May 18, 2016 – Purchasing an interest in small businesses just became a little easier as private, unregistered securities offerings can now be conducted through one of society’s most powerful exchanges: the Internet.
The Securities and Exchange Commission (SEC) rules on equity crowdfunding were promulgated in 2015, and became effective on May 16, 2016, opening the door to a new federal form of unregistered securities offering.1 The federal scheme supplements the state-based equity crowdfunding scheme that Wisconsin adopted in 2014.
Securities attorneys, business advisors, and their clients should find crowdfunding an intriguing option among the many other state and federal methods for non-public securities offerings already available to issuers and investors.
What is Equity Crowdfunding?
Equity crowdfunding is a form of securities transaction – specifically, a manner of unregistered private securities offering that uses an Internet platform.
com mitchell.lindstrom quarles Mitchell D. Lindstrom (Marquette 2015) is an associate in the business law practice group at Quarles & Brady LLP, Milwaukee, focusing on mergers and acquisitions, securities, and general corporate law. Reach him by com mitchell.lindstrom quarles email or by phone at (414) 277-5178.
com swb mtfn Scott W. Brunner (Marquette 2012) is an associate in the transaction’s practice group at Meissner Tierney Fisher & Nichols S.C., Milwaukee, focusing on securities, commercial real estate, and general corporate law. Reach him by com swb mtfn email or by phone at (414) 273-1300.
To be sure, this new form is not limited to stock ownership and the like; other securities forms, such as bonds, are allowable under the law, though the phrase “equity crowdfunding” has garnered popularity.
Equity crowdfunding was conceived under Title III of the JOBS Act2 (for the federal law) and 2013 Wisconsin Act 52 (for the state counterpart). It permits entities to offer securities to potential investors in consideration for equity (or any other permitted security or investment interest) in the issuer’s businesses.
While equity crowdfunding involves an Internet click-through process, the result is similar to the more traditional private placement offerings that result in equity or debt holdings. Note, however, that equity crowdfunding is quite different than rewards-based crowdfunding on websites like Kickstarter, which focuses on donation-based crowdfunding campaigns.
Private offering regulations have flirted with Internet use in the past (notably through SEC Regulation A, SEC Regulation D, and certain state small offering exemptions). However, equity crowdfunding opens the door much wider by allowing those seeking capital to make relatively low offerings without adherence to more onerous and expensive registration processes. It also expands the potential investor pool, providing businesses with access to throngs of potential investors who might not meet the sophistication or accreditation levels typically required with other private offering exemptions.
MOBCraft Beer was the first entity to attempt equity crowdfunding in Wisconsin, successfully issuing an offer on Internet portal CraftFund.com, bringing on investors as a result. MOBCraft’s example can now be replicated on the federal level.
The Process of Crowdfunding and the Key Players
Equity crowdfunding securities are “unregistered securities” at both the state and federal level, yet federal and state regulation is still exceedingly important – as with any securities transaction. As a general rule, interstate securities covered by federal securities laws are exempted from state-based registration processes.3
Federal equity crowdfunding results in a covered security, exempting it from state-based registration or qualification requirements.4 However, federal preemption will not prevent a state from exerting its fraud authority under 15 U.S.C. § 77r(c)(1) or implementing notice-filing requirements as permitted by 15 U.S.C. § 77r(c)(2).
At the same time, the SEC’s intrastate exemption5 provides a window through which Wisconsin may control the registration of securities offerings made by Wisconsin businesses and exclusively offered to Wisconsin persons. Certain rudimentary filing requirements for issuers do still exist at both the federal and state levels.
The U.S. and Wisconsin have their own set of distinct crowdfunding laws, but the mechanics and players through which crowdfunding is conducted are fundamentally the same for Wisconsin and federal offerings. The important distinction is that Wisconsin’s crowdfunding exemption applies only to offers and sales of securities that are from a Wisconsin business entity and to Wisconsin persons6; whereas the federal crowdfunding registration exemption focuses on interstate offerings.
In each instance, crowdfunding primarily involves: 1) a business issuing securities; 2) the investors; and 3) a specific form of website known as a funding portal or intermediary that “hosts” the securities offering. The Internet portal that hosts the equity crowdfunding transaction also must adhere to certain registration and compliance criteria, differing, of course, based on whether the portal seeks to host federal offers or just Wisconsin offers. The Wisconsin Department of Financial Institutions (WDFI) maintains an Internet portal registry identifying those properly registered entities.
Funding portals on the federal level that are not broker-dealers must use brand new Financial Industry Regulation (FINRA) and SEC/EDGAR registration and filing processes to get started.
Crowd-Learning: Learn About Crowdfunding
Grab lunch and join the crowd on June 9 for a webcast seminar (1 CLE credit), Introduction to Equity Crowdfunding, produced by State Bar of Wisconsin PINNACLE®.
Attorneys Scott Brunner and Mitchell Lindstrom are the presenters.
They Wrote the Book (Chapter)
Brunner and Lindstrom also teamed up to add a chapter (published in February) on crowdfunding in the PINNACLE publication, Securities, Mergers, and Acquisitions in Wisconsin, available in print and through PINNACLE Books
Monetary Limits for Investors and Issuers
Equity crowdfunding creates an investment opportunity (via a private placement) for investors with a lower net worth. However, less regulation over the type of investor is unsurprisingly met with more stringent monetary limitations.
Specifically, under the federal framework, the aggregate amount an issuer may sell to all investors as part of a crowdfunding offer is $1 million, which includes any amount sold via crowdfunding during the previous 12 months.7 The aggregate amounts sold to any particular investor during the 12-month period preceding the date of transaction are as follows:
for investors with either an annual income or net worth less than $100,000, the greater of $2,000 or 5 percent of the investor’s annual income or net worth (applied to the lesser of the annual income or net worth); or
for investors with both an annual income and net worth greater than $100,000, the greater of 10 percent of the investor’s annual income or net worth, not to exceed $100,000.8
Thus, investors with a lower income or net worth may invest up to $2,000 in an issuer during the applicable 12-month period, and investors with a higher income or net worth may invest, potentially, up to $100,000. For private offers conducted using the freedom of the Internet, this is new territory.
The Wisconsin framework presents similar limitations, but with even higher possible aggregate offering amounts depending on the investor and materials disclosed.
In any 12-month period, an issuer may issue up to $1 million in securities under the crowdfunding exemption. An issuer may issue up to $2 million in securities under the exemption if the issuer has undergone and made available to each prospective investor documentation from a GAAP-compliant financial audit.9 A single investor cannot invest more than $10,000 per issue, unless the purchaser is an “accredited investor”10 or “certified investor.”11
A certified investor is a category of investor that is new and specific to Wisconsin, and it allows for less stringent monetary qualifications than the federally defined accredited investor. Specifically, a certified investor is a Wisconsin resident who either: 1) has an individual income greater than $100,000, or joint income with the individual’s spouse of greater than $150,000, in each of the past two years; or 2) has a net worth, or joint net worth with the individual’s spouse, of at least $750,000 (including the individual’s primary residence as an asset and any debt on that residence as a liability).12
In contrast, under the SEC’s regulations, an accredited investor that is a natural person must either: 1) have an individual income greater than $200,000, or joint income with the individual’s spouse of greater than $300,000, in each of the past two years; or 2) have a net worth, or joint net worth with the individual’s spouse, of at least $1 million (excluding the value of the investor’s principal residence).13 It’s worth noting that both the state and federal crowdfunding exemptions may permit an investment clawback if the aggregate investment amount is not met.14
The regulations that govern this new form of securities transaction are plentiful, and advisors should become familiar with each detailed rule. This introduction barely scratches the surface. Compliance for clients – at least for issuers and those looking to develop funding portals – will be a meticulous process. But securities offerings are by their nature a highly regulated field, so the dense crowdfunding mechanics should not dissuade clients from considering crowdfunding.
Certain industries may well find crowdfunding a welcome alternative to traditional methods of procuring investment, particularly as it incorporates the quick flow of the Internet and its billions of global users (not to mention the possibility for media attention, as seen with MOBCraft).
While the distinctions between federal and state-based crowdfunding are significant, issuers in particular should consider the form and level of market through which they anticipate attracting investment. With the new SEC rules finally in place, investors and businesses should understand that federal interstate crowdfunding offerings and state-based intrastate offerings are both possible.
1 Crowdfunding, 80 Fed. Reg. 71,387 (Nov. 16, 2015) (reprinting final rules dated Oct. 30, 2015).
2 Jumpstart Our Business Startups Act, Public Law No. 112-106, 126 Stat. 306 (2012), enacted in April 2012.
3 15 U.S.C. § 77r.
4 15 U.S.C. § 77r(a)(1)(A), (b)(4)(C).
5 15 U.S.C. § 77c(a)(11).
6 Wis Stat. § 551.202(26)(a); Wis Stat. § 551.202(26)(a); see also 17 C.F.R. 230.147(d)(1)–(2).
7 15 U.S.C. § 77d(a)(6)(A).
8 15 U.S.C. § 77d(a)(6)(B); 17 C.F.R. § 227.100(a).
9 Wis. Stat. § 551.202(26)(c)1.b.
10 17 C.F.R. § 230.501(a).
11 Wis. Stat. § 551.202(26)(d).
12 Crowdfunding, 80 Fed. Reg. 71,387 (Nov. 16, 2015) (reprinting final rules dated Oct. 30, 2015).