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State securities regulators ready rules for crowd-funding opportunity for entrepreneurs

Washington State securities regulators intend to make sure that entrepreneurs anxiously awaiting adoption of the rules that will permit them to begin raising capital under new state crowd-funding law won't face any of the frustrations and disappointments that have followed passage of similar legislation at the federal level.

  

The bill under which entrepreneurs can raise funds up to $1 million a year in small amounts from in-state investors passed the Legislature, was signed by the governor last month and goes into effect June 12. But officials of the State Department of Financial Institutions have until October 1 to put in place the rules and the process under which the fund-raising can get under way.

 

Joe Wallin

In an effort to ensure that everything is done on schedule, Scott Jarvis, director of the Department of Financial Institutions, says even before the legislation goes into effect, his agency has begun the planning process for how the rulemaking will unfold between now and October.

  

Washington is now one of a handful of states where lawmakers have decided the promise of a new source of fundraising for entrepreneurs won't likely come about in any meaningful way at the federal level and thus have decided to act locally.

  

It's becoming increasingly likely that what Congress, with an election-year flourish two years ago, passed as the JOBS Act to open the door for entrepreneurs to fund their start-up businesses by attracting average investors on the internet will remain a promise unfilled.

  

It's now been almost two years since Congress passed the bill and gave the Securities and Exchange Commission 180 days to put together the rules for how entrepreneurs could fund their start-up companies via the internet to allow selling equity to large numbersof average investors.

 

Well, entrepreneurs around the country are still waiting for those rules to emerge from the SEC, which must pass rules to implement the legislation officially titled Jumpstart Our Business Startups.

And there is a growing sense that the details of compliance, once the SEC finally acts, will be so onerous on entrepreneurs that the costs of starting to raise capital on the Internet will deter many if not most would-be entrepreneurs.

 

One of those cost factors imposed under the federal act involves a requirement that entrepreneurs must use what are called "portals" basically a new kind of SEC-regulated website with unique responsibilities to oversee the entrepreneurial fund-raising activities, investor risk and monitor money raised.

 

Under the state legislation, economic development organizations and ports will serve as portals for the entrepreneurs at the outset, with the legislation's second deadline being methods of qualifying other portals by next April 1.

 

But unlike with the federal legislation, Washington state entrepreneurs raising funds won't be required to use a portal.

 

The bill allows eligible businesses to raise up to $1 million during any 12-month period and repeat the process in subsequent 12-month periods with accredited and non-accredited investors allowed to participate, up to the investment caps imposed by the federal legislation.

 

Joe Wallin, the Davis Wright law firm attorney who had the leading-edge role in bringing about the state crowd-funding statute, sees it as "potentially a good avenue for companies to raise capital."

 

Wallin, who wrote the first draft suggestion the legislation and included it in a blog post later testified on its importance in making the state more business friendly.

 

He suggests, as others have, that having a crowd-funding law in place to allow entrepreneurs who are residents of this state to sell small amount of equity to investors who must also be Washington residents could attract entrepreneurs from other states to move to Washington.

 

"States are vying to get businesses to move to their states to bring jobs and entrepreneurs who build businesses through crowd-funding will eventually also create jobs," he adds.

 

Rep. Cyrus Habib, the King County lawmaker who sponsored the bill, said "we're putting our state in a place to attract entrepreneurs, and to capitalize on their energy and brainpower. And ordinary people get to buy a piece of the action."

 

Since the Internet has been viewed as the vehicle of choice by entrepreneurs and crowd-funding advocates to reach large numbers of average investors most effectively, the fact that only Washington residents are eligible to invest in the Washington state-based companies creates an outreach challenge for the startups.

 

Wallin says "companies will have to be very careful" how they conduct their equity offerings, using either portals that only allow investors of a particular state to view offerings, or "work connection to connection in a manner that doesn't involve generalsolicitation to non-residents."

 

Part of the role of portals will be to ensure that a firm's annual fundraising via crowd funding doesn't exceed the legal $1million restriction.

 

If there's any doubt that optimism is the byproduct of entrepreneurism, witness the fact that venture capitalists and other investors are rushing into the creation and development of the companies whose business is serving as portals and helping provide services to those who will be hoping to raise equity under the eventually implemented federal act.

 

The VC's have poured millions of dollars this year into companies like Indigogo, Crowdbit and Teespring and other such crowd-funding support companies.

 

Wallin, the Davis Wright attorney, think portals will attract funding from experienced investors. "They are Potential great investments," he said. 

 

Unlike most rule-making hearings by state agencies, the crowd-funding hearings may draw substantial and boisterous gatherings.

As DFI Director Jarvis put it, "this is a crowd of young and enthusiastic supporters who have little knowledge of the process of rulemaking."

 

Part of the challenge for the agency as the rulemaking moves ahead is that some entrepreneurs may fail to understand that, as Securities Administrator Bill Beatty emphasized, "our mission is a dual mission: to protect investors and promote small business capital formation."

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State crowd-funding legislation to ease raising money for startups gets early legislative focus

A proposal that would permit entrepreneurs to raise up to $1 million a year from small investors through what's known as crowd funding, which is seen as a tool to both facilitate the launch new companies and create jobs, will get its initial hearing before the Washington Legislature the end of this week.

 

Washington is among a handful of states where lawmakers have decided that no matter what finally happens with long-awaited implementation of a federal crowd-funding law, they want to move ahead at the state level to open new funding doors for entrepreneurs and startups. And the scheduled hearing Friday may suggest there's some momentum to get the bill passed soon.


The bill (HB2023) is viewed by legislative supporters, and there is no visible opposition, as "a tool for small-business growth all around the state" as well as a potential lure to attract would-be entrepreneurs in other states to move here to launch their business. Only state residents could raise equity under the proposed law and only state residents could buy shares in the companies.

 

Rep.  Cyrus Habib

The federal crowd-funding legislation was passed by Congress in the spring of 2012 as the JOBS Act and directed the Securities and Exchange Commission to come up with the rules that would allow entrepreneurs to begin raising funds under the act. The SEC has moved at a glacial pace in implementing the rules and may still be as much as a year away from final approval to allow crowd funding to begin.

 

If supporters of the bill in the Washington Legislature are successful, the state measure will become law and create the opportunity for entrepreneurs in this state to begin using crowd-funding to raise money from large groups of small investors, primarily on the Internet, before the federal legislation even becomes operative.

 

The fact that Washington and a handful of other states are pressing ahead without regard to what happens in Washington, D.C., is an example of a growing realization that it has become more workable for legislation and regulation to be done at the state level. The reason for that emerging sentiment isn't just the gridlock that allows little to get done in Washington, but also the brainlock that occurs when something does get approved in Congress and is then turned over to the bureaucracy and regulators to implement.

 

Rep. Jeff Morris

HB2023, sponsored by Rep. Cyrus Habib, whose 48th District spans Redmond, Bellevue and Kirkland, would like the federal act allow companies to raise up to $1 million a year from small investors. The Internet is viewed as the most likely vehicle to reach large numbers of those small investors, who would be permitted to invest a maximum of $2,000.

 

Rep. Jeff Morris, D-Mount Vernon, a key supporter of the state legislative proposal, is one who thinks state legislation will serve the needs of both start-up entrepreneurs and small investors who would like to have equity in such companies better than the eventual federal act.


"The federal crowd-funding law, even once rules are in place, is going to require companies to work through an intermediary and is likely to have compliance expenses that will be cost-prohibitive for many start-ups," said Morris.


Morris, who is a co-founder of the Northwest Energy Angels and former director of the Northwest Energy Technology Collaborative (NWETC) at the Washington Technology Center (WTC), is an angel investor far more knowledgeable on the topic of funding start-ups than might be expected of legislators.


The SEC has produced more than 500 pages of proposed rules as it nears the point, more than 18 months after the legislation was approved by Congress, of clearing the way for entrepreneurs to actually begin raising money under the act. But observers think the

90-day comment period will likely produce voluminous comments that will cause the SEC to extend the time when the rules actually go into effect until late this year or early next.

 

Habib says flatly it would be "highly undesirable" for entrepreneurs to have only the federal legislation to deal with in seeking to employ the crowd-funding concept of raising money and selling equity.

 

"I think it will be far easier for start-up entrepreneurs to deal with local regulators who, can design rules that fit our culture, that are less burdensome to issuers, and give us the opportunity to create our own fund-raising product," said Habib, a Seattle attorney who works with many small firms.

 

Habib's first attempt at the bill last session would have imposed an excise tax of 3 to 5 percent, a tax of up to $50,000 on a $1 million fund raise, with the explanation that it was necessary to cover costs the state would incur in things like more consumer protection for investors and added costs for state oversight of the crowd-funding activity.

 

But he has backed off of that in the current version, saying thatrather than imposing an excise tax, "we will give authority to regulators to decide what kind of a fee to impose on the entrepreneurs. The program has to pay for itself, but we decided it's best to leave that to the Department of Financial Institutions to determine what's necessary to achieve that."

 

It was Habib who made the observation that the bill would be a tool for economic development for all parts of the state.

"Using equity crowd funding for those who can't just start a business without money and don't happen to know a friendly millionaire will be a way to raise capital for small businesses anywhere in the state," Habib said.

 

And he and Morris both suggested that small economic development organizations or chambers of commerce could serve the role of gatekeeper, meaning someone to fill the legally required role of an entity to sign off on the legitimacy of the fund-raising effort, to say it wasn't a scam or fraud. Otherwise the gatekeepers would be attorneys, accountants or similar professionals who would be involved in reviewing the legitimacy of would-be entrepreneurs.

 

Scott Jarvis, director of the state Department of Financial Institutions, which has been working closely with lawmakers as the legislation has taken shape, says it is "closely monitoring the SEC's final action to be sure the state legislation avoids conflict with it or sends confusing messages."

 

He said lawmakers and his department must also provide some sort of cost benefit analysis to ensure that any costs incurred by the state or the agency must be provided for and that will depend, in part, on the size of the group of entrepreneurs seeking to raise money through crowd funding.

 

"To steal liberally from 'Field of Dreams,' there is a question as to'If we build it, will they come in sufficient numbers as to justify the costs,'" Jarvis quipped.

 

Among angel investors in favor of the proposed state legislation is Tom Simpson, longtime venture capitalist now head of the Spokane Angel Alliance, who suggests "it will broaden the capital-formation alternatives for certain unique, early-stage enterprises not otherwise candidates for traditional angel or v.c. funding."

 

 

In fact, Simpson shares the view of many angel investors that traditional funding won't likely follow crowd-funded businesses but adds "as long as everyone knows the pros and cons, I expect this form of fund raising to stimulate the growth of new, innovative businesses in this state."

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Long wait for SEC's crowd-funding rules stirs legislature to consider state-level measures

It's now been a year since Congress, with a bipartisan display remarkable for this politically dysfunctional era, passed the JOBS Act that was touted as a breakthrough for funding entrepreneurial start-ups and thus eventually creating jobs.

 

Well, the entrepreneurs are still waiting for the rules that would let them proceed to launch businesses by using internet websites to gather small amounts of money from large numbers of people online.

 

 The rules are to be written by the Securities and Exchange Commission where, despite repeated pressure from some members of Congress who really care about the issue rather than merely having voted for a JOBS bill in an election year, there's been no action.

 

But some states, including Washington, have decided they're tired of waiting and are seeking to proceed on their own. In fact, two bills that would allow Washington entrepreneurs to raise up to $1 million a year from Washington residents on the Internet have been filed in the state House of Representatives, one of the measure described as "democratizing venture capital."
  
And sponsors of the measures filed in this state say they are needed regardless of what kind of rules the SEC finally brings forth. The key sponsor of one of the bills, Rep. Cyrus Habib, D-Bellevue, frankly makes clear details of his bill (HB2023) are being worked on to groom the measure for serious consideration in the 2014 session.
Rep. cyrus habib
Rep. Cyrus Habib

 

The measure Congress passed last May was officially called the Jumpstart Our Business Startups (JOBS) Act by the clever bill drafters who attach can't-oppose names and acronyms to legislation to help ensure that balky lawmakers will find it difficult to vote against. Few lawmakers wanted to vote against JOBS in an election year.

 

Despite the congressionally mandated 180-day timeframe to the SEC, whose then-chair had large misgivings about the legislation, that time passed, as did a promised end-of-year date. Now the SEC has a new chairman, Mary Jo White, who has promised Congress she will make issuing the rules a priority.

 

If there's any doubt that there's a queuing up of entrepreneurs and those who would be involved in crowd funding, consider that the LinkedIn group "CrowdSourcing and CrowdFunding" has over 19,000 members.

 

Both supporters, who view the legislation as a major breakthrough for funding startups, and critics, who are convinced it's a funding disaster in the making, are awaiting the opportunity to be proven right once the rules allow the process to begin.

Tom simpson

Tom Simpson,

angel supporter

 

Tom Simpson, the long-time venture capitalist who now runs the Spokane Angel Alliance, thinks if the rules are "effectively drafted and supported, we would see large amounts of liquid capital flowing into emerging companies, in amounts even greater than during the pre-Sarbanes-Oxley, IPO glory days."

 

"Current regulations are chocking our nation's entrepreneurial fuel tanks," he added.

 

Bill Payne, generally regarded as the Dean of Angel Investors because of the role he plays in providing guidance to angel groups both in this country and internationally, sees a possibility that the regulations to be issues by the SEC "will be so restrictive that crowd funding will be viewed as not worth the effort."  

 

Bill Payne

   Bill Payne,

not a fan

 

Payne, who summers in Montana and winters in the Las Vegas area and who has launched four angel-investor groups around the West, has been a critic of the crowd-funding legislation from the outlet and says "I am less excited about crowd funding now than I was when it was passed."

 

"My guess is that entrepreneurs' advisors have suggested they seek angel capital instead of crowd funding," added Payne, who told me for a column I did a year ago that he viewed crowd funding "as a trainwreck waiting to happen" because he felt "a lot of investors will get scammed."

 

An issue that may further delay SEC action, and provide an added challenge for the internet masses to begin buying shares in companies via the Internet, is the potential sales tax liability in a crowd-funding project.

 

The U.S. Senate this week approved giving the 45 states that currently charge sales taxes the right to require large online retailers to collect tax on purchases made by their residents. The legislation must still clear the House, but political observers give it a good chance for passage and while it would only apply to online sellers that have sales of at least $1 million in states where they don't have physical operations, the SEC may decide to wait final determination on the bill.

 

Habib's bill would impose an excise tax of somewhere between 3 and 5 percent on investors, which Habib explains as necessary to cover costs the state would incur in things like more consumer protection for investors and added costs for state oversight of the crowd-funding activity.

  

"We can't go to the legislature in this financial environment ask for legislation to try something new and not cover the fiscal impact," habib added.

  

Rep. Frank Morris, D-Mount Vernon, who filed the other Washington state bill (HB2054)also a Democrat, said the state proposal is important regardless of SEC rules.

Rep. Frank Morris
Rep. Frank Morris

 

"The federal crowdfunding law, even once rules are in place, is going to require companies to work through an intermediary and is likely to have compliance costs that are cost-prohibitive for many start-ups," Morris said.

 

"The intent of the state legislation is to facilitate crowdfunding for Washington investors in Washington companies, with regulation that is protective of consumers, but less cost-prohibitive."

  

Bill Beatty, Securities Administrator for the state Department of Financial Institutions, points out that any offerings under state legislation would be "intrastate only, that is, limited to Washington Companies offering to Washington investors," adding such legislation at the state level doesn't require SEC approval.

 

Meanwhile, interest on the part of entrepreneurs and businesses that hope to be a part of the process continues to grow.

 

A business called Crowdfund Productions LLC is putting on Pro and Contra Conferences around the West, including one last week and Denver.

 

 

A Pro and Contra Conference is schedule for Seattle in September, by which time the SEC rules may be out, opening the door for a lot more pros and cons to be aimed by entrepreneurs and support groups.

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