Log in
updated 2:54 PM CDT, Jul 28, 2018

FlynnsHarp logo 042016

Arrival of federal crowdfunding gives start-up companies options

Almost four years overdue, federal crowdfunding rules went into effect last week to fulfill a 2012 Congressional mandate to "democratize" the process by which entrepreneurs and small businesses can raise start-up capital from "the crowd" of investors of average means.

Some cynics might view as "Democracy in action" the fact that it took almost four years for the Securities and Exchange Commission to come up with the rules that Congress originally gave it 180 days to enact so the legislation known as the Jumpstarts Our Business Startups (JOBS) Act could go into effect.

But the upside of the years of delay was that almost half of the states, including Washington, were spurred to seize the opportunity to come up with intrastate versions of the crowdfunding concept. As a result entrepreneurs in most states have the choice of federal or state regulations to use in seeking start-up capital from average investors, a choice that would likely not have come to pass without the SEC's foot dragging.

And in fact, the act's regulatory debut of 17 federal filings the first day was characterized as "pretty impressive" by Faith Anderson, the respected Registration and General Counsel Program Manager in the Securities Division of the state Department of Financial Institutions (DFI).

How the individual states have fared in the responses to their crowdfunding legislation has depended on a number of factors. Oregon, for example, because it has a non-profit dedicated to helping entrepreneurs through the process, has had good reviews.

Montana, on the other hand, has an unusual constraint that requires that half of a startups' business must be done in Montana.

"Makes it a pretty small prospective market," quipped Liz Marchi, the Kalispell-based leader of three Montana angel funds.

Before its crowdfunding legislation was approved last year, Montana was already rated the top state in the nation for start-up businesses on the Kauffman Index, the annual state ranking of startups by the Kauffman Foundation, largest entrepreneurship-focused non-profit in the country.

Marchi, who is finding enough entrepreneurs already emerging in the Big Sky Country, is not a big fan of crowdfunding for entrepreneurs, saying "I plan to stay away until all the unintended consequences have been worked out."

Meanwhile, Oregon's non-profit called Hatch Oregon, which travels around the state vetting startups it works with, is getting positive attention from startups there for what amounts to an incubator that seeks to guide entrepreneurs past the financial rocks and shoals of the crowdfunding game.

Hatch, whose platform hosts 10 of the 11 offerings filed in Oregon so far, offers no guarantee to the companies it works with. The incubator also produced a video called "Let's Be Frank" that tries to outline the risks in plain language.

Washington has no such entity to inexpensively help entrepreneurs along the road toward fundraising. But regulators have sought to put in place a program that helps guide startups to produce a document that ensures they are in compliance with securities laws, that investors are protected and entrepreneurs themselves are steered away from possible future liabilities.

The intent is an entrepreneur could be helped through the process without having to necessarily incur the expense of an attorney.

But the fact not all startups want to be so carefully guided is evident by the fact that one of two companies filing under the crowdfunding law got considerable media attention by lamenting that its efforts to get the paperwork done and get to fundraising was being hung up in red tape.

The sense is that what the filing firm viewed as "red tape" was insistence by state regulators that all the requirements be met, and one of the challenges for startup hopefuls is that not all attorneys understand the law and its regulatory requirements at this point.

One nagging aspect of the SEC rules in place that govern the crowdfunding laws of all the states is something known as Rule 147, referred to as the "intrastate offering" exemption, which has strict requirements that intrastate offerings be contained within the boundaries of a single state. In other words, an entrepreneur filing under the Washington State law not only can't take money from the resident of another state, but the resident of another state isn't even to see the offering.

So far, the SEC has been firm in the view that if someone in another state sees the information on the offering, it is no longer intrastate, which would basically nullify the fund-raising effort.

Anderson, chair of the Small Business/Limited Offerings Project Group of the National Securities Administrators Association, produced a report some months ago for the securities departments of all 50 states that was critical of Rule 147 and its impact on entrepreneurs.

The SEC has apparently gotten enough push back from the states on that constraint that, as Michelle Webster, financial legal examiner for DFI, explained, the SEC has several proposals, which are currently merely proposals it will consider that would amend the JOBS Act rules. One that would address that almost universal Rule 147 irritant would allow intrastate visibility for an offering as long as only residents of the filing company's state were permitted to invest.

But the fact is there is no timeline for the SEC to actually act on proposed amendments to rule 147. And some suggest the agency might never act since they do not have a Congressional push to do so.

Joe Wallin, a Seattle attorney with Carney Badley Spellman, who basically wrote the state legislation that created the crowdfunding law in this state, has been critical of the fact that those assisting entrepreneurs to raise funds cannot legally charge a fee representing a percentage of dollars raised unless licensed as a broker-dealer.

That's a federal restriction and Wallin is convinced an easing of that rule would find a lot of individuals and groups stepping forward to provide fee-based assistance based on a percentage of the dollars raised rather high hourly fees.

Washington' Securities Administrator, Bill Beatty, suggested that from now forward, with both federal and state options open to would-be crowdfunders, to be determined is: "will the federal model, which requires the use of licensed portals, or the typical state model, which allows issuers to conduct the offering, be more attractive?"

The sense has been that the cost of using a licensed portal could be a substantial slice of the $1 million that a crowdfunding startup would be permitted to raise the first year. But Beatty said he has gotten the sense of more reasonable pricing from some portal operators.

"If the costs prove to be reasonable, I think federal crowdfunding has a much better chance of gaining traction and being a useful tool for some small businesses," he said.

Continue reading
  1910 Hits
  0 Comments
1910 Hits
0 Comments

Concerns about Internet advertising may make crowdfunding tool difficult for entrepreneurs

It was born with great flourish in the spring of 2012, passed by Congress and signed by the president and hailed as the wellspring of new companies and jobs as the nation sought to emerge from the Great Recession. In fact, with a marketer's touch in a presidential election year, it was even called the JOBs Act.

Now after a nearly four-year wait for a recalcitrant Securities and Exchange Commission to adopt the rules required to implement the intent of the Jumpstart Our Business Startups Act to allow businesses to raise up to $1 million a year from a large number of small-equity investors, the rules are set to go into effect May 16.


Meanwhile, more than half of the states, tired of waiting for the SEC to act, have adopted their own versions of what is known as crowdfunding, which is largely expected to be Internet outreach to large numbers of potential investors by entrepreneurs seeking capital.

Because of SEC rules in effect under the Securities Act of 1933, the states' legislation limits fund-raising to residents in the state where the business is located.


And with the arrival of federal crowdfunding comes a growing concern that the crowdfunding laws of the various states may be rendered "impractical" since those who use the Internet or social media, the logical tools to reach a "crowd" of prospects, must ensure no one in another state can see the offering.

Washington was one of the first states to enact legislation to permit crowdfunding, with many of those testifying during the Washington Department of Financial Institutions' rule-making process suggesting entrepreneurs would be queuing up to look to crowdfunding to raise money.

But despite that expectation, in the 15 months since DFI enacted the rules and the law went into effect, only two businesses have filed to raise money in this state via crowdfunding. In fact, according to DFI Director Scott Jarvis, only 100 companies around the country have used intrastate crowdfunding to raise capital.

 
Joe Wallin 
Thus given that there is no line of entrepreneurs forming to seize the crowdfunding opportunity, there is no certainty how much demand there will be for the opportunity to raise money through crowdfunding once entrepreneurs have a choice between federal and state rules. The federal will allow businesses to raise money from investors anywhere in the country rather just in their home state. Using state law requires entrepreneurs to only raise money intrastate. 

One reason for slower-than-anticipated interest could be that the resurgent economy has made it easier to raise money through traditional funding sources, suggests Joe Wallin, a Seattle attorney with Carney Badley Spellman, who basically wrote the state legislation that was passed two years ago.

"The ebb and flow of the economy may impact the ability of entrepreneurs to tap traditional sources of capital so at some point, if not right away, the crowdfunding approach may become more popular," he said.

And now comes the likely additional deterrent to intrastate crowdfunding with the warnings about Internet use to advertise the offering, since the advertising may only be to residents of the state in which the offering is made.

Faith Anderson 

According to the SEC's directive, if someone in another state sees the information on the offering, it is no longer intrastate, which would basically nullify the fund-raising effort.

In one of the most thorough examinations of the new role of states in the crowdfunding phenomenon, Faith L. Anderson of the state DFI's Securities Division, describes as "draconian" the fact that rules "do not provide any relief for insignificant deviations" from the advertising limitations.

"A single out-of-state sale will void the exemption (for the entrepreneur raising money via intrastate crowdfunding) and result in an unlawful offer or sale of securities in the absence of another available exemption," she wrote.

Anderson's comments are part of a report she produced for securities departments of all 50 states as chair of the Small Business/Limited Offerings Project Group of the National Securities Administrators Association.

Anderson's document to her peers is designed to explain the strengths and weaknesses of both federal and intrastate crowdfunding options. But her focus on the challenges the SEC rules pose to intrastate offerings includes the comment that the combined effect of federal rules "is to severely restrict an issuer's ability to take advantage of state crowdfunding provisions that are premised on these federal provisions."

But the SEC staff has said the agency is considering amendments that could make Internet use possible.

"There is no timeframe by which the SEC may finalize the proposed amendments to Rule 147 (the rule that has raised a number of concerns for intrastate crowdfunding)," Anderson said in an email exchange with me. " In fact, they may never as they do not have a Congressional duty to act in this regard."

And Wallin added: "Unless it makes the changes being suggested for use of the internet in intrastate crowdfunding, the SEC is tamping down a nascent but important opportunity to cultivate local funding and entrepreneurship ecosystems before they even have an opportunity to develop."
 
But Wallin notes he is "optimistic that whatever the SEC finally decides, the state can figure out...maybe through new rules or amendments."
 
And Anderson closes her briefing to peers with: "As we learn what works and what doesn't from the viewpoint of entrepreneurs and small business owners, states and the SEC may make further adjustments to their crowdfunding rules."
 

Thus there seems to be optimism that what Congress launched with the right intent, but watched while the SEC dithered for almost four years, may still produce an opportunity for entrepreneurs to create jobs rather than being jobbed by thoughtless regulations.

Continue reading
  1395 Hits
  0 Comments
1395 Hits
0 Comments

52°F

Seattle

Mostly Cloudy

Humidity: 63%

Wind: 14 mph

  • 24 Mar 2016 52°F 42°F
  • 25 Mar 2016 54°F 40°F
Banner 468 x 60 px