The state of crowdfunding in Michigan
The Michigan Invests Locally Exemption, which went into effect on Dec. 30, 2013, amended the state’s uniform securities act to provide an exemption from registration under Michigan securities law for the sale by a company of its securities, most notably sales of securities via equity crowdfunding through third-party Internet portals.
In the short time that MILE has been in effect, the Securities and Exchange Commission has restricted the use of social media to promote intrastate equity crowdfunding efforts, which may have a chilling effect on participation in equity crowdfunding under MILE. The state of Michigan, however, continues to lead the charge in developing an intrastate equity crowdfunding system that may provide an alternative source of financing for small businesses, while keeping investment dollars in Michigan.
MILE, and equity crowdfunding in general, took a significant initial hit when, on April 10, the SEC staff released new compliance and disclosure interpretations related to intrastate offering exemptions. In order to take advantage of MILE, the transaction must also comply with the intrastate exemption.
One of the initial perceived benefits of equity crowdfunding, as contemplated under MILE, would be the ability of a company to publicly sell its securities, primarily through social media. The use of social media has been integral to the wildly successful rewards-based crowdfunding (through sites such as Kickstarter and Indiegogo). The SEC, however, said since a post on the company’s website or social media could conceivably reach potential investors outside of the state, it would constitute an interstate offer for sale of securities and would no longer qualify under the intrastate exemption. Losing that exemption can have dire fiscal consequences to the company. The company may be required to repay those investments received when improperly relying on the intrastate exemption, plus interest. Worse yet, the company may be required to register its securities with the SEC, which would expose the company to significant fees, costs and ongoing compliance requirements.
Issuing companies are not the only parties affected by these compliance and disclosure interpretations. The SEC provided that companies may use third-party Internet portals to promote an offering to residents of a single state, as allowed under MILE. Those third-party Internet portals, however, must make sure that the offers of securities are only made to residents within the state in which the sales are to be made and must include, at a minimum: disclaimers and restrictive legends that make clear the offering is limited to residents of that particular state; and limiting access to information about specific investment opportunities to persons that confirm that they are residents of the particular state. The CDIs place the burden on the third-party portals to put these measures into effect, but to avail itself of the intrastate exemption, the company must make sure the third-party portal it uses complies with this requirement.
But while these CDIs issued by the SEC may potentially narrow the benefit and applicability of MILE, Michigan has taken steps to remain at the forefront of equity crowdfunding. HB 5273 proposes the creation of Michigan investment markets that would allow broker-dealers to handle intrastate transactions without registering under federal regulations, while also providing a secondary market for the resale of securities purchased pursuant to MILE. The broker-dealers who can handle these intrastate transactions must be registered with the state as Michigan investment markets. The Michigan investment market must confirm that the seller of the intrastate securities is a resident or is doing business in the state of Michigan. HB 5273 provides that a seller participating in a Michigan investment market is a resident of Michigan. If it is determined that such seller was not a resident of Michigan at the time of participation, any transactions conducted by the seller while not a resident are void. The transactions that are conducted through the Michigan investment markets must be between residents of the state of Michigan. Additionally, under the proposed legislation, fees for securities transactions conducted through Michigan investment markets are limited to no more than 5 percent of the value of the transaction.
The creation of an accessible secondary market could potentially encourage equity crowdfunding investments in small businesses. Without it, potential investors may be hesitant to participate in equity crowdfunding if there is not a readily available means to exit their investment down the road. It is encouraging to see Michigan at the forefront of the intrastate equity crowdfunding movement. If HB 5273 is signed into law, Michigan will likely be the first state to have allowed for the creation of secondary crowdfunding markets. The state will still need to create regulations governing the Michigan investment markets and transactions and there may be some logistical issues in determining how the Michigan investment markets work. Will there be significant equity crowdfunding under MILE without a readily available secondary market for those intrastate securities? Will there be a volume of intrastate securities sufficient to justify the creation of the Michigan investment markets?
While equity crowdfunding under MILE has been a bit slow, there have been some companies that have fulfilled their offerings on investment portals like Localstake. As we learn more about equity crowdfunding under MILE, there should be more opportunities for Michigan residents to invest in their local small business ventures. With continued support from the Michigan legislature, equity crowdfunding under MILE could certainly develop as a viable alternative financing resource that could help startups and small businesses thrive, while helping keep investment dollars, jobs and viable businesses in the state of Michigan.