United States: Texas Opens Its Doors To Crowdfunding

In the race between states vying for startup businesses, Texas proposes to sweeten the deal with a new proposal that exempts crowdfunding initiatives from state securities laws.

For those new to the concept, crowdfunding refers to a method of raising money from a large number of small investors, typically through an online portal or platform, in order to finance a new business venture. Entrepreneurs who raise money through crowdfunding often use social media to share their efforts, which increases traffic to their crowdfunding page. Certain crowdfunding sites, such as Kickstarter, operate on a donations-based model. That is, individuals contribute to their preferred startups and causes without receiving any equity or interest in return. Consequently, Kickstarter campaigns are not considered securities offerings.

Other platforms, such as AngelList and CircleUp, restrict participation to accredited investors. While this allows them to comply with federal securities laws, the limited access to such offerings goes against the appeal of crowdfunding as a more open, egalitarian, and small-business friendly platform for raising capital. Therefore, proponents of crowdfunding have advocated for an exemption to the federal securities laws that would allow them to raise relatively small amounts of capital from the general public while avoiding the burdens of current regulations.

This goal appeared to be within reach after Title III of the JOBS Act prompted the SEC to draft a new exemption making it easier for small businesses to raise money from non-accredited investors via online portals. While observers in the startup community were initially optimistic about the potential for crowdfunded offerings on a national scale, they have lowered their expectations after the SEC took a year and a half to release proposals for its crowdfunding rules. It is not yet known when those rules will go into effect.

The Texas State Securities Board Publishes Proposal for Crowdfunding Exemption

The Texas State Securities Board recently released its own proposed crowdfunding rules for public comment. As with the proposals in other states, the Texas rules rely on the intrastate offering exemption set forth in Section 3(a)(11) of the Securities Act.

This exemption provides that any issue of securities offered only to investors residing within one state, where the issuer is a resident of the same state, is exempt from registration under the federal securities laws. Each state has its own intrastate offering regulations, and exemptions for crowdfunding proposals must generally fall under this exemption or they are preempted by federal securities laws.

The key provisions of the proposed crowdfunding exemption in Texas are as follows:

Eligible businesses may raise up to $1 million per 12-month period.

An issuer must be a Texas entity to be eligible for the crowdfunding exemption, and it may only offer securities in Texas. The eligibility and residency requirements mirror those set forth in Rule 147, enacted pursuant to the federal intrastate offering exemption.

In order to meet the residency requirements, an issuer must be able to demonstrate the following:

  • The issuer must be organized in and have its principal place of business in Texas;
  • at least 80% of the issuer's gross revenues during its most recent fiscal year prior to the offering must be derived from the operation of a business in Texas;
  • at least 80% of the issuer's assets at the end of its most recent semiannual period prior to the offering are located in Texas; and
  • at least 80% of the net proceeds of the offering must be used in connection with the operation of the issuer's business within Texas.

While the exemption is designed to benefit startup companies, the company must have a defined business plan and investment goals. Finally, customary bad actor disqualifications also apply, and the issuer may not be an investment company or an SEC reporting company.

Once an issuer meets these requirements, it may raise up to $1 million within each 12-month period (including offerings by control persons).

Non-Accredited investors may contribute up to $5,000 per offering.

Investments pursuant to the proposed crowdfunding exemption are limited to $5,000 per investor, unless the investor is an accredited investor as defined in Rule 501 under the Securities Act of 1933. If an issuer wishes to raise larger amounts from accredited investors, it must verify the investor's accredited status first. Investor funds must be placed in escrow until the specified minimum offering amount has been raised.

In addition, only investors resident in the State of Texas may participate in crowdfunding offerings. Investors will be required to submit a Texas driver's license number, voter registration card or property tax records to prove that they are Texas residents. Before purchasing any securities, prospective investors must confirm their acknowledgment of certain customary disclaimers.

Offerings must be carried out online through a registered dealer or crowdfunding portal.

The responsibility for verifying eligibility of investors lies with each online dealer or crowdfunding portal. Each site must review any documents submitted by a prospective investor and confirm the investor's residency in Texas before allowing access to the portal. In addition, crowdfunding portals must conduct background and regulatory checks on each issuer and each of the issuer's directors, officers, and other control persons to determine eligibility with the crowdfunding exemption and the potential risk of fraud.

Those establishing crowdfunding portals may register by filling out a form, completing a background check and paying the standard registration fee for securities dealers in Texas. Principals are not required to pass the General Securities Registered Representative (Series 7) Exam or the Uniform Securities Act State Law (Series G5) Exam. Instead, new procedures have been proposed to allow such portals to register as restricted dealers. Crowdfunding portals operating under the proposed rules must limit their access and trading activity to Texas, and may not offer investment advice, manage investor funds, or facilitate secondary market transactions, among other prohibited activities.

While crowdfunding portals will be required to maintain certain offering-related records for at least five years following an offering, they are not required to monitor individual offerings on an ongoing basis. Portals are, however, subject to certain post-registration reporting requirements and renewal fees.

Issuers are required to submit limited disclosures.

Issuers raising money through crowdfunding must claim an exemption from registration by filing new Form 133.17 with the State Securities Board. Issuers must post a summary of the offering and an offering disclosure on a registered crowdfunding portal or dealer site at least 21 days before any securities may be sold. The disclosure must include risk factors, a description of the issuer's business, operations, and management, a description of the securities and other material information. However, the required disclosure will be brief compared to disclosures required for larger offerings. The State Securities Board expects to release guidance for crowdfunding disclosures simultaneously with the rules' enactment.

All communications with investors must occur on the portal via open message boards accessible to other prospective investors. Issuers are permitted to distribute a limited notice stating that the issuer is conducting an offering and providing a link to the crowdfunding portal that will host the offering, but the notice may only be distributed to investors located in Texas. This provision limits the possibility of advertising crowdfunding offerings through social media.

Notably, issuers relying on the crowdfunding exemption will not be required to provide reviewed or audited financial statements unless audited financial statements are already available for any of the three years prior to the offering. Issuers may instead have their CEO certify that the issuer's financial statements are accurate and complete as of the date of the offering.

SEC's Crowdfunding Exemption Seen as Flawed

The SEC's proposed rules have been widely criticized by analysts for being overly burdensome and costly. In particular, the proposal requires issuers raising $500,000 or more to submit audited financial statements on an annual basis, and all issuers must be prepared to submit financial statements in accordance with GAAP. Companies raising $100,000 or less must submit a tax return for the most recent fiscal year. Furthermore, issuers are subject to annual filing requirements.

As a result of these and other regulatory burdens, the SEC estimates the cost of compliance for raising capital at up to 40% of the proceeds raised, while some analysts have noted that the cost can be even higher for offerings at the lower end of the scale. Furthermore, the SEC's proposal requires funds to be held in escrow during a review period, even after the target minimum amount has been raised.

These federal-level obstacles have led several states to propose new rules or legislation that rely on the intrastate offering exemption under the Securities Act. All of these initiatives would allow small businesses within each state to tap into crowdfunding as an innovative way to raise capital from the general public.

Texas' Recipe for Crowdfunding Success

What makes the Texas proposal unique is the sheer size of the state. With a population of 26 million, Texas offers a business-friendly regulatory environment and a sufficiently large market for small- and medium-sized businesses to raise financing through crowdfunding. At present, Texas is the second largest state to support a crowdfunding initiative. California, the largest state, has pending a Crowdfunding proposal which would require action by the state legislature. Michigan, the next largest state to enact a crowdfunding exemption, has less than half the population of Texas.

The Texas proposal also has a few advantages over the proposed exemptions in other large states. For example, the Texas proposal was initiated by and enjoys the support of the Texas State Securities Board. By contrast, Florida recently saw its legislation die in committee following reported opposition from the Florida Office of Financial Regulation.

Furthermore, while issuers in Texas would be subject to the customary rules related to fraud, nothing in the proposed rules would create additional liabilities for small businesses raising capital through crowdfunding. California's crowdfunding bill, however, contains potential pitfalls for the unwary small business issuer and has not yet left the sponsor's committee in the State Assembly. In particular, the California legislation entails greater risks of litigation for issuers by authorizing courts to award treble or punitive damages to purchasers of securities where the issuer violates certain qualification provisions of the crowdfunding exemption. Indeed, Texas' proposal is focused on striking the balance between protecting investors and encouraging small businesses to thrive.

Next Steps for Crowdfunding in Texas

The rules proposed by the Texas State Securities Board were published in the Texas Register on May 9, 2014 and are subject to a 30-day public comment period before they may be adopted. After the comment period ends, the State Securities Board may adopt the proposal as published, adopt it with amendments, or revise it and republish it for public comment. Strasburger & Price will keep you apprised of developments, and our attorneys are always open for discussion about how these changes can affect your business.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Related Topics
 
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions