It might have seemed like an April Fool’s Day joke, but, after four years of stop and go efforts, North Carolina’s intrastate crowdfunding law finally went live on April 1st.
To date, 33 states and the District of Columbia have adopted local crowdfunding rules. But North Carolina’s law breaks new ground by creating a flexible approach that accommodates small, offline and DIY offerings and addresses issues that have stymied other states, such as a lack of escrow agents.
The NC PACES Act generally permits North Carolina companies to raise up to $2 million annually from an unlimited number of North Carolina residents (including non-accredited investors) without triggering complex federal or state registration requirements. In addition to traditional internet-based “crowdfunding” offerings, North Carolina businesses can conduct “Local Public Offerings” of up to $250,000 through the use of general advertising (such as a newsletter or website posting provided that those materials have been pre-cleared with State regulators).
North Carolina, whose “First in Flight” motto honors local entrepreneurs the Wright Brothers, was initially in the vanguard on intrastate crowdfunding. In April 2013, it became the third state to propose such legislation. While the bill (HB680, then referred to as the NC JOBS Act) was well received in the NC House of Representatives, momentum stalled and it never reached the floor of the NC Senate. HB680 was subsequently revised and replaced by SB481, renamed the “North Carolina Providing Access to Capital for Entrepreneurs and Small Businesses Act” (or the NC PACES Act) and enacted into law in July 2016.
North Carolina is also the home state of Rep. Patrick McHenry, who championed the original federal JOBS Act.
Learning from Others
While some have criticized the State for its failure to act, the delay presented an opportunity to assess the national landscape and to learn from the hurdles faced by similar legislation in other jurisdictions. For example, many states are forced to implement technical changes to their existing intrastate crowdfunding laws to enable the use of new Rule 147A of the Securities Act of 1933. NC PACES includes provisions flexible enough to permit offerings to proceed under new Rule 147A, in addition to the traditional path under Section 3(a)(11) and Rule 147 of the Securities Act of 1933.
The end result for North Carolina is a statute and set of rules that, by design, are flexible enough to adapt to the changes imposed by new and changing federal regulations and market practice.
Many aspects of the rules mirror those implemented by other jurisdictions by requiring an issuer conducting any type of offering under NC PACES to:
• pre-clear disclosure materials and other filings through State regulators,
• provide financial disclosures (note that financial statements need not be audited or reviewed unless a company wants to raise more than $1 million in a 12-month period),
• establish minimum and maximum offering caps
• limit the amount that unaccredited investors may invest (capped at $5,000 investment per issuer),
• engage an escrow agent to hold investor funds until the minimum offering is met, and
• retain records relating to the offering.
But North Carolina’s procedures are also significantly different from the traditional approach in several groundbreaking ways.
North Carolina companies can raise capital under the exemption through two distinct paths.
NC PACES Offering: Fashioned after the traditional “investment crowdfunding” approach used under Regulation Crowdfunding and in intrastate offerings in other states, companies can raise up to $1 million in 12 months by using an internet “platform” to solicit and communicate with investors. (Companies with a year of reviewed or audited financials could elect to raise up to $2 million in 12 months through this process). The internet “platform” is the exclusive communication method for the offering, thus general advertising is prohibited (excluding certain tombstone-like notices similar to those permitted under Regulation Crowdfunding).
Local Public Offering: This novel approach permits the broad use of advertising for offerings of up to $250,000 in 12 months. Issuers may (but are not required to) use the internet to conduct the offering and communicate with investors. Issuers conducting these small Local Public Offerings must pre-clear all advertising materials and meet and closely coordinate the offerings with State regulators.
The Local Public Offering exemption provides an offline option for small businesses, for example, those in tight knit or rural communities where internet access or usage may be limited. The exemption is not available for all types of companies (the rules specifically prohibit use by certain real estate companies, issuers of asset-backed securities, REITs and marketplace lenders, among others). In addition, only equity, debt and royalty stream instruments can be offered.
Flexible escrow arrangements
Requiring issuers to engage an escrow agent to conduct intrastate offerings has presented problems in many jurisdictions, particularly when the escrow agent is required to be a bank (entities which generally, and institutionally, have been reluctant to engage in crowdfunding transactions on a one-off basis), that is registered and located within the State. While issuers are required to use an escrow agent for all offerings under NC PACES, there is significant flexibility in who can serve in that capacity. The rules permit out-of-state escrow agents, making it possible for local issuers to use standardized fintech software and service providers to facilitate their offerings. They also allow broker-dealers and certain North Carolina law firms to act as escrow agents.
Companies can “go it alone”
Unlike Regulation Crowdfunding and rules imposed by most other states, North Carolina issuers are not required to use a funding portal or a registered broker-dealer to facilitate an offering. Instead, a North Carolina company can elect to “go it alone” to conduct a Local Public Offering or use its own website to create the “platform” for a larger offering. This flexibility, combined with looser offering mechanics for Local Public Offerings, could significantly reduce costs and eliminate many barriers to entry for many North Carolina companies (particularly those located outside of major cities).
NC PACES could have a significant and meaningful impact on the ability of companies to raise capital. Full implementation of the rules in North Carolina will be tied to effectiveness of the new Rule 147A that goes into effect on April 20, so the offering mechanics have yet to be tested. It is critical for companies and investors to learn more about the limitations and requirements imposed by the rules —it’s simply not possible to fully summarize all of the requirements here. The hope is that raising capital from clients, customers, friends and neighbors just got much easier in North Carolina.
Benji Jones, is a partner with Smith Anderson, the largest business and litigation law firm headquartered in North Carolina’s Research Triangle region. Benji has close to 20 years’ experience advising private and public companies in a variety of corporate and securities law matters, and most recently she’s been focusing her practice on crowdfunding and fin-tech financings. She played a critical role in the passage of North Carolina’s intrastate crowdfunding exemption (NC PACES).
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