On the heels of the U.S. Securities and Exchange Commission (SEC) adoption of final rules to permit equity crowdfunding under Title III of the Jumpstart Our Business Startups (JOBS) Act, Quarles & Brady, LLP in conjunction with the Arizona Technology Council, weighed in on why it may create significant opportunities for Arizona businesses.
These rules released on October 30, 2015, represent a dramatic shift in the SEC’s historical approach to the regulation of private securities offerings, and fundamentally affect the ability of local entrepreneurs to reach out to the public in their efforts to raise capital. The adoption of the rules followed the enactment of Arizona’s new crowdfunding law which took effect on July 3, 2015. According to Quarles & Brady LLP and the Council, both laws may enable companies in the local Arizona economy to enjoy greater access to capital and to reach a greater variety of potential investors.
“Crowdfunding allows companies to use technology to make capital raises more efficient and reach a broader audience of potential investors,” said Kevin J. Walsh, an attorney at Quarles & Brady LLP in Phoenix whose practice focuses on equity financing. “For startups and other emerging growth businesses that may not have ready access to traditional sources of funding, crowdfunding may be an attractive option for raising capital.”
Until recently, crowdfunding has existed primarily in reward-based or donation-based models, such as Kickstarter, which allow individuals to contribute funds to particular projects, either as donations or in exchange for certain products or prizes. By comparison, equity crowdfunding is the process by which a company raises capital through crowdfunding in exchange for equity interest in the company.
“Over a span of only a few years, crowdfunding has brought about dramatic changes to capital formation,” said Steven G. Zylstra, president and CEO of the Arizona Technology Council. “The single biggest impact for local start-ups and growing companies is that under the new rules, entrepreneurs may now, subject to the limitations and conditions in the rules, reach out much more broadly to the public during capital raises through online portals registered with the appropriate regulators.”
The ability to reach out through online portals represents a break from the SEC’s historical approach in a number of ways, including:
- Since the original enactment of the Securities Act of 1933, companies have been prohibited from using general solicitation or advertising in the sale or offering of their securities unless the companies went public and registered their offerings with the SEC, which is a complicated and expensive process.
- The ban on general solicitation remained in place until the enactment of another provision of the JOBS Act in 2013 that permitted limited general solicitation in certain private offerings, but only if the securities are sold exclusively to wealthy investors that qualify as “accredited investors” under federal securities law, which account for only a small percentage of all potential investors.
- With the enactment of the Arizona law and the new rules under the JOBS Act, many Arizona companies will be able to access equity crowdfunding to raise capital from both accredited and unaccredited investors.
There are limitations on the amount of funds that a company can raise and on the amount that a particular investor can invest in a crowdfunding offering, as well as other restrictions and requirements. Companies considering the strategy should seek advice from legal counsel to make sure they are complying with the new rules and to determine whether the approach is right for them.
“At CrowdStreet, we believe all accredited investors should have equal access to institutional-quality commercial real estate investment opportunities as a means of portfolio diversification and wealth creation,” says Darren Powderly, co-founder of CrowdStreet, Inc., a software and services company that recently contributed to a $2,650,000 raise for a real estate development project in Tempe through its crowdfunding marketplace. “By offering real estate operators, funds and private equity companies an online vehicle, they can more efficiently and cost-effectively raise capital and manage relationships with new and existing investors.”
“The new rules adopted by the SEC represent a fundamental shift in the regulatory landscape,” says Jacque N. Westling, a partner at Quarles & Brady LLP in Phoenix whose practice focuses on emerging growth companies, angel investment and venture capital. “While crowdfunding will undoubtedly present both challenges and opportunities, it opens up a whole new approach for raising capital that will likely have a significant impact on Arizona’s entrepreneurial community.”
Editor’s note: See also “Equity Crowdfunding Comes to Arizona,” the “Legal” article in the November 2015 issue of In Business Magazine, in which Kevin Walsh discusses aspects companies should weigh in considering short- and long-term pros and cons of this financing opportunity.