It is now legal for Texas companies to raise as much as $1 million in up to $5,000 increments from Texas adults for an equity share in the company through crowdfunding — an Internet service platform that links companies to investors.
This week, the Texas State Securities Board voted 4-0 to pass rules allowing Texans 18 and older to invest up to $5,000 a year in one or a number of Texas companies for an equity stake. The companies and the investors will be vetted to some degree by the portal services, but they will not be registered through the board.
With the passage of these rules — ahead of federal regulations that are bogged down in the Securities and Exchange Commission — Texas will be the biggest testing ground in the country for this new type of investing.
“There are 20 million Texans age 18-plus who can now invest $5,000 per year in local startups for an equity share,” said Robert Haskins, owner of the Austin-based public relations firm Front Page PR, which specializes in crowdfunding promotion. “That’s $100 billion now available. The state securities commission doesn’t like me talking in those terms, but that’s the reality.”
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Texas is the 13th and largest state to offer intrastate crowdfunding investments, said Judd Hollas, CEO of EquityNet, a crowdfunding platform based in Fayetteville, Ark.
“Texas may be the first really good intrastate success story for portals to find it attractive,” he said. “Some of the states that already passed crowdfunding rules were not big enough for us to spend money to customize our sites to their rules.”
Crowdfunding is an Internet phenomenon in which individuals and companies reach out to new investors by posting projects on Internet services like Kickstarter or Indiegogo to raise money for development or production.
But such sites have been limited by law in two ways. Most sites did not offer an equity share of the company. Instead, they offered free prototypes or promotional items in exchange for a donation. Crowdfunding deals that did offer equity shares were limited to only accredited investors.
In Texas, accredited generally meant someone with a net worth, or joint net worth with a spouse, that exceeded $1 million and with an individual income exceeding $200,000, or joint income exceeding $300,000, said Robert Elder, spokesman for the securities board.
Now, through crowdfunding portals, investing in a Texas company is open to any Texan of legal age regardless of income or net worth. Investors merely have to prove through a driver’s license that they are Texas residents. And there’s a $5,000 cap on investing in a single year.
Local financial planners are skeptical of such investments, to say the least.
“I love it and I hate it,” said Steve Blankenship, founder of Heritage Financial Planning, which has offices in Southlake and Grapevine. “Crowdfunding is ripe for opportunity but also ripe for fraud. States want to be pro-business, but sometimes regulations come back only once people have been burned.”
Blankenship points out that the state securities board has been investigating and shutting down unregistered securities for years, but this new rule shifts the reporting requirements from the state to the crowdfunding portals. Those portals will be required to conduct a reasonable investigation on the background and regulatory history of the businesses issuing securities.
“It’s a way to raise capital, but void of most consumer protections,” he said. “This may become a loophole that pushes these investments off the board’s plate.”
The crowdfunding portals will be registered with the securities board, Texas Securities Commissioner John Morgan said in a previous interview.
Background checks will be done on the portal operators, he said.
“The portal is an intermediary,” Morgan 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 expected to draw expertise to each investment, 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.
The dealer faces a registration process as well, Elder said.
“An applicant can’t do business until approved — otherwise, it’s an unregistered activity,” he said. “But they are not going to be registered in the traditional sense. The issuers do face certain requirements like a business plan, prospectus and disclosure statement and cannot have criminal or disciplinary actions against them.”
The platforms are also required to inform investors that selling their investments may be hard because there is no ready market.
Blankenship argues that the concept will allow some startups to persuade the general public to buy into an nonviable idea — or worse, a hoax.
“You’ve got some good marketers that can tell a good story and they will get investors to part with their money,” he said. “Some will start foaming at the mouth to take advantage of people.”
Crowdfunding could lead to more unsolicited mail in your mailbox and email account as well. While all communication of the deals must take place within the portal between companies and potential investors, the new rules do allow companies to give notice to the public at large that they are conducting an offering and provide a link to the portal’s website, Elder said.
Seeing the deals advertised on social media may be more limited, however, Elder said. The SEC has recently advised investors looking for crowdfunding revenue to avoid social media like Twitter and Facebook because they cross state lines. Such investments must be limited to residents of states that allow it.
The final rule will be published in the Texas Register, probably next week, and is expected to take effect in late November, Elder said.
When will it become live in the state? It depends on when portals register and build their sites.
“The mechanism is in place,” Elder said. “It’s up to them to take action.”