Texas opens its doors to crowdfunding

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Association of Corporate Counsel | Article by Strasburger & Price LLP Lee Polson and Alana Parker | June 5, 2014

Texas

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.

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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.

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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.

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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.

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