By: Jim Verdonik
Founder of Innovate Capital Law
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I write a column about business and law for American Business Journals http://www.bizjournals.com/triangle/search?q=%22Jim+Verdonik%22&%20title=
You can purchase my book Crowdfunding Opportunities and Challenges at http://www.amazon.com/Crowdfunding-Opportunities-Challenges-Jim-Verdonik/dp/1483442802
The SEC's Regulation Crowdfunding became effective on May 16, 2016. Unaccredited investors can now invest in offerings on investment platforms. There are now four new Federal Crowdfunding exemptions that allow you to advertise offerings.
Having so many new Federal capital-raising alternatives raises the question: Do we still need state crowdfunding laws?
Let's answer that question from three perspectives:
- Securities regulators
- Businesses Raising CapitalPeople and Communities are the Biggest Reason for State CrowdfundingState Crowdfunding laws are needed for reasons that have little to do with technical legal rules.
- People like the idea of investing in their neighbors' businesses.
- People like reinvesting in their own communities.This should come as no surprise. People like to buy fresh locally grown fruits and vegetables. People like to drink local craft beers. People like to root for their local high school or college team even though professional athletes are bigger, faster and stronger. People like local live concerts by musicians who don't have a national audience.Collectively, we call these things our local culture. Laws that make it difficult to create a healthy local culture are bad, but that is what securities laws have been doing for decades. Securities laws divert money away from local communities to international money centers.State Crowdfunding laws that legalize platforms that are limited to local businesses simply help investors find the local investment opportunities they want.State Crowdfunding laws are the equivalent of state run farmers markets. They bring together local buyers and sellers in an identified safe place.Isn't it foolish for state government to get in the way of people building and investing in their local communities?Why should it be easier to invest in a business that is halfway around the world than one that is in the next town?Market Opportunity for States to Get Back Into the GameState securities regulators have been underutilized for the past two decades, because most securities offerings use Federal exemptions that preempt state laws that require offerings to be reviewed by state securities administrators.The old state regulatory system is so antiquated that people almost always choose to avoid it, if they can.The surprising thing about state Crowdfunding laws is that the biggest proponents of state Crowdfunding laws should be people who want to increase state regulation of securities offerings, because state Crowdfunding offerings are reviewed by state securities regulators before businesses can sell securities.Why would anyone think that regulators reviewing securities offerings would put investors at risk?Of course, modern state securities regulation requires both carrots and sticks. The old saying is that: "You can lead a horse to water, but you can't make it drink."That's the way securities modern laws work. You have to have carrots to entice businesses to use the state system. These carrots primarily involve offering alternatives to some of the imperfections of the Federal Crowdfunding laws we discussed below.Imperfections of Federal Laws for Businesses Raising CapitalIf the four new Federal Crowdfunding laws were perfect, then most business would refuse to enter the state crowdfunding system.But who ever heard of a perfect law?Each of the Federal Crowdfunding laws lacks some attributes that are useful to some types of issuers:
- Rule 506(c) does not allow sales to non-accredited investors.
- SEC rules and review processes for both Tier 1 and Tier 2 Regulation A offerings are both expensive and time consuming.
- Tier 2 of Regulation A and Regulation Crowdfunding impose ongoing reporting requirements on issuers that are expensive and may harm their ability to compete by making public information their competitors can use against them.
- Tier 1 of Regulation A does not pre-empt state registration laws.
- Regulation Crowdfunding allows you to raise only $1 million per year.
- Regulation A and Regulation Crowdfunding have expensive financial statements requirements beyond the normal securities rules about disclosing material facts.Virtues of State Crowdfunding lawsLuckily, we have a Federal system of government where the states have the power to experiment with new laws. State Crowdfunding laws are imperfect, but they offer some advantages to some businesses:
- Allow unaccredited investors to invest, unlike SEC Rule 506 (c).
- Are much cheaper to comply with than SEC Regulation A.
- Allow businesses to raise more than $1 million, unlike Regulation Crowdfunding.
- Allow businesses to make greater sales efforts outside a technology platform to attract investors to their offering, unlike Regulation Crowdfunding.
- Have greater flexibility than Regulation A or Regulation Crowdfunding for businesses to give investors the types of financial statements that smaller businesses actually prepare to use to run the businesses.In summary, most businesses will use the Federal Crowdfunding exemptions, but there are good reasons to add state Crowdfunding to the list of capital-raising choices.