Crowdfunding investments are coming to Texas in September.
The Texas State Securities Board is in the final rule-making phase of allowing small businesses in the state to solicit up to $1 million annually from unregistered and accredited Texas investors via online crowdfunding portals.
The investors, who can invest up to $5,000 a year in portal offerings, will receive equity shares in the companies in return.
Previously, crowdfunding over the Internet through websites like Kickstarter and Indiegogo has been limited in the state to people who wanted to contribute to a company or cause without any financial return other than promotional items. Now they will receive shares in the company.
Texas will become the 13th state to allow such individual investments to be made over the Internet, Texas Securities Commissioner John Morgan said.
“When we started looking into this, there were three states where this was allowed,” Morgan said. “Now 12 states have passed rules or legislation to allow it. We’ve spent a lot of time looking at the rules in other states, along with talking to other experts in Texas and beyond.”
Crowdfunding was previously limited to rewards such as T-shirts or other marketing giveaways in Texas, said Robert Hoskins, owner of the Austin-based public relations firm Front Page PR, which specializes in crowdfunding promotion.
The effect of the crowdfunding changes on small businesses is huge, he said.
“There are 20 million Texans 18 or older who could invest up to $5,000 a year,” he said. “That creates $100 billion in investment capital in Texas alone. Texas will be the largest equity crowdfunding state in America.”
Hoskins said the businesses most interested in investment crowdfunding are commercial real estate, oil and gas ventures, and franchises.
Morgan said the Texas Securities Commission has broad rule-making ability and does not require the Legislature to enact a law on crowdfunding within state lines.
“That’s a good thing, because there may be situations where you need to tweak the rule if there are unintended consequences and you want the ability to change it,” Morgan said.
Nationally, the Jobs Act of 2012 allows for crowdfunding investments, but the Securities and Exchange Commission has yet to finalize rules.
Morgan said there already are several exceptions to enable companies to sell investments directly to investors, but previously the investor needed to prove he or she had $1 million in liquid assets or earned $250,000 or more a year. If they met that threshold, they could become accredited investors.
After the final rule is approved in late August, Morgan said there will be no such requirement for investors, who will register through privately run crowdfunding portals to search through investment opportunities.
The portals in Texas will be registered as dealers with the Texas State Securities Board, Morgan said. Background checks will be done on the portal operators, as well as unannounced inspections, he said.
“The portal is an intermediary,” he said. “It will host the investor offerings, post all documents required regarding that offering, and there will be a discussion area. It’s a fairly streamlined approach.”
The public forum is an important element to the portal and expected to draw expertise, allowing for the “wisdom of the crowd,” Morgan said. “The crowd will decide if it’s a good deal or a bad deal,” he said.
An individual offering on the portal could be dominated with incorrect or even fraudulent information, however, Morgan admits.
“I think that’s a possibility,” he said. “It could absolutely happen. This is new in Texas and throughout the U.S. A lot of people are watching it closely. But you don’t want to see bad actors ruining it for everybody. If shills or conspirators are gaming this, it’s done in the light of day in an open forum.”
Helen Stephens, a certified financial planner and co-owner of Aspen Wealth Management in Fort Worth, is not convinced the crowd expertise will winnow out poor investment choices.
“If you are talking about the wisdom of the crowd, most people don’t get into the stock market until it’s up, which is not the time to invest,” she said. “The average person doesn’t have the background to assess whether an investment is good or not.”
Stephens said such investing also can tie up savings for an indefinite amount of time.
“It would be a very illiquid investment. You put money in it but you don’t know when you will see it again,” she said. “At what point can you cash out?”
Also, the risk level of such investing is high, Stephens said.
“Everybody wants a good deal,” she said. “But most people don’t have the money to literally and potentially throw it away.”
While the state securities board says it plans to keep an eye on crowdfunding, Morgan said the agency is limited: It has only one inspector for every 1 million Texans.
The state rule will only apply to businesses and investors in Texas, Morgan said. If either party is outside the state, it would violate federal law until the SEC changes the rules, he said.
The securities board board will meet on Aug. 28 and is expected to finalize the rules on crowdfunding, which will then be published. It is expected to become operative in the second half of September, when applicants will begin to come in for the crowdfunding portals, Morgan said.
“It think it’s going to be a good thing,” he said. “It’s another tool in the tool kit for small businesses. The only reason we’re doing this is to help facilitate capital formation for small businesses.”
For more information on Texas crowdfunding, go to www.crowdfundingpr.wordpress.com.