Intrastate Crowdfunding – Integration Stands in the Way of Progress

The basic rule is that if you want to sell securities, you need to register with the SEC. That is much more demanding than it sounds; it is totally impractical for the vast majority of companies that are raising money. So the SEC has created a number of exemptions from registering a stock offering.

One of those exemptions, called the private placement exemption, allows high net worth individuals (generally called accredited investors) to invest without “going public”. Another exemption allows intrastate offerings without registering with the SEC. This means that a company can accept money from people who live within the borders of a single state, so long as the company complies with that state’s securities laws. Of course, this comports with a federal system – things that happen in just one state should just be regulated by that state alone.

To prevent a “loophole”, the SEC has taken pains to make sure that an intrastate exemption is only used for offerings that are truly made in one state. Amongst other things, the stock must be held by the purchaser for at least nine months, preventing people from acting as mere shills for an out-of-state buyer.

Easy enough, except for one thing. The SEC prohibits utilizing multiple different exemptions at the same time. This means that a company can’t raise money using the intrastate exemption simultaneously with raising money using another exemption also.

The new Georgia Peach

To avoid being an illegal offering, the company must meet a strict multi-part test which considers factors like whether the offerings are part of a single plan of financing and the money is to be used for the same general purpose. But there is a safe harbor. A company can wait six months between fundraising rounds.

The proposed rules for the federal JOBS Act avoid this problem. If a company uses federal crowdfunding, it won’t be considered “integrated” with efforts to raise money using a more traditional private placement at the same time. This means that under the federal law, a company can raise up to $1 million using crowdfunding and the rest of the money that is needed through wealthy investors.

So for somebody opening up a restaurant, bar, car dealership – or forming the high tech company – it becomes a real challenge to use intrastate crowdfunding at all. The only time that you can be sure is when you use the safe harbor. However, that usually means that you have to wait for six months before raising money from either your intrastate crowdfunding investors or your traditional accredited (wealthy) investors.

Hopefully, the SEC will realize that this integration issue could completely stomp out intrastate crowdfunding. The way to fix this problem is to include an exclusion from the definition of integration for intrastate crowdfunding offerings – just like under The JOBS Act. But if the SEC fails to do so, it wouldn’t be the first time that the federal government tried to keep all the fun for itself.
Jonathan Frutkin

Jonathan Frutkin is CEO of Cricca Funding, LLC. He’s the author of “Equity Crowdfunding: Transforming Customers into Loyal Owners” which is available in paperback, Kindle and audio book formats.

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