More than a third of all U.S. states have enacted laws allowing investment crowdfunding within their borders. California, the biggest state and the fifth largest economy in the world, may be among the next to do so.
Two separate bills are progressing through the state legislature and, if all goes well, could reach the Governor’s desk by the end of summer. And they live up to the state’s reputation as a trendsetter.
The California Crowdfunding bill (AB 722), championed by Assembly member Henry T. Perea and Small Business California, a small business advocacy group, would allow small businesses in the state to raise up to $1 million from California residents. It aims to fix what its backers perceive as flaws in the federal JOBS Act as well as state crowdfunding laws that rely on the federal intrastate exemption. AB 722 uses a federal exemption for offerings of $1 million or less (Regulation D, Rule 504).
The Local Economies Securities Act (LESA, or more officially, SB 577) , a bill making its way through the state Senate, would make it easier for sustainable businesses such as cooperatives, micro-businesses, renewable energy businesses, small farms and agricultural land trusts to raise capital. Introduced by state Senator Ben Hueso and sponsored by the Sustainable Economies Law Center, the American Sustainable Business Alliance and Slow Money Northern California, it is the first crowdfunding bill to specifically address sustainable enterprises.
While the bills are on separate tracks, they are viewed as complementary, and could potentially be merged.
LESA grew out of the the Sustainable Economy Law Center’s (SELC) work with cooperatives, farms and other community-based groups. The center saw a lack of financing options for beginning and low-income farmers looking to lease or acquire land, especially when they must compete with developers and speculators. At the same time, says Christina Oatfield, policy director at the SELC, there are many people who want to invest in sustainable agriculture and other businesses that align with their values.
Related: Crowdfunding, Oregon Style
And while there is plenty of funding for renewable energy technology, access to capital is still an obstacle for community-owned renewable energy systems, she said. LESA attempts to remedy those funding gaps.
LESA creates exemptions for the following:
- Creates an exemption for offerings of less than $500,000 with basic financial disclosure.
- Unaccredited investors would be capped at $1,000 per deal, and accredited investors at 5% of their net worth.
Small Farms and Agricultural Land Trusts:
- Allows small farm enterprises or agricultural land trusts to raise up to $2 million for the purchase, lease or improvement of property for agriculture purposes. The issuer must be majority controlled by people actively engaged in the farm enterprise or controlled by a nonprofit public benefit corporation.
- Investors are capped at $1,000 per deal; “qualified purchasers” (net worth of $250,000 or more and annual income of $100,000 or more) may invest as much as $5,000. Accredited investors are capped at no more than 5% of their net worth.
Renewable Energy Projects:
- Allows nonprofits, mutual benefit corporations, and cooperatives to raise up to $2,000,000 to finance the purchase of solar panels or wind turbines.
- Investors are capped at $1,000 per deal; “qualified purchasers” (net worth of $250,000 or more and annual income of $100,000 or more) may invest as much as $5,000.
- Raises the cap for eligibility under an existing state law that exempts any offer or sale of a membership in a California consumer cooperative corporation from securities regulations. Currently to be eligible, the offering must not exceed $300 per purchaser. That is raised to $1,000 per purchaser.
The Local Economies Security Act was unanimously passed through the California Senate Banking Committee last week, and was due move to the Senate Judiciary Committee next week. However, the hearing was postponed to accommodate amendments. The act would work with the intrastate exememption as well as existing exemptions for nonprofits and small offerings.
David Levine, cofounder & CEO of ASBC, said LESA is a grassroots way to direct more funding to sustainably-minded enterprises. “This is not about government subsidies. This lets people decide what types of companies they want to invest in. They can put their money where there values are.”
Capital to Grow and Create Jobs
The backers of the bill, including Small Business California and other organizations representing 3.6 million small firms in the state, cite a lack of seed capital for small businesses, particularly those owned by women and minorities. The bill would offer start-up and emerging small businesses new avenues for finding investors who can provide capital to help them grow and create jobs.
AB 722 would add to the California Corporate Securities Laws specific conditions under which the Department of Business Oversight (DBO) would review and issue a permit for a crowdfunding offering in California. That state qualification makes it eligible for Reg D Rule 504 exemption.
Reg D, but Open to All
While that exemption is commonly associated with offerings limited to accredited investor, such as Title II under the JOBS Act, AB 722 would be open to all investors. That’s because it meet a different, and less-used, qualification for the exemption (see footnote below).
Maine is the only other state to base its intrastate crowdfunding law on Reg D, Rule 504. (For more on Maine’s law and the benefits of Reg D, see this post by Joe Wallin)
The authors of the bill frame it as a better alternative to Title III of the JOBS Act, which is stuck in rule-making limbo. In particular, the legislation remedies what it sees as flaws in the JOBS Act, such as the requirement that companies go through a crowdfunding portal that can take a cut of up to 15 percent; prohibitions on advertising by the issuing company; and insufficient investor protection.
Instead, the Assembly bill does away with the portal requirement, allows companies to communicate directly with investors (except for telephone solicitations), and requires companies to assess an investor’s suitability before accepting an investment (as is standard under Regulation D Rule 504). Offerings would also undergo review by Dept. of Business Oversight lawyers.
Similarly, one of the obstacles to state crowdfunding under the intrastate exemption (Section 3(a)(11) of the federal Securities Act) has been confusion over what constitutes out-of-state advertising. The S.E.C. has suggested that Internet advertising would violate its prohibition on cross-border solicitation—with steep penalties. Under Reg D, Rule 504, issuing companies do not have to worry about their advertisements reaching beyond state borders, says Mark T. Hiraide, a securities lawyer and board member of Small Business California.*
He characterized the bill as one that would help both small firms and local investors. AB 722 “allows Main Street investors to participate in deals they otherwise could not,” says Hiraide.
The California Crowdfunding Bill (AB 722) proposes the following:
- Companies can raise up to $1 million
- Investors are capped at $5,000 or 10 percent of the investor’s net worth, whichever is less
- No intermediary portal required
- Bans telephone solicitation, but otherwise allows companies to directly reach out to investors
- Companies must perform a suitability check on investors
- Offerings are reviewed by the state’s Dept. of Business Oversight, which promises a 60-day review
- No crowdfunding portal is required
- A fee of .4 percent of the offering amount is collected by the state’s DBO
- Offerings must comply with Reg D, Rule 504
A similar bill had failed to make it through the legislative process last year after missing a key deadline.
Proponents of both bills are hopeful that they will successfully navigate the legislative process and land on the Governor’s desk before Labor Day. If signed, they could go into effect as early as January 2016.
LESA “is a potentially transformative bill for California’s sustainable businesses and like-minded investors,” says the ASBC’s Levine. Noting that California has always been a leader in environmental policy, he adds: “It’s a really strong model for other states as well.”
* As Hiraide explains, Rule 504 exempts from federal registration and allows companies to solicit or advertise their securities to the public, if one of the following circumstances is met:
– The company registers the offering exclusively in one or more states that require a publicly filed registration statement and delivery of a substantive disclosure document to investors;
– A company registers and sells the offering in a state that requires registration and disclosure delivery and also sells in a state without those requirements, so long as the company delivers the disclosure documents required by the state where the company registered the offering to all purchasers (including those in the state that has no such requirements); or
– The company sells exclusively according to state law exemptions that permit general solicitation and advertising, so long as the company sells only to “accredited investors.”
AB 722 satisfies the first and second condition (state registration is the same as state qualification).