Congress passed a federal crowdfunding law. This was really exciting, but the federal law is problematic for many, many reasons.
As you are probably well aware by now, Congress passed a federal crowdfunding law. This was really exciting, but the federal law is problematic for many, many reasons. What are the problems with the federal crowdfunding law? To name just a few:
- Companies won’t be able to use crowdfunding as a fundraising tool until the SEC issues lengthy, complex regulations. We have no idea how long this will take. Already the SEC has delayed issuing regulations on a much simpler topic. The crowdfunding regulations may very well be delayed as well.
- The federal crowdfunding exemption forces companies to use registered broker-dealers or registered funding portals. Most private companies raising funds do so without the help of broker-dealers or other intermediaries. But for a company to crowdfund under the federal exemption, it will be forced to use an intermediary. This is unfortunate.
- By virtue of the particulars of the law, companies are going to have to expend significant resources in order to comply with it to raise funds (e.g., PPMs, audited financial statements, etc.). It is going to be very expensive. Call it “Sarbanes-Oxley for Startups.” The law’s costs and burdens are disproportionate to the capped amount of money companies are allowed to raise.
In short, the federal law is, in the opinion of many (and not just lawyers, but other business persons as well), not going to work very well. It is unfortunate that out of the JOBS Act the law appears headed toward making it more difficult for early stage companies to raise money rather than the opposite–when it was clearly the intention of the Congress that the JOBS Act would make fundraising for early stage companies easier.
It is a common lament in Washington that there is not enough funding to go around for all of the companies here. We suffer some “flight”—meaning that smart folks take their pitches to Silicon Valley, where there is more money to fund companies. I agree that we need more money for companies here, and that is why I am writing to advocate that the state of Washington should adopt its own “mini-crowdfunding” law.
It is not uncommon for states to pass “mini” laws. For example, California has a “mini-Warn Act.”
Washington should enact its own mini-crowdfunding exemption, but it should not be modeled on the federal act. Instead, the Washington Securities Division or the Legislature should craft an exemption that will work for local businesses and investors.
What Does A Good Crowdfunding Exemption Look Like?
A “good” crowdfunding exemption would have the following elements:
- A simple, easy-to-determine aggregate proceeds amount (e.g., not to exceed $1M during any twelve month period); normal integration standards would apply to prevent evasion.
- A simple, easy-to-determine per investor limit (e.g., no more than $1,000 per natural person or legal entity).
- Support from state regulators to issue simple regulations or to support legislation in order to bring the exemption to life.
- Protection for directors and officers so that they can have some certainty that they are not going to be personally liable in the case of a business failure (excepting fraud or breach of fiduciary duty, obviously).
The Statutory Approach: Proposed New Statutory Provision
I propose a new subsection to RCW 21.20.320, which exempts certain transactions from the state securities law registration requirements. I propose a new RCW 21.20.320(18) to read as follows:
“The following transactions are exempt from RCW 21.20.040 through 21.20.300 and 21.20.327 except as expressly provided:
(18) Any issuer transaction or sale, if:
a) the aggregate offering proceeds do not exceed $1,000,000 during any twelve (12) month period;
b) all purchasers of securities in the offering are residents of the State of Washington as of the purchase date;
c) no offers of the securities are made to persons who are not residents of the State of Washington;
d) only entities organized in the State of Washington and doing business in the State of Washington may be issuers;
e) no purchaser invests more than $1,000 in the offering;
f) each purchaser executes in writing, in a separate written document, the following:
“I acknowledge that I am investing in a high-risk, speculative business venture, that I may lose all of my investment, and that I can afford the loss of my investment.”
g) no investor who has signed the aforementioned acknowledgment may bring an action against the company or any director or officer of the company except in the case of fraud or breach of fiduciary duty; and h) the offering is conducted in accordance with the requirements of Section 3(a)(11) of the federal Securities Act of 1933.”
Why Washington Residents Only?
You might ask–why limit this exemption solely to Washington residents, and why prohibit the offers of the securities to anyone but Washington residents? The answer is that we have to fit within federal securities law requirements.
Section 3(a)(11) of the 1933 Securities Act exempts from registration “any security that is part of an issue offered and sold only to persons resident within a single state if the issuer is a person resident and doing business within or, if the issuer is a corporation, incorporated by and doing business within that state.” Federal Rule 147 provides a federal “safe harbor” for offers and sales in compliance with Section 3(a)(11) and creates a checklist for compliance with the federal standard that could be built into a Washington crowdfunding exemption. Washington companies utilizing this exemption would have to take steps to ensure that no non-Washington residents were offered or sold securities in the offering. This requirement could potentially be satisfied by requiring certifications by prospective investors that they are Washington residents in order to log into secure portals to review potential transactions. Each issuer could be required to certify that it is truly a local Washington business, with its principal office in Washington, generating revenues primarily from Washington operations.
Help From State Regulators
To make crowdfunding in Washington a reality under a Washington-specific exemption, advocates, as a practical matter, will need to convince our state securities regulators that the benefits of crowdfunding as a local financing strategy outweigh the potential costs of administration and the risks to the public. If state regulators can be involved in the process of drafting and passing proposed legislation (or, alternatively, adopting a state rule), it will be possible to craft a crowdfunding exemption that will work. Washington could become a leader in crowdfunding, and attract the next generation of entrepreneurs here.
Washington recently became a leader in Social Purpose Corporations. It needs to become a leader in crowdfunding as well.