Article of Interest

Texas Crowdfunding Portals Provide Texas Businesses New Access to Investment Dollars
By: R. Jason Pierce

The pool of investors accessible by Texas businesses just got a lot deeper, thanks to new rules finalized by the Texas State Securities Board, or TSSB. Starting in late November 2014, TSSB-approved Texas Crowdfunding Portals (or “TCPs”), began facilitating public securities offerings by Texas businesses to Texas investors without regard to any requirement as to income or net worth and without the regulatory scrutiny that companies typically undergo in public offerings.

TSSB Rules 115.19 and 139.25 provide a new set of guidelines within which TCPs may operate. The new rules provide that TCPs be Texas business organizations engaged exclusively in intrastate offers and sales of securities in Texas. Texas businesses can raise up to $1 million in funds per year from Texas investors by utilizing TCPs. Any investor is able to invest up to $5,000 per year in a company’s securities through a TCP. No investment cap will be imposed on investors meeting the definition of “Accredited Investors” in Section 501, Regulation D of the Securities Act of 1933, which defines “Accredited Investors” as, among other things, investors with a net worth of at least $1 million, excluding their home, or have an annual net income of at least $200,000.

As opposed to well-known crowdfunding sites such as Kickstarter or IndieGogo, TCPs will allow a Texas company to offer actual ownership in the company. Currently, other reward-based crowdfunding sites are prohibited by securities laws from permitting companies that use their sites from offering investors true ownership.

According to the new TSSB rules, TCPs must remain neutral facilitators of securities offerings, meaning that TCPs may not offer advice to investors, be affiliated with or hold a financial interest in any company utilizing their website, receive a financial interest in an offering company as compensation for services provided, and may not hold, manage, or handle investment funds. TCPs will be required to obtain an affirmative acknowledgment from investors of the following: (1) the risks associated with purchasing a security for which there may be no secondary market; (2) the securities have not been registered under federal or state law, and therefore cannot be resold unless such securities are registered or exempt from registration under state law; (3) investors are relying on their own examination of the issuer and the offering; and (4) no state or federal authority has confirmed the accuracy of any information published on a TCP.

Companies offering securities on TCPs must include, in a summary of the offering which must be readily available to potential investors on the website, (1) a description of the business, business plan, operating history, and planned use of offering proceeds; (2) who will manage the company, including executive officers, directors, managers, and persons owning 20 percent or more of any class of stock; (3) a description of the securities being sold and any other outstanding securities of the company; and (4) current financials of the company. All information about any offering must be made available to the Texas Securities Commissioner and potential investors for at least 21 days before they are sold.  While the disclosure requirements under the new TSSB rules are relaxed compared to those imposed by federal regulations, offers made through TCPs are still subject to the liability provisions in federal and state statutes addressing full and fair disclosure.

TCPs are required serve the role of “gatekeeper” for ensuring that offerings on their websites remain “intrastate” in nature and comply with the requirements of the federal exemption for intrastate offerings in the Securities Act of 1933, Section 3(a)(11), 15 U.S.C. §77c(a)(11), and Securities Act Rule 147, 17 CFR §230.147, which provide an exemption from expensive federal registration requirements for securities offered by a company that (1) is organized in the state where it is offering securities, (2) carries out its business in that state, and (3) makes offers and sales of securities only to residents of that state. TCPs must not only ensure that investors are residents of Texas, but must also ensure that the TSSB disclosure requirements are met by the offering company.

TCPs are further restricted from endorsing any particular offering over another, either explicitly or implicitly. For instance, a TCP may apply only objective criteria to which offerings it hosts, such as only facilitating offerings for certain types of securities (i.e., common stock, preferred stock, or debt securities), geographic location of the companies it hosts, or a specific industry or business sector of the companies. Such criteria must be fully disclosed, not only to the TSSB, but also to potential investors on the TCP website. Also, any communications by the hosted companies to potential investors must be made public on message boards hosted by the TCP.

Finally, the TCP may not receive, handle, or manage any investor’s investment funds. Instead, to avoid any risk to investor’s funds, or compromising a certain TCP’s neutrality in the offerings it facilitates, subscription funds must be paid directly to escrow accounts established at either state- or federally-chartered banks or depository institutions. Any fees associated with the escrow accounts must be paid directly by the company being invested in to the escrow agent, not by the investors. If an offering is terminated without being funded or closed, all money paid by investors pursuant to the offering must be returned to the investor.

The “Jumpstart Our Business Startups Act of 2012,” or “JOBS Act,” empowered the U.S. Securities and Exchange Commission to promulgate rules governing crowdfunding, but progress on such rules has been slow and as of the time of this article, has only issued proposed rules, which were released in late 2013. With the finalization and enactment of TSSB Rules 115.19 and 139.25, Texas becomes the thirteenth state in the United States to pass its own regulations concerning crowdfunding.  As a result, Texas small businesses will have largely unfettered access to potentially millions of investor dollars.

R. Jason Pierce is an attorney at Whitaker Chalk Swindle & Schwartz PLLC in Fort Worth and practices in the area of corporate law.  He can be reached at 817-878-0568.