While the comprehensive set of crowdfunding regulations (“Regulation Crowdfunding”) proposed by the Securities and Exchange Commission (“SEC”) pursuant to Title III of the JOBS Act remain pending, several states have begun to take the matter of equity crowdfunding into their own hands. Texas is the most recent state to take the initiative on crowdfunding. As the second most populous state in the United States, Texas would grant companies using the crowdfunding exemption access to a broad base of potential investors.
Made effective on November 17, 2014, Texas’ crowdfunding exemption is based on the intrastate offering exemption of the Securities Act of 1933 and SEC Rule 147. Because of this, only Texas based companies meeting certain criteria may use the offering exemption, and only Texas residents may invest in those offerings. Beyond being limited to Texas companies and investors, many provisions of the Texas crowdfunding exemption will be familiar to those who have been following the SEC’s Regulation Crowdfunding (including the use of crowdfunding portals and the $1 million raising cap).
Texas’ crowdfunding exemption addresses and imposes a number of limitations on Issuers, Investors, and Dealers/Portals—each to be discussed in turn.
As an initial matter, any company wishing to use the crowdfunding exemption must be organized in the state of Texas and must maintain its principal office in Texas. Companies that pass these two initial hurdles must then demonstrate: (i) at least 80% of the company’s gross revenue during its most recent fiscal year is derived from the operation of a business in Texas; (ii) at least 80% of the company’s assets at the end of its most recent semiannual period prior to the offering are located in Texas; and (iii) the company will use at least 80% of the net offering proceeds in connection with the operation of its business within Texas. (Excluded from using the exemption are “bad actors,” investment companies, and SEC reporting companies.)
The exemption then requirements companies to make a number of disclosures when registering to become an issuer. Companies must disclose, among other information, (a) a general description of its business, (b) its management and major stockholders, (c) how the offering proceeds will be used, and (d) financial information. Notably the financial information does not need to be audited, it simply must be certified as true by the principal executive officer. (But if the issuer does have audited financials for any of the previous three years, those must be disclosed.)
Once all of the Texas residency requirements have been satisfied and all of the necessary disclosures made, companies may then issue securities through the crowdfunding exemption. Companies are limited to raising no more than $1 million in any 12-month period—the same cap imposed by the SEC’s Regulation Crowdfunding.
Investors in these offerings are limited to Texas residents. As will be described below, it is the responsibility of the dealer/crowdfunding portal to verify an investor’s Texas residency. Non-accredited investors are limited to investing a maximum of $5,000 in any offering, while accredited investors (as defined in SEC Rule 501) are not limited to any particular amount. Unlike the SEC’s Regulation Crowdfunding, investors are not otherwise limited by net worth or annual income.
Any offer or sale of securities by an issuer must be made through a registered dealer or registered crowdfunding portal. It is the responsibility of the dealer/portal to verify investor residency before allowing investors to view available offerings. Residency is verified through such identification as a Texas driver license, Texas voter registration card or property tax records.
The Texas’ crowdfunding exemption, like the seven other states with similar exemptions, is hampered by the fact it is based on the intrastate offering exemption. As such, companies using these crowdfunding exemptions are limited in both their access to investors as well as their communications about the offering. The SEC’s Regulation Crowdfunding is supposed to address and solve these problems, but it is unknown when the SEC will issue its final rules and what form exactly they will come in.
Please feel free to contact us for more information on which states currently allow equity crowdfunding and the state-by-state rules for conducting such an offering.