Industry Watch

Ryan Schildkraut. Photo by Joel Schnell

State legislature examines equity crowdfunding

How would Kickstarter-type campaigns be regulated as funding source?

By Nora Poole

On a crowdfunding site like Kickstarter, it isn’t all that difficult to raise money for, say, developing a new product. Many ventures have used such sites to bring great ideas to life. But what if entrepreneurs could also go online to attract equity investments directly into their small companies, from investors of all stripes?

That’s the idea behind MNvest, a legislative proposal to enable intrastate equity crowdfunding in Minnesota. MNvest was launched as a grassroots campaign in September 2014 by Ryan Schildkraut and Zach Robins, attorneys at Winthrop & Weinstine’s Minneapolis office. Both work closely with small businesses and entrepreneurs.

A consortium of entrepreneurs, business leaders, trade groups, and legislators got behind the idea, seeing it as a way to encourage entrepreneurship, expand small businesses, create jobs, and increase the tax base.

With support from both sides of the aisle, in January legislators officially introduced the idea as Senate bill SF 138 and House bill HF 328. But soon after, concerns about the legislation were raised by Mike Rothman, commissioner of the Minnesota Department of Commerce, in a letter addressed to Senator Terri Bonoff, a key supporter.

In the letter, Rothman worried about what he viewed as inadequate protection for investors, the maximum offering and investment limits being too high, and the legislation lacking disqualification for “bad actors,” among other considerations.

As we go to press, it remains to be seen if or how the legislation might be amended.  

Meanwhile, Robins notes, equity crowdfunding has already been used in other states for investing in everything from  restaurants to real estate to craft breweries. “We’d hate to see Minnesota get left behind,” he says.

Today’s system of securities laws was established in the 1930s following the Great Depression in order to protect individuals from making poor investment decisions. When a business is dealing with securities (basically anything defined as an ownership interest in a company, including equity and debt), it has to be registered on both a state and federal level.

Registration is a complicated, expensive, and time-consuming process, especially for small businesses and startups without the capital that larger corporations have access to. “It’s not a path that any small business we work with ever really goes down,” Schildkraut says.

For small businesses, there are several grounds for exemption from the registration process. A private offering exemption can apply to businesses who choose not to “publicly solicit” investment. This goes beyond having a company publicly listed on Nasdaq, Schildkraut says. For all intents and purposes, a public offering is “anything beyond secret.”

“What a lot of people don’t realize is that it’s totally illegal for a company to publicize that it’s even looking for investors,” Schildkraut explains. “Once an offering is publicized in any way, it is no longer private, and therefore you no longer have an exemption.” This makes it difficult for small businesses and startups to access capital, since they don’t have the same relationships to major financial institutions and accredited investors that larger companies have.

However, another exemption on the federal level addresses intrastate offerings, Schildkraut continues: “If your offering is confined to the borders of a state, the federal government doesn’t actually have the authority to regulate that, so as long as you have an exemption within your state, you have an exemption on the federal level.”

Currently, Minnesota has no intrastate exemptions. That’s where MNvest comes in. “MNvest is the corresponding state-level exemption to the intrastate federal exemption,” says Schildkraut.

On the federal level, the Jumpstart Our Business Startups Act, or JOBS Act, passed in April 2012. “The ultimate goal of the JOBS Act was obviously to create jobs, but also to help ease the way for younger companies and growing companies,” Robins explains.

At the time, the legislation looked like a beacon for the world of small business. “Titles II and III of the JOBS Acts essentially threw out the ban on private companies advertising the fact that they’d like to raise capital,” says Robins. This opened the gate for businesses to advertise the fact that they’d like to raise funds online, allowing anyone to invest using the Internet or other means.

Title II specifically addresses accredited investors, or individuals who already meet certain U.S. Securities and Exchange Commission rules and regulations (namely having a net worth of over $1 million). Title III, Robins continues, addresses those who are not accredited investors. “Title III has unfortunately not been enacted by the SEC,” he says.

Although the SEC had over two and a half years to enact regulations for the bill and was instructed to do so by Congress, it has not done so yet, Robins explains.

“Really, in a way, [securities crowdfunding] is legal, as long as companies follow the rules promulgated by the SEC,” Schildkraut clarifies. The problem is that the SEC hasn’t enacted any such rules. It has come out with proposed rules, Robins notes, but they are 587 pages long and nearly impossible to understand. “They would be a nightmare for anyone to try and comply with,” he says. “The SEC has estimated that the cost for a company trying to raise $1 million while complying with these rules would be about $250,000.”

The bottom line? As it stands, the process is complicated, inefficient, and prohibitively expensive for small businesses attempting to use crowdfunding to raise capital.

In response, states have been taking matters into their own hands. Well over a dozen have already passed intrastate crowdfunding legislation in order to qualify for federal exemption, including Wisconsin and Michigan.

Robins and Schildkraut took the initiative to bring a similar legislative proposal to Minnesota, inspired by their work helping local startups and small businesses raise capital the old-fashioned way (via private offering). “It has been such a source of frustration for many of our clients,” Robins says.

Seeing that nobody else was taking the initiative, he explains, he and Schildkraut stepped up to the plate. The pair spent months meeting with local businesses, trade groups, entrepreneurs, and politicians to spread awareness and raise support for the bill.

Casey Helbling, founder of Minneapolis-based Software for Good, is among those who got behind Schildkraut and Robins. He and his team created the website for MNvest. “We know so many small and independent businesses that are looking for financial resources to complete growth projects,” he says. “MNvest offers Minnesotans the opportunity to invest in small businesses they care about and trust, knowing that their investment will lead to job growth and deeper community in the areas where they live and work.”

Senator Bonoff cites the creativity and entrepreneurial spirit of the millennial generation in particular as a driving force behind the changes MNvest aims to bring to the table. “It’s time to think informatively about all aspects of the business lifecycle,” she says. “These days, technology plays an enormous role in the way we live our lives, including how we bank and invest.”

Coming out of a recession, she continues, small businesses have been struggling, which helps explain why the legislation is seeing support from both sides of the aisle: “MNvest will make starting and investing in businesses easier for everyone.”