their crowdfunding exemptions to work in tandem with the federal intrastate exemption, which basically means that an issuer could be exempt at both the federal and state levels if it conducts an offering solely within the state where it resides. The state exemptions have generally removed certain of the more objectionable requirements of the Proposed CF Regulations, including use of a broker-dealer or “funding portal” for any exempt crowdfunding, preparation of audited financial statements for offerings of over $500,000 and distribution of financial reports to investors after the sale. In addition, some of the exemptions have provided routes for raising amounts well beyond the $1 million cap under the Federal CF Exemption.
Kansas and Georgia were the first states to go the intrastate route with their Invest Kansas Exemption and Invest Georgia Exemption. Other states with intrastate exemptions from registration include Alabama, Indiana, Michigan, Washington and Wisconsin. In addition, action for a crowdfunding exemption is pending in New Jersey, North Carolina and Texas.
Most of the new state exemptions have the same offering cap as under the Federal CF Exemption. However, some states increase the cap to $2 million if the issuer has audited financial statements. The proposed New Jersey exemption could have a much higher cap because it excludes from its cap any amount sold to an “accredited investor” (generally, a person with annual income over $200,000 or a net worth over $1 million).
All of the state exemptions follow the federal principle that it is advisable to control potential losses by limiting the amount that may be invested by an individual investor. Under the Federal CF Exemption, the limitation on investment depends on the income or net worth of the investor. The state exemptions have individual investment limitations ranging from $1,000 for Kansas to $10,000 for Georgia, Michigan and Wisconsin, irrespective of the income or net worth of the investor (except for the Washington exemption). The state exemptions generally permit an accredited investor to invest an unlimited amount (subject to the overall cap for the offering).
Many commentators believe that the burdensome requirements of the Federal CF Exemption will defeat the JOBS-Act purpose of making it easier for small companies to raise capital. The big unknown is whether the availability of a cheaper and quicker intrastate crowdfunding exemption will bolster entrepreneurial activity in a particular state. The intrastate exemptions adopted by many states appear to provide a reasonable alternative for crowdfunding–an exemption that lacks certain expensive investor protections of the Federal CF Exemption, but that still limits the amount that individuals could lose.
Bios: Tom Sharbaugh is a partner, and Randy Barr is an associate, in the Business & Finance Practice Group of Morgan Lewis & Bockius LLP. They both represent investors and companies in emerging growth securities offerings. Randy earned his B.S. in economics, with a concentration in marketing, from the University of Pennsylvania, Wharton School in 2010.