Reprinted from National Law Review Seth W. Ashby, Kimberly A. Baber, Jacob A. Droppers, Harvey Koning, Michael G. Wooldridge of Varnum LLP Thursday, January 23, 2014
Effective December 30, 2013, Michigan Gov. Rick Snyder enacted into law Public Act 264 of 2013 (the “Act”). Among other things, the Act establishes a crowdfunding method of raising capital in Michigan. “Crowdfunding” refers to soliciting small individual contributions from a large number of people (or the “crowd”). Crowdfunding has attracted significant attention recently, but the federal and state laws that regulate securities substantially restrict the ability of companies from engaging in crowdfunded offerings of their equity. However, the federal Jumpstart Our Business Startup Act of 2012 (the “JOBS Act”) created a foundation for private companies to raise capital through securities offerings using crowdfunding.
On October 23, 2013, the Securities and Exchange Commission (“SEC”) released proposed rules to implement the federal crowdfunding exemption from registration of such an offering. The proposed rules remain subject to a public comment period as of the date of this advisory, and the timing for the adoption of final rules is uncertain. The SEC’s proposed rules, which largely follow the statutory requirements of the JOBS Act, include fairly onerous restrictions on offering participants that could make the costs of crowdfunding under these rules prohibitive for many small businesses.
By passing the Act, Michigan has become one of only a handful of states (a total of four states at last count) that allow companies to raise capital, solely within their borders, through crowdfunding without reliance on federal crowdfunding rules. A brief summary of both the requirements and limitations of the Michigan-based exemption in the Act are outlined below.
- Intrastate Requirements. As a prerequisite, the Act’s exemption mandates compliance with the so-called “intrastate” exemption under SEC rules. Specifically, the company issuing the securities (“issuer”) must be an entity formed under Michigan law, and the offering may be made only to Michigan residents. Even a single “offer” to a non-Michigan resident will void the exemption, so precautions must be taken to ensure compliance. In addition, the issuer must (i) derive at least 80% of its gross revenues from Michigan, (ii) have 80% of its assets in Michigan, (iii) use at least 80% of the net proceeds of the offering in Michigan, and (iv) have its principal office in Michigan. The issuer may not be a public or private fund.
- Restrictions on Resale. The securities sold may not be resold within 9 months of the closing to any non-Michigan resident.
- Maximum Offering Amounts. The Act creates two distinct maximum offering amounts. If the issuer makes audited financial statements available to investors as part of the offering process, the maximum offering amount is $2,000,000. If the issuer does not make available audited financial statements, the maximum amount is $1,000,000. Sales of securities by the issuer within the prior 12 months are aggregated for this purpose.
- State Notice. At least 10 days before an issuer makes an offer of securities in reliance on the exemption (or uses any publicly available website in connection with a securities offering in reliance on the exemption), the issuer must file a written or electronic notice with the State of Michigan. The notice must include: (i) a $100 filing fee; (ii) a copy of the disclosure statement to be provided to investors; (iii) a copy of an escrow agreement with a bank stating that funds will be released to the issuer only when the minimum target amount is reached; and (iv) a notice of whether the issuer plans to engage a website to assist with the offering.
- Solicitation and Sale Requirements. General solicitation of investors is permitted, but there are certain limitations, including: (i) if the investor is not an “accredited investor” (as defined by SEC rules), the issuer may not accept more than $10,000 from such investor (there is no limit if the investor is an accredited investor); (ii) all payments from investors must be held by a bank under the escrow agreement described above; and (iii) the issuer must provide a copy of the disclosure statement to each investor at the time the offer is made.
- Sales via the Internet. If the issuer desires to make sales through an Internet website, the issuer must notify the State of Michigan of this fact. Also, the operator of the website must file a written notice that includes information about the operator. The website will not be subject to Michigan broker-dealer requirements so long as it meets certain requirements (e.g., the website may not solicit investors, handle funds or securities, or receive transaction-based compensation such as commissions based on the amount of securities sold in the offering).
- Continuing Disclosure. After the offering, the issuer must provide quarterly reports to the issuer’s investors and the State of Michigan for as long as securities sold in the offering remain outstanding. These reports may be sent directly to investors or made available to them through the issuer’s website. Each report must be free of charge to investors and include information regarding the compensation of the issuer’s directors and executive officers and an analysis of its management, business operations and financial condition.
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