Wisconsin's New Intrastate Crowdfunding Law Lowers the Barrier to Raising Equity
Source: In Business Madison Magazine
5 Tips for Crowdfunding in Wisconsin
It might seem presumptuous to expect a crowd of people to provide capital to your fledgling business, but Wisconsin’s new intrastate crowdfunding law now makes it possible to raise equity funding from a wide pool of potential investors. While American businesses wait for federal crowdfunding rules to be finalized, Wisconsin is one of the first states to offer intrastate equity crowdfunding, allowing small businesses to sell pieces of their company online through Internet crowdfunding sites in return for capital that previously has been unavailable to them.
Whether it turns out to be a boon for business or is undermined by the risks of investing in business startups, which have a higher rate of failure, many believe democratizing capital is a risk worth taking.
“Basically, what it’s doing is creating a new investor class — the general public,” noted David Dupee, founder of CraftFund, LLC, the first crowdfunding site to register with the Wisconsin Department of Financial Institutions. “Really, 95% of the general public can now invest in local businesses, and now resource capital that has been sidelined will be put to use.”
Defined as a way for a business to raise capital by accepting small-dollar investments from a large number of people, usually through the Internet, crowdfunding is gaining in popularity. In Wisconsin, businesses can raise up to $1 million from state investors through online portals.
The amount businesses can raise scales up to $2 million if the issuer, or the company seeking investment, has had an audit in its most recent fiscal year and has made the audit available to prospective investors and the Wisconsin DFI.
A single investor, or purchaser, is allowed to invest a maximum of $10,000 in a single crowdfunding offering, unless he or she is an accredited investor or a certified investor.
The Wisconsin statute defines a certified investor as someone with an individual net worth, or joint net worth with the individual’s spouse, of at least $750,000, or someone who had an individual income in excess of $100,000 in each of the two most recent years (or joint income with spouse in excess of $150,000). Here are a few action items you need to know to take advantage of the new law:
According to Steve Sprindis, co-founder and managing director of Waypoint Private Capital, your first step in the quest for crowdfunding is to determine whether you are eligible for it. Eligibility is not detailed in the Wisconsin law, but mostly in Rule 147 of the federal securities laws, which outlines the conditions a business must meet to be exempt from federal securities laws, and therefore eligible for intrastate offerings.
Among those conditions: The company must be organized under the laws of the state in which it is making the offering, which means no Delaware or Nevada incorporations for Wisconsin-based companies. In addition, the issuer must be doing the bulk of its business in the state, meaning: 1) it generates 80% of its gross revenue here, 2) it has 80% of its assets located here, and 3) it deploys 80% of the proceeds of the offering within the state. Beyond Rule 147, Wisconsin’s statute requires the company’s principal office and a majority of its full-time employees to be located in the state.
Sprindis believes crowdfunding will be good for any business that needs between $1 million and $2 million in capital to start or expand. He noted that it could be used for anything from pure working capital to equipment purchases to real estate purchases.
“It is perfect for any type of company that does most of its business within the state,” he added. “That can include companies in health care, manufacturing, retail, services, restaurants, breweries, and distribution.
“It isn’t very good for companies that sell or distribute their products throughout the U.S. or internationally, such as software companies, retailers who primarily sell through the Internet, or manufacturers who distribute broadly,” he added. “It also isn’t the best option for companies that know they will need additional money from venture capitalists or private equity investors to continue their expansion.”
Once you determine eligibility, Sprindis recommends gathering a group of advisors: an investment banking firm or registered broker with experience in raising money for early-stage companies; a securities attorney conversant in crowdfunding to prepare the necessary materials, filings, and disclosure documents; and members of your internal team with enough marketing expertise to devise and implement a marketing plan — including email, social media, and public relations — for the offering, and enough financial expertise to crunch the numbers. Team members will also be needed to represent the issuing company in the investing process.
Wisconsin law does not permit general solicitation and advertising related to the sale of crowdfunding offerings without permission of the DFI. Due to this non-solicitation rule, Sprindis doubts that portal operators will broadcast your specific investment to their members, so to increase awareness, issuers must plan to actively market their offering.
Since a crowdfunding offering is basically a mini-public offering, the requirements are extensive because of the need for full disclosure to investors and the desire to avoid shareholder lawsuits. In the offering, the issuing company must file a disclosure statement with the DFI. The statement should describe the company, its business plan, the intended use of the proceeds, and every potential and known risk, among other requirements.
Patricia Struck, administrator of the state DFI’s division of securities, advises issuers to be very cautious. “The reason is that anytime you raise money from investors, you have to be confident that you are complying with the securities laws,” she stated. “So even though this new crowdfunding law provides an exemption from registration under the securities laws, nothing can give an issuer an exemption from the anti-fraud law in the securities laws. You still have to be careful about the same kinds of disclosure issues that you would if you were selling an IPO.”
Attorney Kirsten Spira, a partner with Boardman & Clark, said that while Wisconsin has greatly broadened the ability of state companies to invest within Wisconsin without needing to be as concerned about limits on numbers of people and financial sophistication, and while it has minimized the regulatory burden on such offerings, issuers must still be very cognizant of their disclosure obligations.
“I think the change in the law is good because the restrictions on how you can conduct offerings, and who you can conduct them with, were pretty narrow and created a lot of extra expense and hassle and could make it harder for companies to go out and raise capital,” she stated. “This should free up capital within the state, but issuers have to understand that they need to follow the securities laws and understand their obligations as issuers before they undertake it.”
Raise Your Sights
Details of the offering will also include the company, the amount of money you’d like to raise, and the type of security being offered. In determining the amount of money to raise, issuers should factor in the amount needed to cover potential operating losses, working capital, and capital expenditures through the point where you become cash-flow positive or raise your next round of financing. “Give yourself a cushion by increasing the amount you think you need by 20%,” Sprindis advised.
According to Sprindis, issuers most likely will sell class B common stock with limited voting rights and other provisions favored by professional venture capital investors. Since valuation and structure are complicated matters, your broker and attorney really earn their money here.
Opt For an Operator
When choosing a portal or Internet site operator, make sure it’s a Wisconsin-based company that can do intrastate offerings and drive traffic to your offering on its website. That raises an important question that issuing companies should demand to know: Just how will the portal operator drive traffic on your behalf?
Under the crowdfunding law, an Internet site operator used for purposes of the offering must be organized under Wisconsin law, authorized to conduct business in Wisconsin, and registered with DFI for a fee of $100. The operator will be required to maintain records of offers and sales and file quarterly reports to disclose the progress of offerings and the extent to which investors are getting a return on their investment.
All told, Sprindis estimates that the prep work required for the offering will take from 30 to 60 days, the offering period will last between 30 and 90 days, and the entire crowdfunding process could take from 60 to 120 days.
Hunt For Niche Players
The portals, defined as Internet site operators, include CraftFund, LLC and Badger Crowdfunding, and if they are any example, issuers can expect the operators to occupy a number of niche spaces.
CraftFund will operate in the food-and-beverage market, an important sector for the Wisconsin economy. “Our platform will be open to the food-and-beverage category,” Dupee noted, “so that could include breweries, distilleries, cheese-makers, restaurants, cafés, and really anything touching the food-and-beverage space.”
As Dupee explained, crowdfunding involves individual investors taking direct equity stakes in a company. He noted that CraftFund does not operate like a venture capital fund that has a portfolio of companies it invests in. “Each individual investor makes a direct investment in the company,” he stated, “and we’re the vehicle that conducts it through the portal, as the statute requires.”
Tony Nagin Jr. of Badger Crowdfunding hopes to occupy another unique space, the single-purpose limited liability company. In this model, the issuer rents equipment through a single-purpose LLC specifically set up to buy and rent this equipment back to his or her company. The LLC would pay an amount to the shareholders and then close the deal in five to seven years when the equipment is disposed of. Among the beneficiaries would be established companies that run into lending limits with their banks and want to raise capital without harming their banking relationship.
“So it would be off the books, it would be a lease, but it would be a totally separate entity and the shareholders would own 90% to 100% of that LLC,” Nagin explained. “They would not own any portion of the existing company, but they would have a beneficial relationship. The shareholders would receive their distribution, and basically at the end of five or seven years, the equipment is disposed of, and the LLC would be funded and closed out.”
The other benefit of this arrangement is that a successful business that needs to raise money outside the banking channel would not have to give up ownership in their company, Nagin added. “If you have a successful company, and you need the money for machinery, you need money for a new warehouse, or you need some money for tractor-trailer combinations, we’re going to raise money specifically for the purpose of buying that equipment and leasing it back to the company. So basically, they get the outside funding, and they don’t lose ownership of the company.”
This is the brave new world of selling securities over the Internet, according to Spira (Boardman & Clark). “It’s so new that I don’t think we know for sure what’s going to emerge,” she stated, “but I would guess we’ll see some portals that are going to be very broad-based, and I absolutely think we’ll see some that are from niche industries like craft beer.”
The 2012 passage of the federal JOBS Act, or Jumpstart Our Business Startups, embraced crowdfunding as a way to help private companies solicit investments from the general public rather than just accredited investors, something that had been banned since the 1929 stock market crash.
Related rules devised by the Securities and Exchange Commission are still being vetted, but soon crowdfunding will be a national phenomenon. While the SEC finalizes ways to prevent fraud, states like Wisconsin have stepped into the breach.
“Under the Wisconsin crowdfunding statute, you have to limit the offering to what we call an intrastate exemption, and it has to be limited to Wisconsin residents,” Spira noted. “Whereas the federal law, that will be kind of limited to a small IPO that cuts across all state boundaries, and you can make offerings available to anyone in any state that comes to the portal.
“So, the scope is different, but the principle is the same — you are raising relatively small amounts compared to an IPO.”
According to the Wisconsin Department of Financial Institutions, Wisconsin businesses that qualify for the crowdfunding exemption must do the following:
File a notice with the DFI’s Division of Securities at least 10 days before beginning an offering. The notice must include a disclosure document, an escrow agreement with a Wisconsin-chartered financial institution, a financial audit that can be uploaded with the disclosure document, and a $50 filing fee.
Comply with the so-called “instrastate” exemption under federal law, which means that all offers and sales must be to Wisconsin investors.
Make the offer available through one or more Internet sites registered with DFI.
Provide a copy of the disclosure document to each prospective investor, hold all payments in escrow, and do not access them until the target offering amount has been raised.
Provide quarterly reports to investors.
Don’t be subject to the “bad actor” disqualification under federal securities law.
“We’re trying to keep our FAQ page up to date to reflect the questions we are actually getting,” explained Patricia Struck, administrator of the state DFI’s division of securities. “If people have additional questions they think aren’t being addressed, they should let us know. We’re doing this, at least at the beginning, as an interactive exercise. It’s about how to use the statute, how to use the exemption, how to qualify.” This article appeared in the August 2014 issue of In Business Madison Magazine .
About Waypoint Private Capital
Waypoint Private Capital is an investment banking firm that educates and advises middle-market, privately held companies through critical stages of their business' life cycle. Waypoint helps business owners and entrepreneurs sell companies, buy companies, raise equity and debt capital for growth and recapitalization, and plan for a successful exit from the business.
To learn more visit waypointprivatecapital.com or call us at 608.515.3354 or 918.633.2647 and speak with a Waypoint Private Capital expert.
Steve Sprindis is co-founder and managing director of Waypoint Private Capital. © 2012 Waypoint Private Capital, Inc. All Rights Reserved.