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updated 2:54 PM CDT, Jul 28, 2018

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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.

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State crowdfunding legislation moves toward the implementation date despite SEC uncertainties

As criticism of the Securities and Exchange Commission's dawdling with its charge from Congress to implement crowdfunding through the federal JOBS Act grows to a chorus, there's now criticism emerging that the agency is seeking to disrupt the process for states like Washington that are creating intrastate crowdfunding.

The SEC critics, with increasing plausibility, contend that the agency has done its best to ensure that the federal JOBS Act won't come about as Congress intended.

And now that some states have given up waiting for SEC action, it seems that the federal agency is trying to put roadblocks in the way of frustrated state legislatures that have sought to find ways to have crowdfunding for startups work at the state level through selling shares to large numbers of people, typically via the Internet.

Washington is one of a dozen states that have decided nothing meaningful will come out of SEC machinations, prompting the Legislature last spring, after a year of preparation, to pass a bill that will permit entrepreneurs who are state residents to raise up to $1 million a year in small amounts from in-state investors.

The Legislature gave the State Department of Financial Institutions (DFI) until October 1 to put in place the rules and the process under which crowdfunding can be carried out and Bill Beatty, Director of Securities for DFI, says the agency "remains on track" to meet that deadline.

 

The department will have a hearing Thursday on the proposed rules and "will proceed to adopt the rules shortly after that unless we determine we need to make significant changes to the rules as currently proposed," Beatty said.

 

Joe Wallin, an attorney for Seattle-based law firm Davis Wright, predicts that entrepreneurs who are state residents will be able to begin selling shares to large numbers of Washington resident by the end of the year.

 

The legislation in this state and others was in reaction to what has transpired, or failed to transpire, at the federal level after Congress,

with an election-year flourish in the spring of 2012, passed the so-called JOBS Act, officially the Jumpstart Our Business Startups Act.

 

Then Congress turned it over to the SEC to enact rules to implement the law and gave the agency 180 days to put together the process for how entrepreneurs could fund their start-up companies, primarily via the internet, by selling equity to large numbers of average investors.

 

 

It soon became obvious to all but the most myopic, with one delay following another, that SEC Chairman Mary Schapiro had little interest in seeing the law come about, possibly because she was more concerned about protecting average investors than following the law's guidance toward funding entrepreneurs.

 

Now the SEC has a new chairman but there is a growing sense that the details of compliance, if and when 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. Indeed the latest deadline for the rules to be established has passed and the regulators have not provided a new timeframe, now almost two years after the launch date Congress intended.

And now there is also a sense on the part of many crowdfunding supporters, including Wallin, that Congress, unless it has lost interest, may have to intervene to keep the SEC from removing or changing a number of securities rules that stand to burden in-state entrepreneurs who hope to raise funds in their states to launch businesses.

Wallin, who proposed the wording of the original state legislation and whose blog is viewed by many as the final word on what's happening with federal as well as state crowdfunding, worries that the SEC is trying to make it harder for states to do what Congress intended the federal government to do.

 

 

An example is in the fact that the state laws are not subject to the federal crowdfunding law because the companies raising the money are incorporated in those states and raising money solely from investors in those states. Congress created that specific exemption from federal law for intrastate offerings when it enacted the Securities Act of 1933.

However, the SEC has recently issued interpretive guidance on the intrastate exemption that says that if the company uses the internet to promote or discuss its offering then the offering is not an intrastate offering even if a company is incorporated in a particular state and all investors are in that state.

"This is nonsense and it needs to be corrected," says Wallin, who is seeking to stir an outcry from start-up supporters to demand that Congress get involved. "It's nearly impossible not 

 to use the internet to communicate any fundraising or community organizing event that involves these start-up businesses."

"Section 201 of the JOBS Act was a big help to entrepreneurs in that it allowed startups to talk publicly about their efforts to raise money, a process known as General Solicitation," Wallin notes."Unfortunately, the SEC put rules in place that discourage most companies from taking advantage of this new opportunity and Congress needs to restore the intent of its own legislation."

Wallin offers the following suggestion that can be forwarded to members of Congress by those seeking to use the Internet for crowdfunding of their startup:

"Please either pass a simple piece of legislation to fix this or direct the SEC to clarify or fix its intrastate crowdfunding decisions. Otherwise, by prohibiting the 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."

It may well be time, in these final weeks of an election season in which most members of Congress are on the November ballot, to send a message that indifference and ineptitude on the issues of innovation and job creation won't be taken well by those who understand the role entrepreneurs play in economic health.

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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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