California Crowdfunding Exemption
- What is crowdfunding and equity crowdfunding?
- What laws govern crowdfunding?
- What are some of the requirements under the new California crowdfunding law?
- What are some of the similarities and differences between the federal crowdfunding law and California’s crowdfunding law?
- How can issuers file for the California crowdfunding exemption under Corporations Code section 25102(r)?
What is crowdfunding and equity crowdfunding?
Crowdfunding is a financing method in which a project or cause raises money from large groups of people, each contributing typically small amounts of money. Crowdfunding can be donation-based or securities-based. Donation-based crowdfunding means that individuals donate money to a cause without having any expectation of anything in return. In contrast, securities-based crowdfunding or equity crowdfunding involves people investing money in a business with the expectation that they will receive an ownership interest (i.e., security) in the business. Because equity crowdfunding involves the offer and sale of a security, it is regulated by federal and state governments under securities laws.
What laws govern crowdfunding?
The federal Jumpstart Our Business Startups Act (JOBS Act) created an exemption from federal registration requirements for interstate crowdfunding offerings conducted under section 4(a)(6) of the Securities Act of 1933 (codified at 15 USC 77d of the United States Code), and its corresponding Regulation Crowdfunding (Regulation CF), which comprise Rules 100, 201-206, 300-305, 400-404, and 501-504.
However, practically-speaking, use of federal crowdfunding exemption has been limited to larger later-stage companies, and it has remained difficult for smaller businesses to conduct crowdfunding activities due to the high cost of undertaking a crowdfunding offering meeting the requirements of Regulation CF.
On October 11, 2021, AB 511 was signed into law in California to create a new California state crowdfunding exemption, which was added as new section 25102(r) of the California Corporate Securities Law (Corporations Code section 25102(r)) and went into effect on January 1, 2022. The new section 25102(r) created an exemption from qualification in California for crowdfunding offerings conducted under the federal intrastate offering exemption under section 3(a)(11) of the Securities Act of 1933 and its corresponding Rule 147 and Rule 147A. Generally, the new California crowdfunding exemption means that issuers subject to California law who will be selling only to California purchasers can do so under this new state exemption.
What are some of the requirements under the new California crowdfunding law?
The new exemption is available to companies that are incorporated in California or foreign companies that are subject to California’s Corporations Code via section 2115. The exemption cannot be used by “blind pool” companies, companies that issue fractional undivided interests in oil and gas or similar mineral rights, investment companies, nor reporting or public companies (defined as companies that are subject to SEC reporting requirements under section 13 and 15(d) of the Securities Exchange Act of 1934).
To be eligible to use the new 25102(r) exemption, an issuer cannot sell more than $300,000 in securities under any section 25102 exemption during the 12-month period preceding the crowdfunding offering, including any amounts sold in the crowdfunding offering. Any securities sold by the issuer under federal Rule 147 or Rule 147A or in violation of Section 5(a) of the Securities Act of 1933 (i.e., unregistered offerings) will be included in the aggregate offering price in California.
Issuers wanting to rely on the 25102(r) exemption must conduct the offering under the federal intrastate offering exemption in section 3(a)(11) and Rule 147 or 147A mentioned above. The offering must also comply with Subpart A and Subpart B of Regulation CF (17 C.F.R. 227.201 to 227.206).
Subpart A, entitled Crowdfunding exemption and requirements, sets forth the general offering limits for the federal exemption and investor limitations. There are no investment limits for accredited investors. Non-accredited investors can invest: (i) the greater of $2,200 or 5% of the greater of the investor’s annual income or net worth, if either the investor’s annual income or net worth is less than $107,000, or (ii) 10% of the greater of the investor’s annual income or net worth, up to $107,000 maximum investment, if both the investor’s annual income and net worth are $107,000 or more. Subpart B, entitled Requirements for Issuers, sets forth the disclosure requirements, ongoing reporting requirements, promoter compensation, and solicitations of interest and other communications.
What are some of the similarities and differences between the federal crowdfunding law and California’s crowdfunding law?
Similar to Regulation CF, integration of offers and sales under 25102(r) is governed by the federal regulation 17 C.F.R. 230.152.
However, the 25102(r) exemption deviates from Regulation CF in a few ways:
- As mentioned above, the maximum offering amount for California’s exemption is $300,000 versus $5 million for the federal exemption (section 25102(r)(3)(A)).
- Whereas Rule 227.201(t)(2) of Regulation CF would normally require reviewed financials for offerings above $107,000, new section 25102(r)(3)(B) instead allows issuers to rely on the lower standard found in Rule 227.201(t)(1) of Regulation CF and use financial information that has not been audited or reviewed so long as they are certified by the principal executive officer of the issuer as being accurate and true and complete (section 25102(r)(3)(B)).
- The issuer must prominently provide a statement that the furnished financials have been certified by the principal executive officer rather than reviewed by an independent public accountant (section 25102(r)(4)(B) and (C)).
Other additional investor protections added by the new California crowdfunding exemption include:
- The issuer must take reasonable steps to ensure that each non-accredited investor who is a natural person (either alone or together with any representatives) has knowledge and experience in financial and business matters and is capable of evaluating the merits and risks of the investment.
- Purchaser has the right to rescind the investment within three business days.
- The issuer must escrow funds until the minimum offering amount is reached and must return all funds if they do not reach the minimum within one year.
- The issuer cannot conduct any direct solicitation.
- The issuer cannot require purchasers to waive the right to a jury or to require out-of-state governing law or forum.
Lastly, section 25102(r) requires that any inconsistency between federal and state law must be interpreted to the benefit of investors.
How can issuers file for the California crowdfunding exemption under Corporations Code section 25102(r)?
Issuers wanting to rely on the 25102(r) exemption must file the California Crowdfunding Exemption Notice with DFPI and pay the required fee set forth in Corporations Code section 25608(c) at least 15 days before the initial offer. The fee required is the same as that for 25102(f) LOEN and 25102(h) notices. Failure to file the notice in a timely manner or at all does not affect the availability of the exemption, so long as the issuer files the notice and pays the demand fee (i.e., the fee if they had to qualify under 25110) within 15 business days after discovery of the failure or upon the Commissioner’s demand.
The California Crowdfunding Exemption Notice can be found on DFPI’s website here. The Notice must be completed and signed electronically. No paper copies or manually printed, signed, and scanned copies will be accepted. Once completed, e-mail the form to SRD_Support@dfpi.ca.gov and mail a check for payment to:
Department of Financial Protection and Innovation
2101 Arena Boulevard
Sacramento, CA 95834
Once both the Notice and filing fee are received and processed, the Notice will be posted online on DFPI’s Docqnet Self-Service Portal and be publicly available.