By: Jim Verdonik
Jim Verdonik
Founder of Innovate Capital Law
Contact me at:
(919)616-3225
Check me out at www.YouTube.com/eLearnSuccess
I write a column about business and law for American Business Journals http://www.bizjournals.com/triangle/search?q=%22Jim+Verdonik%22&%20title=
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
I recently provided advice to the State of North Carolina about enacting a state Crowdfunding law.
Here are some FAQs that summarize the resulting North Carolina Crowdfunding statute (a/k/a the NC PACES Act) that was enacted in July 2016.
Proposed changes to SEC Rule 147 , which are important to allow more businesses to use state Crowdfunding laws, are also summarized below.
FAQs About
NC PACES ACT of 2016
North
Carolina Crowdfunding
|
||
What is the name of North
Carolina's Crowdfunding law?
|
The North Carolina Providing
Access to Capital for Entrepreneurs and Small Business Act a/k/a the NC PACES
Act.
|
|
What does North Carolina's
Crowdfunding law do?
|
This law amends Section G.S.
78A-17 to add a new exemption from the registration requirements of GS 78A-24
for any offer or sale of securities that meets the requirements of G. S.
78A-17.1.
Subject to complying with
these conditions, you can raise up to $2 million during any rolling 12-month
period.
|
|
Can I advertise or conduct a
general solicitation to sell securities?
|
Yes. This exemption does not prohibit
advertising or conducting a general solicitation within North Carolina.
All advertising and
solicitation must comply with normal disclosure rules. In addition, offers must be limited to
North Carolina residents and only North Carolina residents can purchase
securities in the offering.
|
|
Is there a limit on how many
offers I can make or how many people can buy securities?
|
No, there are no limits on
the number of offers or purchasers within North Carolina.
|
|
Can I sell securities to
non-accredited investors?
|
Yes, but non-accredited
investors cannot invest more than $5,000 during any rolling 12-month period.
|
Section 78A-17.1 (a) (4)
|
Is there a limit on how much
accredited investors can invest?
|
No, accredited investors are
not subject to any individual dollar maximum.
|
Section 78A-17.1 (a) (4)
|
Can I or someone else form an
LLC or other entity to purchase securities in my business and use this
exemption to sell securities of the LLC?
|
No, although such investor
syndicates have become a common way to conduct Rule 506 (c) offerings, the
North Carolina statute does not allow such syndicates to use this
Crowdfunding exemption, because they are private investment companies, unless
rules to be issued by the Securities Division permit such investor
syndicates.
Permitting such investor
syndicates is one of the primary things we can do to improve this law.
|
Section 78A-17.1(a) (6)
|
How much money can I raise
without providing GAAP audited or reviewed financial statements?
|
You can raise up to $1 million
during any rolling 12-month period without providing GAAP audited or reviewed
financial statements, if you do not already have such financial statements.
However, disclosure rules
would require you to provide investors with GAAP compliant financial
statements, whether they are audited or not, if the information is
material. Consult your lawyer about
whether GAAP compliant financial statements are material to your business.
|
Section 78A-17.1 (a) (3) a
|
How much money can I raise,
if you provide GAAP audited or reviewed financial statements for most recent
fiscal year?
|
You can raise up to $2
million during any rolling 12-month period if you provide GAAP audited or
reviewed financial statements for most recent fiscal yea
|
Section 78A-17.1 (a) (3) b
|
Can you also raise additional
capital above these maximums from company insiders under this exemption?
|
Yes, amounts sold to
Controlling Persons of the issuer (officers, directors, partners and holders
of 10% of any class of securities) do not count toward either the $1 million
or the $2 million maximums discussed above.
Sales to other insiders would count toward the maximum, unless you
have another exemption for such insider sales.
|
Section 78A-17.1 (d)
|
Can I raise more money during
the same 12-month period by conducting an offering using another offering
exemption?
|
Yes, under some circumstances
you can conduct multiple offerings using other Federal or state exemptions.
Each offering must fully comply
with the all conditions of one or more offering exemptions. That means you would not have an exemption
for all the sales in the offering if some offers or sales comply only with
this exemption and other offers or sales only comply with different
exemptions. This would make it
difficult to conduct a contemporaneous offering in North Carolina using an
exemption from registration that prohibits general solicitations.
However, depending on rules
issued by the Securities Division, you may be able to raise more money during
the same 12-month period (i) in an offering conducted in North Carolina before
the offering and (ii) in any offering conducted outside North Carolina,
whether before during or after the offering that uses the North Carolina
Crowdfunding exemption.
What constitutes the same
offering or a different offering is a complex legal and factual issue. Consult your lawyer before trying to raise
money in two offerings
|
Section 78A-17.1 (d)
|
Is there any restriction on
who can purchase securities in the offering?
|
You must obtain evidence from
all purchasers that they are residents of North Carolina.
If you want to accept more
than $5,000 from any investor during any rolling 12-month period, you must
obtain evidence that the purchaser is an accredited investor.
|
Section 78A-17.1 (a) (9) a
|
Do I have to report information
about my business to anyone after the offering?
|
Yes. You must provide quarterly reports to
investors and the Securities Division until the securities are no longer
outstanding. For this reason, many
state crowdfunding issuers sell debt securities or revenue share interests
that terminate after a period of time.
Quarterly reports can be
posted on a Website. Quarterly reports
must contain executive compensation and an analysis of the issuer's business
operations and financial condition, but full financial statements are not
required, unless later rules to be issued by the Securities Division require
them.
|
Section 78A-17.1 (c)
|
Can I take money directly
from investors?
|
No. All investor money must be deposited into
an escrow account.
Escrow agents must report the
receipt of funds to the Securities Division and issuers must provide
quarterly reports to investors.
The escrow agent must a bank
or other depositary institution located in North Carolina or that is approved
by the Securities Division.
|
Section 78A-17.1(a) (10)
|
Is there a minimum amount you
must raise to hold a closing?
|
The statute does not specify
a minimum, but the issuer must disclose a minimum to investors and a date
after which investors can withdraw funds from escrow if the issuer fails to
meet the minimum. The issuer must file
with the Securities Division a copy of an escrow agreement that requires the
escrow agent to hold all funds until the minimum is met and that allows
investors to withdraw if the minimum is not met before the date disclosed to
investors.
|
Section 78A-17.1 (a) (5) c
|
Do I have to offer or sell
through an Internet Website?
|
No. Use of an Internet Website is
optional. You can advertise or solicit
any way you want and you can deal directly with investors, but the money must
the held in escrow as described above.
Federal rules about making offers outside the state and the laws of
other states may limit your advertising and solicitation activities.
Websites that specialize in
Crowdfunding offerings are likely to be useful in handling closing logistics
even if you solicit investors through other means.
For example, such websites will
ensure legal compliance by arranging for an escrow agent to accept ad hold
investor money and collecting information about investors required to comply
with the law, such as residency and whether or not they are accredited
investors.
|
Section 78A-17.1 (a) (9)
|
If I choose to use an
Internet Website, can I choose any Website?
|
Only Websites that are owned
by an entity that is organized under NC law or authorized to do business in
North Carolina can conduct offerings.
The Website operator must register with the Securities Division,
unless the Website is exempt under Section 78A-17.1 (a) (11)
Website operators must
maintain offering records and provide access to the Securities Division.
|
Section 78A-17.1 (a) (12)
|
Can I pay a commission to
people to sell securities in the offering?
|
Both Federal and state law (G.S.
78A-36) require people who sell securities for compensation to register.
Officers and directors of
issuers are exempt from registration, if they do not directly or indirectly
receive commissions or other compensation for offering and selling
securities.
You should consult with your
attorney about who you can compensate and the nature of the compensation.
|
Section 78A-17.1 (a)
|
Who can use this exemption
from registration?
|
Issuers must be a business
entity formed under NC law and/or registered with the NC Secretary of State.
This means an entity
organized in NC or in Delaware or other state can use the exemption if it is
qualified to do business in NC, subject to complying with Section 3 (a) (11
or SEC Rule 147 discussed below.
Businesses that have a
Covered Person who has committed Bad Actor violations under Federal law cannot
use the exemption, unless the Securities Division grants a waiver.
Companies that cannot use the
exemption include (i) public reporting companies (ii) investment companies,
and (iii) companies that are not investment companies because of Section 3
(c) of the Investment Company Act.
Unfortunately, this provision
about exempt investment companies excludes the use of single purpose vehicles
(SPVs) and investor syndicates that are widely used in SEC Rule 506 offerings
and that are proposed to be permitted in Section 4 (a) (6) offerings by the
Fix Crowdfunding Act. This limitation
is one of the biggest drawbacks of the law.
In addition, many businesses
are excluded from using the exemption because of Section 3 (a) (11) or SEC
Rule 147 as described below.
|
Section 78A-17.1 (a) (1)
Section 78A-17.1(a) (6)
|
What Federal Exemptions must
cover the offering?
|
The NC statute requires the
offering to comply with Section 3 (a) (11) and/or SEC Rule 147.
Section 3 (a) (11) is broad
but ambiguous:
"Any security which is a part of an
issue offered and sold only to persons resident within a single State or
Territory, where the issuer of such security is a person resident and doing
business within or, if a corporation, incorporated by and doing business
within, such State or Territory."
Because most issuers were reluctant to
risk liability on such an ambiguous exemption, the SEC issued Rule 147 to
provide a safe harbor for complying with section 3 (a) (11).
Rule 147 is very narrow, which means many businesses do
not qualify to use the current version of Rule 147. The restrictions include that the issuer
must be organized in the state, must have its principal office in the state
and must satisfy all three 80% tests:
-
80% of
consolidated revenue are derived from the state
-
80% of
consolidated assets are located in the state
-
80% of offering
proceeds will be used in the state
SEC has proposed to amend Rule
147 to update it to reflect modern business practices, because today even many
small businesses conduct substantial inter-state and international business.
See the table below for
comparison of existing Rule 147 to the proposed amendment.
|
Section 78A-17.1(a) (2)
|
Do to have to file any
disclosures with the Securities Division of the NC Secretary of State?
|
Yes. At least ten (10) days before you can begin
to make any offers or use any publicly available Web site in the offering,
you must file with the Securities
Division a $150 filing fee, a notice of claim for the exemption and a
disclosure document that includes:
-
a description of the business
-
names of 10% owners of any class of securities
of the business
-
names and experience of the management team
and directors
-
description of the securities being offered,
including the percentage ownership and implied valuation
-
identity of agents or others who will sell the
offering (including any Web sites) and their compensation
-
Names URLs and addresses of any Websites that
will be used
-
description of any litigation or legal
proceeding involving the issuer or its management team
|
Section 78A-17.1 (a) (5) a
and b
|
What other information should
disclosure documents contain?
|
Disclosure documents must include
other material information consistent with normal securities disclosure
practices (including risk factors) in light of the sophistication level of
investors required by G. S. 78A-8 and Federal securities laws.
|
Section 78A-17.1 (a) (13)
|
Who has to see the disclosure
document?
|
Disclosure documents must be
provided to offerees, purchasers and the Securities Division.
Rules issued by the
Securities Division about updating disclosure documents will be important to
determining offering efficiency. For
example:
-
Does the issuer have to file every update
before disclosing updates to investors?
-
How long do updates have to be provided before
closing?
-
What are the procedures for investors withdrawing
money previously deposited in escrow after an update?
|
|
COMPARISON
OF SEC RULE 147 ISSUED IN 1974
AND
PROPOSED
NEW RULE 147
(Proposed
October 30, 2015)
|
||
ISSUE
|
1974 RULE 147
|
2015 PROPOSED RULE 147
|
Relationship to Section 3 (a) (11)
|
Constitutes
a safe harbor for compliance with Section 3 (a) (11)[1]
|
Creates a
new exemption under Sections 28 of the 1933 Act and does not rely on Section
3 (a) (11).
|
Limits on Amount Raised
|
Issuers
can raise unlimited amounts.
|
No limit
on amounts issuers raise, if the offering is registered in the state where
the offering is made.[2] If the offering is not registered, issuers
can only use proposed Rule 147, if they comply with a state exemption from
registration that (i) limits sales to $5 million in any 12-month period and
(ii) limits the amount each investor can invest in such exempt offerings.[3]
|
Offers
|
Offers
must be confined to one state, which creates issues about Internet and other
advertising.[4]
|
|
Issuer Incorporation
|
Requires
that issuers be organized in the state where the offering is being conducted.
|
Permits
issuers to be organized in any state.[7]
|
Principal Office or Principal Place
of Business
|
Requires
that the issuer's principal office be in the state where the offering is
being conducted, but does not define principal office.[8]
|
Requires
that the issuer's principal place of business be in the state where the offering
is being conducted. The principal
place of business is in the state in which the "officers, partners or
managers of the issuer primarily direct, control and coordinate the
activities of the issuer."[9]
|
Conducting Business in the State
|
Requires
issuers to conduct business in the state where the offering is being
conducted.
|
Requires
issuers to conduct business in the state where the offering is being
conducted, but has a more flexible definition of what constitutes doing
business in the state,[10]
|
Test for Conducting Business.
|
Three-part
test based on 80% of consolidated, revenue, assets and uses of offering
proceeds. Issuer must satisfy all three parts of the test:
-
80%
of consolidated revenue are derived from the state
-
80%
of consolidated assets are located in the state
-
80%
of offering proceeds to be used in the state
|
Four-part
test that adds the location of a majority of the issuer's employees to the
80% of consolidated revenue, assets and uses of offering proceeds tests. Issuer only needs to satisfy one of the
four criteria of the test. [11]
|
Ability to Change States
|
Would have
to reincorporate, move the principle office and change where satisfy all
three 80% tests for doing business.
|
Some
issuers will be able to satisfy the doing business test in more than one
state and could do offerings in different states if they change the location
of the principle place of business.
The proposed rule would prohibit issuers who change the state where
their principal place of business is located from doing a Rule 147 offering
in their new state until nine months after the last sale in the Rule 147
offering conducted in their prior state.[12]
|
Preempt State Registration Laws
|
No
|
No
|
Integration
|
No special
integration rule, except that offerings separated by six months will not be
integrated.[13]
|
Safe
harbor excludes integration with (i) any prior offerings, (ii) Regulation A
offerings, (iii) Regulation Crowdfunding offerings made under Section 4 (a)
(6), (iv) employee benefit plans and Regulation S offerings and (v) offerings
made six months after completion of the Rule 147 offering. Also relaxes integration for certain
registered offerings.[14] Issuers can conduct contemporaneous
offerings using other exemptions, if each offering complies with its own
exemption.
|
Investor Residence
|
Requires
all investors to be residents of the state where the offering is made and
requires issuers to obtain written representations from investor about
residency.[15]
|
Issuers
must have a "reasonable belief" each investor resides in the state
where the offering is being made.[16] No requirement to obtain written investor
representations about residency, but reasonable belief may require more than
investor representations.
|
Re-sale Restriction Period for
Investors
|
9-month
holding period for re-sales outside the state begins when the issuer
completes the offering.[17] Creates problem that investor often does
not always know when the issuer completes the offering.
|
9-month
holding period for resales outside the state starts when the investor
purchases the securities,[18]
which is in the investor's knowledge and control.
|
Legend Requirements
|
Yes[19]
|
Yes[20]
|
Stop Transfer Instructions
|
Yes[21]
|
Yes[22]
|
Disclosure of Transfer Restrictions
Required
|
Yes[23]
|
Yes[24]
|
[1]
230 C.F. R. § 147 (a)
[2]
Proposed Rule 147(a) (1)
[3]
Proposed Rule 147(a) (2)
[4]
230 C.F. R. § 147 (a)
[5]
Proposed Rule 147(b)
[6] Proposed Rule 147(f)
(3) "The proposed amendments
would eliminate the current restriction on offers, while continuing to require
that sales be made only to residents of the issuer's state or territory." Proposed Rule Amendments to Facilitate
Intrastate and Regional Securities Offerings SEC Release No 33-9973 (October
30, 2015) (80 Fed. Reg. 69,785) between
fn 10 and fn 11
[7]
Proposed Rule 147(c) (1) and Proposed Rule Amendments to Facilitate Intrastate
and Regional Securities Offerings SEC Release No 33-9973 (October 30, 2015) (80
Fed. Reg. 69,785) at fn 44
[8]
230 C. F. R. § 147 (c) (1) (i)
[9]
Proposed Rule 147(c) (1)
[10]
Proposed Rule 147(c) (2)
[11]
Proposed Rule 147(c) (2) (iv)
[12]
Note 1 to Proposed Rule 147(c) (1)
[13]
230 C.F. R. § 147 (a) (a) (2)
[14]
Proposed Rule 147(g)
[15]
230 C.F. R. § 147 (f) (1) (iii)
[16]
Proposed Rule 147(d)
[17]
230 C.F. R. § 147 (e)
[18]
Proposed Rule 147(e)
[19]
230 C.F. R. § 147 (f) (1) (i)
[20]
Proposed Rule 147(f) (1) (i)
[21]
230 C.F. R. § 147 (f) (1) (ii)
[22]
Proposed Rule 147(f) (1) (ii)
[23]
147(f) (3) (230 C.F. R. § 147 (f) (3))
[24]
Proposed Rule 147(f) (3)
