Equity crowdfunding comes to Florida - or has it?

• Author: Cohn, Stuart R.
• Position: Business Law

Effective October 1, 2015, Florida has joined the growing number of states that have adopted a "crowdfunding" registration exemption. (1) The exemption is intended to permit small businesses to raise capital through Internet and broad-based marketing without the costs and rigors of a state securities registration process. The exemption essentially lifts the ban on widespread solicitation of potential investors that applies to nonregistered securities offerings. (2) The exemption's basic elements are 1) a maximum offering amount; 2) limitations on the amount of securities that a nonaccredited investor can purchase; 3) mandatory use of a licensed dealer or intermediary; and 4) escrowing of investor proceeds until a minimum target amount has been raised. These and other specific requirements are discussed in greater detail below.

The good news is that the Florida Legislature sought to respond to the capital needs of small businesses. The bad news is that Florida continues to be an outlier state when it comes to securities laws. Our securities statute, including the crowdfunding amendment, is much more restrictive on the capacity of small businesses to raise capital than the securities laws of nearly all other states. (3) Florida's crowdfunding exemption reflects this restrictive tradition by imposing numerous conditions, limitations, liability pitfalls, and cost elements not imposed in analogous crowdfunding exemptions adopted in other states. The result is that one must seriously question whether Florida's exemption will provide a viable process for small business financing.

What is Crowdfunding?

Crowdfunding has been with us for a long time. The term refers to the use of mass marketing to obtain relatively small amounts of donations from a large and diverse group of people. The Internet has become a major source of crowdfunding, and websites have developed to facilitate financing efforts. (4) Music groups seeking funds for a tour, artists seeking help in creating new works, and budding entrepreneurs needing funding for their research and development efforts have all turned to such sites. Donors generally receive nothing more than gratitude or perhaps a small token of appreciation. Requests for financial support could not be accompanied with any offer or suggestion of an economic return, as that would trigger the securities laws and violate long-standing prohibitions against nonregistered offerings being mass-marketed. Thus, until recently, the notion of equity-based crowdfunding did not exist within the federal and state securities laws. Small business advocates pushed for some kind of relief that would allow businesses to raise capital in a crowdfunding-type manner. The Securities and Exchange Commission (SEC) appeared unresponsive to those pleas, but Congress took up the task as part of the JOBS Act of 2012. (5)

The JOBS Act of 2012

What began as a simple concept to allow small businesses to use the Internet to raise relatively small amounts of capital from a broad variety of investors turned into a highly complex set of conditions and requirements by the time the crowdfunding portion of the JOBS Act was completed. It is appropriate to ask: "What happened on the way to the forum"? (6) The role played by the ever-cautious SEC in developing the statutory conditions is uncertain, but it is clear that a perceived concern that a fairly simple exemption allowing the use of Internet solicitation of investors would lead to abusive and fraudulent offerings was a major factor in piling on requirements that go beyond those for most other exemptions. As a result, the federal crowdfunding exemption is replete with significant, time-consuming, and potentially costly conditions, including the mandatory use of a licensed broker or federally registered intermediary to act between the company and the investors; substantial obligations imposed on intermediaries to supervise and police the offering; extensive disclosure requirements that, for some offerings, include audited financial statements; limitations on advertising; and annual filings with the SEC. And that is before any supplemental SEC rules are adopted as required in several statutory sections. It is a sign of the inherently defective statutory exemption that, three years after its enactment, the SEC has yet to adopt rules necessary to make the exemption effective. (7) As commentators have noted, whatever supplemental SEC rules are adopted will not save the exemption from its strict statutory requirements. (8) The only redeeming feature of the federal exemption is that it preempts state laws and, therefore, provides for nationwide solicitation and sales without the need to comply with state registration or exemption provisions. That feature, however, is of limited value if the federal exemption itself is, as many believe, basically a nonstarter. (9)

The Impetus for State Crowdfunding Exemptions

To date, about half of all states have adopted a state-based crowdfunding exemption by legislation or regulation. The state exemptions are generally much less restrictive than the federal counterpart. (10) State adoptions have been in response to the recognized need for an enhanced financing capacity for small businesses and the apparent failure of the federal crowdfunding exemption to meet this need. However, compliance only with a state exemption is not enough. The federal securities laws apply to all offers and sales of securities through the use of an instrumentality of interstate commerce, (11) which covers nearly every securities offering imaginable. Therefore, an offering under a state's crowdfunding exemption must also comply with a federal exemption. The federal exemption that state crowdfunding exemptions have turned is the federal intrastate offering exemption found in [section]3(a) (11) of the Securities Act and in Rule 147 adopted by the Securities and Exchange...