Virginia Intrastate Crowdfunding: SEC Amendments Leave Virginia Law Outdated
Many of us are familiar with crowdfunding, particularly reward-based crowdfunding through websites like Kickstarter and Indigogo. Reward-based crowdfunding allows companies to raise money from members of the public in exchange for prizes that vary depending on the amount of money you donate to the company’s project (e.g. $5 gets you a personalized Thank You from the CEO, $15 gets you a company t-shirt, etc.). This rewards-based funding model can also be referred to as non-equity crowdfunding because companies are not selling ownership positions to those who invest in a particular project. In fact, non-equity crowdfunding has historically been the only type of public crowd-based investment allowed under federal and state securities laws; that is until 2012.
In 2012, the Jumpstart Our Business Startups Act (“JOBS Act”) was signed into law to ease many of the United States’ security regulations and to encourage private investment in the country’s small businesses. Title III of the JOBS Act is also known as the “Regulation Crowdfunding” because it permits companies to use crowdfunding to issue equity positions to investors without having to register the offering under the Securities Act of 1933 (“Securities Act”). The law was designed to help both investors and business.
On the investor side, most of the general investing public would never have a chance to get in on the ground floor of the next Google or Facebook, because those opportunities would always be given exclusively to deep-pocketed and well-connected angel investors. The average investor had to wait for a public offering to get any kind of equity in that company. The JOBS Act probably will not change that kind of opportunity disparity when it comes to companies on par with Google or Facebook. However, the revised securities laws now give the average investor a chance, whereas the previous rigid disclosure restrictions and accreditation requirements effectively prevented any chance.
On the company side, the world has suddenly become your oyster. The JOBS Act eases private investment requirements and allows companies to tap into the cumulative wealth of the nation’s general citizenry for the first time. Generally, depending on the company’s market and the type of investment sought, even getting in front of significant private investment money (e.g. angel investors) can cost thousands of dollars and substantial resources all for a single pitch that hopefully goes well. Furthermore, even if the company gets that private investment money, the terms of the investment and perhaps even the control and direction of the company are then largely dictated by that investor. Crowdfunding, especially online, substantially expands the accessible pool of private investment money and allows a company to perfect its pitch on a website with videos, testimonials, and disclosure documents that effectively capture the companies message and vision. Also, the larger pool of investment opportunity provides businesses with more control over the terms of the investment they receive, because the company owner can turn down an investment conditioned on unfavorable terms when hundreds of other active investors may invest on the company’s terms.
The JOBS Act creates different types of crowdfunding opportunities, each with their own rules and limitations. The primary investment avenues under the Act are Regulation A+, Title III (“Reg CF”), Rule 506(c) (“Reg D”), and intrastate crowdfunding. The most recent regulatory developments involve intrastate crowdfunding. Intrastate crowdfunding has historically been governed by Section 3(a)(11) of the Securities Act and the Security and Exchange Commission’s (“SEC”) Rule 147 to that Section. Section 3(a)(11) exempts from registration securities that are offered and sold only to investors in one state. The SEC created Rule 147 to provide objective standards for local business seeking to rely on Section 3(a)(11). Accordingly, Rule 147 has been deemed a “safe harbor” from security registration requirements. Similar intrastate crowdfunding exemptions exist in state statutes that are largely conditioned on complying with Rule 147 and the Securities Act. However, the intrastate crowdfunding landscape changed on October 26, 2016 when the SEC amended Rule 147 and established a new intrastate offering exemption under Rule 147A of the Securities Act.
Prior to these changes by the SEC, the utility of intrastate offerings was very limited. Section 3(a)(11) and Rule 147 required the offering company to be incorporated in the state in which it conducted the offering and to solicit and sell only to residents of that state. For example, in order for a Virginia company to take advantage of the intrastate exemption, it must have been incorporated in Virginia and offered and sold securities only from Virginia residents. The solicitation requirement prevented a company from using any type of media or communication method that could potentially reach non-Virginia residents. In other words, companies were not allowed to advertise their offerings using the internet because it would likely reach someone in another state. A further limitation was that many modern corporations decide to incorporate in another state for various business and liability reasons. So even though the SEC and Virginia had intrastate exemptions, it was effectively useless in the modern internet marketplace and a source of potential liability in the internet crowdfunding space. The SEC’s amendments to Rule 147 sought to correct these limitations by “modernizing” it.
The SEC did not truly fix any of these problems in its amendment to Rule 147, as the SEC found that the legal framework of Section 3(a)(11) would not allow for an amendment to Rule 147 that permitted out-of-state offers or that permitted offering companies to be incorporated out-of-state. Instead, the SEC decided to rely on its general exemptive authority and create a new rule, Rule 147A, that allowed for out-of-state offers and out-of-state incorporation. Rule 147A is an alternative to the Section 3(a)(11) and Rule 147 “safe harbor” and not subject to its restrictions which is why it allows for general solicitation by non-resident companies. As alternatives, companies can now conduct offerings under either exemption. New Rule 147A created “modernization” and opportunity. Under Rule 147A, companies incorporated anywhere can generally advertise offerings and solicit investment by any means, including the internet and even social media. In fact, the SEC provides official guidance on making an offer using Twitter. The catch, however, is that the offering must also comply with state law.
On paper, intrastate crowdfunding offerings look better than federal crowdfunding offerings. For example, while Title III has an investment cap of $1 million, Virginia allows up to $2 million in investment. Also, unlike Title III’s cap of $100,000 for high net worth investors (“accredited investors”), accredited investors may invest as much as they like under Virginia’s law. Similarly, Title III limits investment for all other investors (“non-accredited investors”) to $2,000, while Virginia allows the average investor to invest up to $10,000.
However, it is important to note that Virginia’s statute requires the Issuer to be a Virginia company and sell only to Virginia residents in compliance with Rule 147 and Section 3(a)(11). This means that the intrastate option is not available to non-Virginia companies and, more significantly, the offering cannot reach out-of-state residents, i.e. no general solicitation using the internet, Twitter, etc. So even though the SEC has modernized intrastate crowdfunding with new Rule 147A, these changes are effectively moot without the General Assembly amending Virginia’s Interstate Crowdfunding Exemption to accommodate Rule 147A and the SEC’s modernized approach.
When amended Rule 147 and new Rule 147A became effective on April 2017, Virginia's intrastate crowdfunding exemption remained of limited value as the General Assembly did not update the Code to incorporate the SEC's modernization measures.  Until such legislative updates are made, companies and investors in Virginia can continue to tap into several other options to raise money through equity crowdfunding to utilize newly accessible pools of investment opportunity.
 Specifically, a Tweeted offer can satisfy the disclosure requirements by including an active hyperlink to the required disclosure. Final Rules: Exemptions to Facilitate Intrastate and Regional Securities Offerings, SEC.com at 18-19 (last accessed March 22, 2017) available at https://www.sec.gov/rules/final/2016/33-10238.pdf
 The Illinois General Assembly amended its Securities Act to incorporate new Rule 147A and added catch-all language to allow the Illinois statute to remain relevant and responsive to future SEC modernization efforts. See Illinois HB 3791 (amending 815ILCS 5/4(T)(1) to exempt intrastate offerings “made in compliance with the requirements of Section 3(a)(11) of the Securities Act of 1933 (15 U.S.C. 77c(a)(11)) and Rule 147 adopted under the Securities Act of 1933 (17 CFR 230.147), Rule 147A (17 CFR 230.147A), or any other federal exemption providing for intrastate offerings from time to time in effect.”) (emphasis added). The updated Illinois statute goes into effect on June 1, 2018.
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