Capital Markets Client Alerts Emerging Companies
By: Don Reynolds, Larry Robbins, and Annalise Perry
After several rounds of revisions, North Carolina recently implemented rules under the July 2016 Providing Access to Capital for Entrepreneurs and Small Businesses (“PACES Act”), creating new channels for companies to raise money through crowdfunding without undergoing state-level securities registration. While there are many details in these new rules for companies (and investors) to consider before embarking on a crowdfunding capital raise, below are four things in particular that you should know about North Carolina’s crowdfunding rules.
1. Companies must raise a minimum target amount.
Similar to crowdfunding sites like Kickstarter, which require a company to reach a pre-set goal in order to close a campaign, a company utilizing the Invest NC Exemption must receive commitments for a threshold dollar amount in order to accept any funds from investors. Companies that fail to reach their threshold amount within 12 months, even if they receive some funding commitments, must return all funds to investors.
Fortunately, companies have some flexibility in deciding what this threshold amount will be. Companies must set a target offering amount (up to $1 million, or up to $2 million if additional disclosures are provided) and then set a minimum offering amount, which can be no less than 20% of the target offering amount. It is in the best interests of both the company and its investors that the minimum be a large enough sum that the company can effectively move its business forward even with only that amount of financing. In other words, “build a bridge, not a pier.”
Issuers should be conscious of the fact that a number of the expenses involved in completing an Invest NC offering will be incurred prior to knowing whether the minimum offering amount is met. As a result, an issuer that fails to meet the minimum offering amount will not only be without any investor funds, but also out the amount of costs involved in preparing disclosure documents and engaging service providers, such as funding portals, escrow agents and attorneys. Additionally, securities sold to a company’s controlling persons, funding portal or registered dealer (if applicable) are not included in the calculation of the minimum offering amount or the target offering amount, so companies cannot count on these sales pushing them above the minimum offering amount. Companies are also limited to accepting no more than $5,000 from a non-accredited investor, though there is no limit on the amount an accredited investor may invest.
2. The offering must be online, unless it’s a “Limited Public Offering.”
Each securities offering under the Invest NC exemption must be completed via an online public platform, which must include a communication channel in which information related to the offering can be shared and discussed among the public, potential investors and the company. It must also provide a progress indicator (such as a pie chart) showing the company’s progress towards raising its target offering amount. The platform will also provide potential investors with the company’s disclosure documents and must comply with administrative rules, such as the preservation of communications and documents for six years following the commencement of the offering.
A company has the option of maintaining the platform through its own website, and therefore would be responsible for ensuring the platform’s compliance but have control in managing the platform’s design and functions. However, a company can also use a third-party platform maintained by a registered funding portal or a registered dealer. Use of a third party may relieve some of the administrative burden of a securities offering, thus allowing the company to focus on capital-raising; however, these services will be an additional cost for companies to consider. And currently, many of the national crowdfunding platforms are only accessible to accredited investors. Until there are additional funding portals registered with the Secretary of State, many companies will have to maintain platforms themselves and, in doing so, ensure their websites have the capabilities to comply with platform requirements.
Recognizing that some companies may prefer to raise money without the use of the internet, the new rules also provide an alternate channel for companies to raise funds under the PACES Act. Under the rules for Local Public Offerings (“LPO”), a company is permitted to raise up to $250,000 in a 12-month period without the use of the internet or a platform. The company must set a minimum offering amount of no less than 25% of the target amount and must comply with several of the rules included in the Invest NC Exemption, such as the filing of Form NCE and the use of an escrow agent (discussed below). Prior to advertising or selling any securities, the company must also arrange and attend a conference with the Secretary of State’s Securities Division to discuss compliance with the exemption.
The rules regarding advertising and general solicitation are also slightly different for an Invest NC offering and a LPO. Under both, advertising materials must direct prospective investors to the company’s disclosure documents (i.e., the platform in an Invest NC offering) and include a disclaimer that the offering is only available to North Carolina residents. The only other information permitted to be included in Invest NC advertising notices are the terms of the offering (price, closing date, nature of the securities to be sold, etc.) and factual information about the company and offering. Companies completing a LPO have more flexibility in utilizing advertising, as these notices may contain more information than that permitted for the Invest NC offerings, so long as such communications are provided to the Secretary of State in advance of use. Any meetings and gatherings discussing the LPO require providing ten business days’ notice.
3. Companies must engage an escrow agent.
Companies utilizing the exemption must establish an escrow account to hold investor funds, at least until the minimum offering amount is met. The escrow agent can be (i) a bank or depository institution, (ii) a registered dealer, or (iii) a lawyer. The company and its escrow agent must enter into an escrow agreement addressing compensation and other terms specified in the rules, including that the account must be FDIC or NCUSIF insured. The escrow agent will collect information and accept funds directly from investors and, once the minimum offering amount is met, is responsible for notifying the Secretary of State and releasing the funds to the company. Escrow agents are also responsible for maintaining all documents related to its service as escrow agent for six years after the commencement of the offering.
4. You still have to comply with federal securities laws.
These new North Carolina exemptions are designed to work for offerings that qualify for the so-called “intra-state” exemption from registration for federal securities law purposes. Theoretically, other federal exemptions might work as well. The trick is that you need to be sure your offering does actually also comply with an applicable federal exemption, or you might have to give all your investors their money back and/or you could suffer additional consequences.
In addition to these items, companies should review the full rules in determining if a crowdfunding offering is the right option for its particular needs and goals.
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Don Reynolds, Larry Robbins, and Annalise Perry are attorneys in our Capital Markets and Emerging Growth Companies Practice Groups, assisting companies in financing and growing their businesses. If you have any questions related to this Client Alert, feel free to call (919-781-4000) or email your Wyrick Robbins contact or any of the following: Don Reynolds (firstname.lastname@example.org), Larry Robbins (email@example.com), or Annalise Perry (firstname.lastname@example.org).