What’s the Matter with Kansas: How States are Changing the Crowdfunding Landscape
Bryan Hill is an intern with Social Enterprise Associates. He obtained
his master's degree in International Finance and Economic Policy (MIA)
at Columbia University and has extensive experience in the world of
impact investing. Claire Williams contributed to this article. She is
an associate with Social Enterprise Associates.
While investors and entrepreneurs have been waiting on federal action around equity crowdfunding rules, several states have been drafting their own crowdfunding laws that would prevail over proposed federal guidelines - so long as both the issuer and investor are local. Motivated by a desire to create local jobs, the trailblazer was the Invest Kansas Exception in 2011. Soon thereafter Georgia and Michigan passed similar laws. Today, twelve states have begun considering crowdfunding laws or regulations.
How State Laws Differ
These state laws tend to focus on maximizing capital flows, while federal laws aim to protect investors. The biggest differences are that entrepreneurs don't have to use intermediaries, and when they do they don't have to be registered; there is far less paperwork, for example the issuer does not have to provide audited financials; and there is less required in terms of background checks. (Among other differences.)
State exemptions do have requirements that aim to protect investors and minimize fraud. In some states all investors must sign documents stating that investments are risky and that they may lose all of their money, fundraises are limited to $1,000,000 in size, (or potentially $2,000,000 in North Carolina), and there are investment caps ranging from $2,000 to $10,000.
A Slow Start
In spite of the streamlined approach, the local regulations have not resulted in an explosion of start-ups taking advantage of state exceptions. According to Businessweek, from 2011 to the end of 2013 roughly 20 companies tried to raise money through the new equity crowdfunding mechanisms in Kansas and Georgia combined.
The potential reasons for the slow start are many. It may be that it is taking entrepreneurs and/or investors time to gain familiarity with the new marketplace, it may be the economy, or it may be the fact that there wasn't an existing pipeline of potential fundraisers at the time of the exemption. (Even in traditional markets it takes a long time for businesses to wind their way to a successful fundraise.)
According to Marcus Cannady, VP of Marketing and Development for SparkMarket, a Georgia-based portal, one factor in the slow emergence of state-specific portals had to do with the exemprion laws themselves. The initial language of both the Kansas and Georgia laws prevented crowdfunding portals from establishing themselves as LLCs, which made them extremely high-risk undertakings. Once Georgia changed this rule, platforms like SparkMarket started to emerge. (The law has not yet been changed in Kansas.)
Emerging platforms such as SparkMarket are start-ups themselves, and engaging with a nascent marketplace under heavy regulatory and political scrutiny.
Mr. Cannady is nevertheless quite optimistic, and SparkMarket recently completed the first successful portal-based intrastate equity crowdraise utilizing non-accredited investors, and has an increasingly robust pipeline of clients. (For more information on the first fundraise click here: Bohemian Guitars.)
A Local Focus
Should intrastate raises become commonplace, then an important question may be whether the companies that use them will be somehow distinct from those using other fundraising mechanisms.
Mr. Cannady believes the answer is yes, and it is a question of motivation. By and large accredited investors are focused on high growth businesses that are likely to manifest profitable exit opportunities. Locally focused investors making more modest disbursements, on the other hand, are more likely to be motivated by issues such as community impact, and the import of actively participating in the shaping of one's civic realities. As a result intrastate portals may emerge as the primary domain of endeavors with a visibility and impact in the immediate community -- coffee shops, organic supermarkets, or undertakings utilizing historic buildings, to name a few.
As noted by Mr. Cannady, interstate raises based on the JOBS Act are also likely to be distinct from those utilizing intrastate portals - not because of the differences in the regulations - but because investors in California are unlikely to take much of an interest in coffee shops in Georgia.
While motivated by stimulating the still slow moving capital markets, and decreasing the regulatory weight present in the JOBS Act, state exemptions' most important long term effect may prove to be the creation of an avenue for increased local participation in community development. That having been said, the differences between the regulations regarding interstate and intrastate raises may also prove quite valuable as market participants will be able to scrutinize the details of the markets' relative development when determining how to best move forward.
These facts notwithstanding, the continued emergence of mechanisms supporting equity investment opportunities for non-accredited investors is certainly a development worth watching for investors, regulators, and entrepreneurs alike.
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