How States are Changing the Crowdfunding Landscape

Kansas

Guest post by Social Enterprise Associates, www.socialenterprise.net, a consulting firm using the power of the marketplace for good. This registered B Corporation helps companies get ‘game ready’ to raise capital and position for success. The firm fosters ‘triple bottom line’ solutions to generate financial, social and environmental returns. Contact Drew Tulchin, drew@socialenterprise.net @SocialEntAssoc

While investors and entrepreneurs have been waiting on federal action around equity crowdfunding rules, several states have been drafting their own crowdfunding laws that would prevail over proposed federal guidelines – so long as both the issuer and investor are local. Motivated by a desire to create local jobs, the trailblazer was the Invest Kansas Exception in 2011. Soon thereafter Georgia and Michigan passed similar laws. North Carolina and Alabama are currently considering legislation that is likely to pass in the next year.

HOW STATE LAWS DIFFER

These state laws tend to focus on maximizing capital flows, while federal laws aim to protect investors. The biggest differences are that entrepreneurs don’t have to use intermediaries, and when they do they don’t have to be registered; there is far less paperwork. For example, the issuer does not have to provide audited financials and there is less required in terms of background checks (among other differences).

State exemptions do have requirements that aim to protect investors and minimize fraud. In some states all investors must sign documents stating that investments are risky and that they may lose all of their money, capital raises are limited to $1 million in size, (or potentially $2 million in North Carolina), and there are investment caps ranging from $2,000 to $10,000.

A SLOW START

In spite of the streamlined approach, the local regulations have not resulted in an explosion of start-ups taking advantage of state exceptions. According to Businessweek, from 2011 to the end of 2013 roughly 20 companies tried to raise money through the new equity crowdfunding mechanisms in Kansas and Georgia combined.

The potential reasons for the slow start are many. It may be that it is taking entrepreneurs and/or investors time to gain familiarity with the new marketplace. It may be the economy, or it may be the fact that there weren’t an existing pipeline of potential fundraisers at the time of the exemption. (Even in traditional markets it takes a long time for businesses to wind their way to a successful capital raise.)

SEE RELATED: [INFOGRAPHIC] WHY JOBS ACT IS DISRUPTIVE TO STARTUP FINANCE

 

A LOCAL FOCUS

Should intrastate raises become commonplace, an important question then may be whether the companies that use them will be somehow distinct from those using other capital raise mechanisms.

The answer is yes. Locally focused investors are more likely to be motivated by issues such as community impact, and the import of actively participating in the shaping of one’s civic realities than the high growth and exit strategies used by traditional investors. Intrastate portals may emerge as the primary domain of endeavors with visibility and impact in the immediate community — coffee shops, organic supermarkets, or undertakings utilizing historic buildings, to name a few.

Interstate raises based on the JOBS Act are also likely to be distinct from those utilizing intrastate portals – not because of the differences in the regulations – but because investors in California are unlikely to take much of an interest in coffee shops in Georgia.

While motivated by stimulating the still slow moving capital markets, and decreasing the regulatory weight present in the JOBS Act, state exemptions’ most important long term effect may prove to be the creation of an avenue for increased local participation in community development. The differences between the regulations regarding interstate and intrastate raises may also prove quite valuable, as market participants will be able to scrutinize the details of the markets’ relative development when determining where and how to invest.

SEE ALSO: [INFOGRAPHIC] 5 BEGINNER TIPS FOR ANGEL INVESTING

 

Bryan Hill is an intern with Social Enterprise Associates. He obtained his master’s degree in International Finance and Economic Policy (MIA) at Columbia University and has extensive experience in the world of impact investing.  Claire Williams contributed to this article. She is an associate with Social Enterprise Associates.

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