Crowdfunding in Colorado Is Now Available
| Publication year | 2015 |
| Pages | 49 |
Articles
Business Law
Crowdfunding in Colorado is Now Available
By Herrick K. Lidstone.
Business Law articles are sponsored by the CBA Business Law Section to apprise members of current substantive law. Articles focus on business law topics for the Colorado practitioner, including antitrust, bankruptcy, business entities, commercial law, corporate counsel, financial institutions, franchising, and securities law.
Coordinating Editors
David P. Steigerwald of Sparks Willson Borges Brandt & Johnson, P.C., Colorado Springs—(719) 475-0097, dpsteig@sparkswillson.com; Curt Todd, Denver (bankruptcy)—(303) 955-1184, ctodd@templela w. comcastbiz. net
The 2015 Colorado General Assembly adopted the Colorado Crowdfunding Act, which created an exemption in the Colorado Securities Act for capital formation through securities-based crowdfunding based on the federal intrastate exemption. This can be accomplished through broker-dealers, sales representatives, or on-line intermediaries to Colorado residents by Colorado businesses under the federal intrastate exemption for the offer and sales of securities. The Securities Commissioner has adopted rules implementing the Colorado Crowdfunding Act. This article discusses crowdfunding in Colorado as defined by statute and the rules. It also addresses questions that have not been addressed in other articles on crowdfunding, including the obligations of an issuer to its new (and potentially numerous) equity investors and the significant issues regarding transferability of crowd funded securities.
House Bill 2015-1246, the Colorado Crowdfunding Act, became effective August 5, 2015. The Act added CRS § 11-51-308.5 to the Colorado Securities Act[1] to establish an exemption from registration under the Colorado Securities Act for capital formation for small businesses seeking up to $1 million ($2 million if audited financial statements are available) from a crowd of prospective investors in what looks much like a public offering of securities. HB 1246's primary sponsors were Representatives Pete Lee and Dan Pabon and Senators Mark Scheffel and Owen Hill, and it passed through the 2015 Colorado General Assembly almost unanimously. According to the legislative declaration:
1) start-up companies play a critical role in expanding economic opportunities, creating new jobs, and generating revenues; and
2) lack of access to capital is an obstacle to starting and expanding small business, inhibits job growth, and has negatively affected the state's economy.
The General Assembly also determined that, in its judgment, costs and complexities of compliance with the existing registration or exemption requirements of the federal and state securities laws "can outweigh the benefits to Colorado businesses seeking to raise capital by small securities offerings" and that crowdfunding . . . raising money on-line through small contributions from a large number of investors . . . will enable Colorado businesses to obtain capital, democratize venture capital formation, and facilitate investment by Colorado residents in Colorado start-ups, thereby promoting the formation and growth of local companies and the accompanying job creation.
The Colorado Crowdfunding Act
The Colorado Crowdfunding Act[2] requires that the issuer and the offering be exempt from the registration requirements of federal law pursuant to the intrastate exemption set forth in § 3(a)(ll) of the Securities Act of 1933 (1933 Act)[3] and Rule 147 adopted by the Securities and Exchange Commission (SEC).[4] The Colorado Crowdfunding Act was not self-implementing. Although effective August 5, 2015, the Colorado Crowdfunding Act required rulemaking from the Colorado Division of Securities (Division) to be implemented.
To be adopted before the effective date of the Colorado Crowdfunding Act, on July 29, 2015, the Division acted on an emergency basis to adopt Rules 3.20 through 3.30 after publishing draft rules and receiving public input.[5] The final rules were adopted under the Colorado Administrative Procedure Act[6]on September 2, 2015 and were effective October 15, 2015.
It is important to note that no issuer may use the Colorado Crowdfunding Act "in conjunction with any other exemption pursuant to section 11-51-307, 11-51-308, or 11-51-309 during the immediately preceding twelve-month period."[7] The precise meaning of this statutory language is not clear but is expected to be clarified by further rulemaking. The rules and Colorado Division of Securities staff interpretations are expected to follow the guidance set forth in SEC Rule 147, which integrates offers and sales of securities as a single offering when they are "part of the same issue (i.e., are deemed to be integrated)."[8]
The Rules
The rules, as adopted, are intended to implement the legislative intent as expressed in the statute and to make crowdfunding a feasible alternative to the normal methods of capital formation by small businesses in Colorado—receiving capital from friends and family, a private placement pursuant to federal Regulation D,[9] venture capital financing, or a state or federally registered public offering.
Because the Colorado Crowdfunding Act is based on the federal intrastate exemption, it can only be used by Colorado businesses soliciting funds from Colorado residents, primarily for use in Colorado. The securities offered and sold pursuant to the Colorado Crowdfunding Act must "come to rest" in Colorado—meaning there have to be transfer restrictions imposed under Rule 147 to ensure that, for at least nine months following the completion of the offering, the securities sold in a crowdfunding offering are not transferred to persons who are not Colorado residents.
The Issuer and Disclosure
As a result of the federal intrastate offering being the basis for the Colorado Crowdfunding Act, the issuer must be organized or incorporated under Colorado law. The issuer must have its principal place of business in Colorado and must derive at least 80% of its gross revenues (and those of its subsidiaries on a consolidated basis) from operations in Colorado. At least 80% of the issuer's assets (on a consolidated basis with its subsidiaries) must be located in Colorado. Finally, the issuer must intend to use at least 80% of the proceeds of the offering in Colorado.
The Colorado Crowdfunding Act is not a private placement. The Act contemplates, and the rules provide for, the issuer giving a broad public notice to persons who may be interested in the offering. The notice may be in print format or in electronic format (email, social media, etc.), but must be limited to Colorado residents. Following the guidance of SEC Compliance and Disclosure Interpretation 141.04, Colorado Rule 3.24.1 provides that where an electronic-based notice "sent by or on behalf of the issuer" has appropriate legends and warnings, the public notification is permitted, even where it may be accessible to non-Colorado residents.
The Colorado Crowdfunding Act and the rules[10] impose the obligation for full and fair disclosure on the issuer seeking to raise funds from the crowd. The rules include Form CF-2,[11] which forms the basis for disclosure, although it is expected that many issuers will also use a memorandum format or a business plan for disclosure, which they will incorporate by reference into the Form CF-2. It is likely that prospective investors will want to perform further due diligence and make inquiries of t he issuer. Where the discussions with prospective investors lead the issuer to disclose material information not already contained in the Form CF-2 disclosure, the issuer must amend the Form CF-2 disclosure within five business days.[12] Where material events occur after the filing of the initial Form CF-2 (or after the filing of any amendment), the issuer must appropriately amend the disclosure within five days.
The Investors
The investors must be Colorado residents.[13] In fact, using language similar to SEC Rule 506(c),[14] the Colorado Crowdfunding Act requires that before making any sales, "the issuer shall obtain documentary evidence from each prospective purchaser that provides the seller with a reasonable basis to believe that the purchaser meets the [Colorado residency] requirements."[15] This arguably requires more than a simple investor affirmation as to residency because it requires "documentary evidence." This language suggests that the issuer must review and maintain copies of the investor's driver's license, state voting registration, utility bills, or other documentary evidence to establish residency, in addition to the investor's affirmation.
No person may invest more than $5,000 in a crowdfunding offering unless that person is an "accredited investor" as that term is defined by the SEC. If a person is an accredited investor, there is no statutory limitation on the investment amount (subject to the maximum limits of the crowdfunding offering). In determining whether a person is an accredited investor, Rule 3.24.A.1 requires the issuer to have a "reasonable basis" for establishing the accredited investor status. This is language that is similar to Rule 506(c)(2)(H).[16]Although Colorado's rules are silent, it is unlikely that an investor self-certification will be sufficient to meet Colorado's reasonable basis requirement. Issuers would be well-advised to obtain some sort of written documentation from the prospective investor to establish her status as accredited.
In any crowdfunding offering in Colorado, the prudent issuer will require the purchaser to provide documentary evidence as to residency,[17] and (if applicable) as to accredited investor status.[18] In addition, the issuer will require the investor to sign (electronically or on paper) a subscription agreement or...
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