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Crowdfunding and Other Options for Idaho Entrepreneurs

Added by Hawley Troxell in News on November 27, 2013

Historically, state and federal securities laws have stymied many entrepreneurs who seek to raise capital through a securities offering. For small business owners, the process of registering securities with the Securities and Exchange Commission (SEC) is prohibitively expensive. These entrepreneurs often also lack access to the institutional or wealthy investors (accredited investors) upon which the most popular registration exemptions depend. To improve access to the securities market for these entrepreneurs, Congress created a new registration exemption under the Crowdfund Act. This Act was passed with bipartisan support in April 2012 as part of the JOBS Act, and the SEC recently released a draft of Regulation Crowdfunding (Regulation CF) to implement the exemption when finalized. While some Idaho entrepreneurs may find this new exemption attractive, it will not be right for all. (For a more comprehensive summary of proposed Regulation CF, click here.)

Crowdfunding refers to the concept of obtaining relatively small investments from a relatively large number of investors. The Act permits entrepreneurs to raise up to $1 million in any 12 month period by offering securities over the Internet. Under this exemption, small businesses may access the general public without the expensive process of registering securities, and entrepreneurs without access to accredited investors may now meaningfully participate. Moreover, entrepreneurs seeking to raise relatively modest amounts of capital should experience significant cost savings under this exemption. If the draft of Regulation CF is not altered and no subsequent comment period is required, Idaho entrepreneurs could benefit from this new source of fundraising within the first half of 2014.

But the proposed Regulation CF will not suit all entrepreneurs. First, although the exemption is open to all investors, investment by individuals is limited according to investor income or wealth. Second, savings under this exemption decrease dramatically as offering amounts increase—businesses seeking to raise more than $500,000 (up to $1 million) are subject to reporting requirements similar to registered securities offerings. Savings may be further eroded by fees paid to funding portals (a financial intermediary created specifically for this exemption) or the registered broker dealers required to conduct crowdfund offerings. Third, entrepreneurs seeking to use this exemption must disclose certain potentially sensitive information, including how they plan to use the funds raised and business strategy. Because such disclosures will be available on EDGAR, the SEC’s public database, some entrepreneurs may find the prospect of providing competitors their strategy and business plan particularly unattractive. Lastly, under this exemption, solicitation is limited to published notices directing potential investors to the financial intermediary’s website and providing basic information about the business and the offering.

As an alternative to crowdfunding, entrepreneurs should consider Rule 506(c), another exemption created by the JOBS Act. Under Rule 506(c), small businesses can raise an unlimited amount of capital with disclosures determined only by market forces. The catch under Rule 506(c) is that all investors must be accredited (i.e. institutional or wealthy investors as defined in Rule 501) and the businesses conducting the offering are personally charged with verifying this accredited status. The verification requirement of Rule 506(c) creates potential liability concerns and the requirement that investors be accredited presents problems for entrepreneurs lacking established connections with such investors. But because Rule 506(c) also allows for general solicitation, entrepreneurs without established connections may be able to overcome this problem. (For a more comprehensive summary of Rule 506(c) click here.)

Entrepreneurs can also avoid federal registration requirements by complying with the requirements of an intrastate state offering under Section 3(a)(11) of the Securities Act of 1933 or Rule 147. These offerings must comply only with applicable state law. Under an Idaho state exemption, Idaho entrepreneurs can raise up to $2 million through general solicitation, provided that (i) investors are limited to Idaho residents and the offering complies with the federal requirements of an intrastate offering; (ii) the Idaho Department of Finance is notified of the intent to rely on this exemption and the Director issues an exemption order; and (iii) investment by non-accredited investors is limited to $2,500 and investment by all investors is limited to 10% of each investor’s liquid net worth. In comparison to Regulation CF, Idaho entrepreneurs, through this state exemption, can raise more funds, enjoy reduced disclosure requirements, and solicit and sell to all types of investors so long as investors are Idaho residents. (For a more comprehensive summary of this Idaho state exemption click here.)

The above registration exemptions represent only some of the options available to Idaho entrepreneurs. If you are contemplating a securities offering for your small business, or if you have questions about your options, please contact a member of our corporate group or call us at 208.344.6000.