As of July 1, Hoosier entrepreneurs seeking to raise capital (join the club, right) now have a new tool: crowdfunding. Indiana’s new crowdfunding law sailed quickly and almost unopposed through the General Assembly—140 yeas to 1 nay. Despite any instinctual suspicion some may have of a law that both parties agree on, this legislation may actually be useful to you. Here are six questions to consider in deciding whether to Hoosier crowdfund:
Can I raise capital from out-of-state investors?
No. For the time being, federal law still prohibits you from crowdfunding on a national scale. The SEC, which is currently under congressional mandate to make rules permitting crowdfunding, has yet to finalize those rules.
Rather than wait for the feds, a handful of states have chosen to pass their own crowdfunding laws. They can do this because of the “intrastate” exemption in the Securities Act of 1933. That Act, which generally protects us all from snake oil salesmen by prohibiting the sale of securities outside of highly-regulated public markets such as the NYSE and Nasdaq, does not apply to offerings that are exclusively intrastate because the SEC only has jurisdiction over interstate offerings. Indiana has now joined the ranks of states using this exemption to permit local companies to crowdfund the intrastate sale of securities.
Notably, as written, the new law only applies to companies organized under Indiana law. If you’re local but incorporated under Delaware law, you can’t use the new exemption.
How much can an entrepreneur raise?
Under Indiana’s new law, Hoosier entrepreneurs may raise up to $2 million in a 12-month period via crowdfunding if they provide potential investors with audited company financial statements. Without audited financials, the limit is $1 million. Of note, crowdfunding can piggyback on traditional methods to raise additional capital.
You may raise capital through an Indiana crowdfunding campaign from Indiana residents only. As the issuer, you’ll need to verify that each investor is an Indiana resident (a driver’s license number would likely suffice). Also, you may accept no more than $5,000 from any single investor, unless that investor is an accredited investor.
How, and how much will it cost?
This answer, of course, varies and is somewhat detailed and complicated, but here are some basics:
(A) You must provide a disclosure document to all prospective investors. The document must contain certain basic information about your company, including a business plan, intended use of the proceeds, amounts to be paid to owners and officers, the identity of all persons owning at least 20% of the company, the terms and conditions of the securities offered, and more. Lawyers and accountants will most likely be involved.
(B) You must use a third party web portal (think Localstake). The web portal operator may but is not required to be a registered broker-dealer, and will certainly charge a fee.
(C) You’ll have to provide quarterly reports to investors so long as any crowdfunded shares are outstanding.
Costs are difficult to calculate, but by comparison, estimates under the proposed SEC rules range from $6,500 to $26,000 for a $100,000 raise, and $80,000 and $190,000 for a $1,000,000 raise, plus a couple thousand dollars per year for ongoing reporting (see here and here).
Sure. The law may be ignored. If the cost of capital is prohibitively high, entrepreneurs will ignore crowdfunding and stick with tried-and-true methods. Also, the $5,000 per investor limit likely will complicate reaching higher raise targets.
Another worry is that, unlike the draft SEC rules, Indiana’s law doesn’t cap an individual’s 12-month contribution, so conceivably grandpa could make fifteen $5,000 investments in one year and blow his savings. Securities Commissioner Carol Mihalik has reminded issuers that fraud remains illegal and will be prosecuted, but there is potential for investors to lose their shirts.
Finally, some venture capitalists have expressed their disinclination to participate in a Series A where there’s a mob of crowdfunders populating the cap table.
What happens when the SEC finally adopts national crowdfunding rules?
Indiana’s crowdfunding laws will gather dust. The current exemption for intrastate offerings is probably the least used ’33 Act exemption. The reason is simple: though exempted from federal law, intra-state offerings are still governed by state laws, and these “Blue Sky Laws” almost invariably mimic their federal counterparts. So if nearly identical regulations must be followed, companies rarely chose to limit their pool of prospective investors to only one state.
There will be differences between Indiana’s crowdfunding law and its federal counterpart, but these differences are unlikely to matter. To take the most notable difference: our law allows raises of up to $2 million, while the SEC rules (if finalized as drafted) would limit raises to $1 million. But raising more than $1 million will be difficult when the investor pool is limited to Hoosiers at $5,000 a pop, and the lure of a national pool with the higher proposed individual limits will be irresistible to most, even if it means shelling out for audited financials (which the proposed SEC rules require for any plus $500,000 raise).
In short, if you are seeking to raise less than $2 million dollars exclusively from Hoosiers in many small increments, you just got the green light. But you’ll have to keep waiting for the SEC to finalize its rules if you want to run a national crowdfunded equity sale.