Attorneys explain ‘Crowdfunding’
By Sheila Pursglove
Legal News
Iris Linder and Nick Oertel are attorneys with the Business and Corporate Practice Group at Foster Swift in Lansing.
A graduate of the University of Michigan Law School, Linder focuses her practice extensively in corporate and securities work; she has experience representing companies in connection with fund formation and private placements of securities, as well as SEC reporting and registration. She also works on venture capital investment transactions, representing both investors and portfolio companies. She is active in the American Bar Association’s Private Equity and Venture Capital Committee, and Federal Regulation of Securities Committee.
A graduate of Michigan State University College of Law, Nick Oertel has been a member of the firm’s Business and Corporate Group since 2009. He focuses his practice in the areas of corporate transactions, Michigan non-property tax disputes, private placements of securities and business planning.
What is crowdfunding?
Linder: “Crowdfunding” – sometimes also referred to as “crowdsourcing” – refers to efforts to raise money from a large number of people (the “crowd”) using web-based platforms and social media.
When did crowdfunding become popular?
Linder: Crowdfunding started out as a way to fund the arts. Artists desiring to raise funds to make films, musical recordings, visual artworks and similar projects were the first users of crowdfunding platforms. Among the more popular platforms, Indiegogo was founded in 2008, Kickstarter launched in 2009, and RocketHub went online in 2010.
Interest quickly evolved to utilizing crowdfunding not only to fund arts projects, but also to fund civic and charitable projects, and ultimately to fund businesses. By 2011, some businesses were successful in using crowdfunding to raise product development money by pre-selling products that were still in the development stage.
Why is legislation needed for businesses to raise money using crowdfunding?
Linder: Under the Federal Securities Act of 1933, as amended, and state securities acts, if a business sells equity (and in many cases debt) securities, the security must be either registered or exempt from registration. Early stage companies and many other businesses cannot realistically register their securities, given the cost and complexity of registration. For this reason, they rely on exemptions from registration when they sell securities. Under securities laws that have been in effect for the last 80 years, exemptions are not available if the company selling the securities has engaged in "general solicitation" in connection with the sale.
Any broad based outreach to prospective investors is considered to be general solicitation, including web and social media postings, television and radio advertisements, and advertisements in widely distributed print media such as newspapers and magazines. As a result, crowdfunding was not legal as a vehicle for soliciting purchases of securities.
How did Congress respond when the small business community clamored for the right to sell securities using crowdfunding?
Linder: On April 5, 2012, the JOBS Act was signed by President Obama and became law. Title III of the JOBS Act authorizes the use of crowdfunding without registration for small offerings of securities (no more than $1 million during a 12 month period) to both accredited and non-accredited investors. However, this law will not become effective until the SEC issues final regulations that deal with many complex issues relating to disclosures, the offering process, regulation of the crowdfunding platforms, and other matters.
On October 23, 2013, the SEC finally released proposed regulations. The comment period has expired, but to date, final regulations have not been issued by the SEC.
Are there any situations in which crowdfunding can currently be legally used to sell securities?
Linder: Yes. There are two contexts in which crowdfunding can currently be used, Rule 506(c) of Regulation D under federal law and the Michigan Invests Locally Exemption (the MILE Act).
What is the MILE Act and how does it work?
Oertel: The MILE Act provides an exemption from securities registration under Michigan law for intrastate crowdfunding. The MILE Act permits an issuer to sell securities to non-accredited investors and utilize general solicitation (including web and social media postings) if specific requirements are satisfied.
What requirements must an issuer satisfy to utilize the exemption provided by the MILE Act?
Oertel: The MILE Act sets forth a number of requirements that an issuer must satisfy. For example, each investor must be a Michigan resident and the issuer must be incorporated or organized in Michigan. The issuer cannot accept more than $10,000 from any single "non-accredited" investor. The issuer's offer must also meet the requirement for the federal exemption for intrastate offerings under Section 3(a)(11) of the Securities Act of 1933, which means that an issuer must: (A) derive at least 80 percent of its gross revenue from the operation of a business within Michigan, (B) have at least 80 percent of its assets located in Michigan, and (C) use at least 80 percent of the proceeds from the offering in Michigan.
Practically, this means that the MILE Act is best suited for small businesses that are truly local in scope, including real estate, restaurants, and similar businesses.
Finally, issuers must beware of SEC interpretations that limit an issuer's ability to advertise (including the use of social media) such offers to non-Michigan residents. As a result, issuers are advised to utilize web portals that require a potential investor's residency to be verified before the terms of the issuer's offer are made available to the potential investor.
What is Rule 506(c) and how does it work?
Oertel: Rule 506(c) was enacted as part of the JOBS Act and exempts certain sales of securities from the registration requirements under federal securities laws. Specifically, Rule 506(c) permits an issuer to raise an unlimited amount of money from “accredited investors.” Importantly, Rule 506(c) permits issuers to utilize general solicitation and advertising. However, as noted, all of the purchasers must be “accredited investors.” Issuers are required to take reasonable steps to verify that purchasers are accredited investors (e.g., by obtaining investor representations, verifying tax filings, and reviewing records from financial institutions). Numerous websites, such as CircleUp and AngelList, allow companies to engage in equity crowdfunding by advertising their issues to pre-vetted accredited investors.
For more information, visit www.fosterswift.com or Foster Swift's technology blog at www.michiganitlaw.com.
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