UPDATE: this bill is stalled and will not pass out of the 2016 legislative session. It may return in a future legislative session. Click here to go back to our main Local Economies Securities Act page and sign up for email alerts with future updates.
The California Local Economies Securities Act, a bill drafted by the Sustainable Economies Law Center (SELC), proposes to exempt certain securities offerings (e.g., advertising of investment opportunities in an enterprise) from California permit requirements, and therefore open doors to raising money for a variety of enterprises necessary to the economic and ecological health of California, including small farms, agricultural land trusts, cooperatives, renewable energy enterprises, other small businesses and nonprofit organizations that support small businesses.
As many people seek to move their savings from Wall Street to "Main Street," they often find that there are very few opportunities to move their money, even for investors willing to make lower returns on their investment. This is in part due to the lengthy and costly securities registration process required in order to publicly advertise investment opportunities. Because the barriers to conducting public advertising of investment opportunities are so onerous for small businesses, many small businesses simply have little to no way of connecting with potential investors to solicit even very small amounts of investment. This bill proposes to allow enterprises to conduct small public offerings through the following exemptions from permitting requirements:
Small Investments: This bill would exempt securities offerings from permit requirements if the business provides basic offering and business information to the public, the total amount raised during the offering does not exceed $500,000, and no individual non-accredited investor invests more than $1,000. Accredited investors would be limited to investing no more than 5% of their net worth.
Farms and Agricultural Land Trusts: This bill would allow a small farm enterprise or agricultural land trust to raise up to $2 million for the purchase, long-term leasing, purchase of an easement, construction, or improvement of real property to be used for agriculture purposes. The issuer using this exemption must be majority controlled by people actively engaged in the farm enterprise or it must be controlled by a nonprofit public benefit corporation. Limitations on each individual investor would be as follows:
Any individual investor could invest up to $2,000 if they do not meet any criteria below that allow larger investments.
An investor could invest up to $5,000 IF the investor has an annual gross income of at least $100,000 or a total net worth of $200,000 or more.
Accredited investors would be limited to investing no more than 5% of their net worth.
Note: "net worth" is calculated excluding an investor's home and home furnishings.
Renewable Energy Projects: Similar to the farm and land trust exemption in the section above, the bill would allow nonprofits, mutual benefit corporations, and cooperatives to raise up to $2 million to finance the purchase of solar panels or wind turbines and related equipment. The same limitations per investor as in the farmland exemption described above would apply.
Nonprofit Organizations: Similar to exemptions from securities permitting or registration requirements in federal law and the law of many US states, this bill would exempt nonprofit organizations in California from permit or registration requirements. Since most nonprofit organizations are not able to make use of investments, and tend to only seek grants and donations, this exemption would be used primarily by nonprofit organizations that provide loans and other services to businesses in under-resourced communities, among other less common nonprofit organizations that earn income from the sale of goods or services. Unlike the other exemptions described above, this exemption would not have a limit on the total amount raised in one year nor limits per investor because nonprofit organizations are typically already subject to many restrictions and public reporting requirements. Furthermore, investors do not typically expect to make large profits from investing in nonprofit organizations so investors are unlikely to be lured into investing in a nonprofit organization because they are hoping to make a big win on a risky investment.
Investor protections that will apply to the Small Investments, Farmland, and Energy offerings described above:
- Investment offering documents must include a cover sheet with a warning to investors stating that investing in small business can be risky, that no investor should invest fund they cannot afford to lose entirely, and that the state has not reviewed the offering materials for accuracy.
- Investment offering documents must contain both financial statements and tax returns for the most recently completed and current fiscal years.
- Investment offering documents must contain a budget for the use of proceeds from the securities offering and plans for how to reach and maintain profitability over the 36 months following the offering.
- Investment offering documents must contain a written statement disclosing information about any legal proceedings involving the issuer, and a list of risk factors that the investor should consider when deciding whether to invest.
- Investment offering documents along with a notice form must be filed with the Department of Business Oversight before the issuer may make securities offerings (e.g., before the issuer can advertise their investment offering).
- Criminal penalties may apply to issuers who fail to follow the restrictions and requirements of these exemptions.
- In the farm and energy exemptions, the enterprise seeking to raise funds, also known as the "issuer," must hold funds in an escrow account until the minimum amount of funds needed to move forward with their intended use of the funds is raised.
- Other restrictions and requirements may apply and this bill may get further amended in the legislative process!
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Frequently Asked Questions
So what is securities law exactly, and how is the current law such a barrier to financing small businesses?
Securities law--the law governing investments--in the United States entails a maze of federal and state laws. The federal Securities Act of 1933 defines a security as “any note, stock, transferable share, bond, evidence of indebtedness, certificate of interest or participation in any profit-sharing," and many other forms of investment. California courts have included other forms of capital investments in the meaning of the term 'securities,' such as pre-purchasing memberships in enterprises that are still in development.
When an investment offering meets the definition of a security, it must generally either be approved by a government agency at each applicable state and federal agency or it must fall under an exemption from permitting. Many small-scale public securities offerings can be exempt from permitting requirements at the federal level because they fall under exemptions from federal permits because they are such small offerings or they are contained entirely in one state, or because of another exemption, but the offering still needs to be permitted by a state regulatory agency, which, in California is the Department of Business Oversight (DBO). However, most US states and the federal government now have permit exemptions for "crowdfunding" where a business seeks investments from a large number of people but where each individual typically invests a small amount of money. California does not have an exemption for public advertising of securities offerings, even if the amount of money accepted from investors and the total amount accepted is very small.
Permitting requirements can be a very time consuming and costly endeavor for small businesses. To qualify for a permit from the Department of Business Oversight requires a fee of $500 to $2,500, depending on the amount of money the business hopes to raise. The Department sometimes take several months to approve permit applications.
Additionally, most businesses seeking to do an investment offering that entails public advertising hire an attorney to ensure their application to the DBO will be approved, which typically costs $10,000 to $30,000. These costs make it difficult for many very small enterprises and start-ups to raise money, especially if they do not have many wealthy individuals among their close friends and family.
What is an accredited investor?
An accredited investor is an individual person with at least $200,000 in annual income, or a married couple with at least $300,000 in annual income, or a person with at least $1 million in net worth, not including their home and furnishings. An entity, like a corporation or nonprofit organization, is an accredited investor if it has $5 million or more in assets. One does not need to obtain any kind of certification, training, or undergo any process to be an accredited investor; anyone who meets those wealth requirements is an accredited investor automatically.
What benefits does the reviewing and permitting of securities offerings by the Department of Business Oversight provide?
California's Department of Business Oversight reviews applications for permits to ensure that the offering documents disclose adequate information to potential investors and do not make any misleading statements so that potential investors can make an informed decision about whether to invest. The regulators also sometimes impose additional restrictions and requirements on the business making the securities offering. For example, the regulators may limit the amount of money that the business can take from any individual non-accredited investors, in an attempt to prohibit less affluent investors from putting large amounts of money at risk. The DBO can also require a business to get audited or reviewed financial statements, among other requirements.
Why is it a good idea to forgo those registration requirements? Don't we need those for investor protection?
There are certain protections provided to investors through the registration process, however, this proposed bill still provides helpful protections to investors in a few key ways, as described in the bill summary above. The high costs of the permit process prevent many entrepreneurs from conducting public offerings, which means that many prospective investors never have the opportunity to even learn about investment opportunities that they may want to access. We at SELC and many of our partner organizations are encountering more and more people with savings who would like to invest in more thriving local economies but are typically barred from even discussing such investments because of the laws that attempt to protect those investors.
This bill seeks to provide a reasonable balance between protecting investors and empowering investors to invest in their own communities. By setting limits on the amounts of money that investors can put at risk in any one enterprise in addition to the limits on the total amount that the enterprise can raise, investor protections are built into the law while also making the investment process more accessible to more entrepreneurs and to more investors. The bill also contains numerous other restrictions and requirements as described above to help investors avoid fraud and scams.
Furthermore, permits from the Department of Business oversight do not guarantee an investment will be as successful as the investor hopes, and exempt securities are still subject to many securities laws intended to protect investors. Regardless of whether a securities offering is permitted or exempt from permit requirements, securities laws prohibit a business from misleading investors, lying to investors, or omitting material information from securities offering documents. These laws would still apply to offerings made under the proposed exemptions in the Local Economies Securities Act. Regulators at the state and federal government still have the authority to intervene in securities offerings where there are reports of potential violations of those laws.
But we already have some exemptions for small businesses in California's securities law. Why do we need more?
Many small businesses in California raise money using small offering exemptions where they can solicit money from very close friends, family, business associates, and accredited investors only through private offerings. To solicit for investment under this law, the entrepreneur must have a preexisting personal or business relationship with most people solicited for investment. Entrepreneurs need to be weary using these types of exemptions because the law is not precise about what counts as a sufficient preexisting relationship, leaving much room for debate and potential disputes. It is extremely difficult for the law to define and categorize human relationships. The proposed bill would greatly simplify the question of who can invest by allowing issuers to solicit all California residents and accept investments in accordance with the clear dollar limits per investor.
Furthermore, the "friends and family" offering exemption greatly privileges individuals who come from wealthy families or elite social networks. Asking only close friends and family or "accredited investors" for investments is not accessible to entrepreneurs from all class backgrounds. The exemptions proposed in LESA would allow entrepreneurs to solicit investment from all California residents, including people from outside one's immediate family or personal networks.
What about the federal JOBS Act? Didn't that make this legal already? Why do we need state-level crowdfunding laws?
In 2012, President Obama signed the JOBS Act, which was a bundle of legislation passed by Congress intended to boost the economy. A portion of the JOBS Act, Title III, is designed to enable investment "crowdfunding" throughout the United States and contains some similar provisions as the proposed California Local Economies Securities Act. However, the SEC fell behind schedule and just recently set the final rules under Title III of the JOBS act.
However, the bill passed by congress became tailored towards businesses hoping to grow very quickly. The federal law entails many requirements that are not very practical for very small businesses, including one requirement that most information about the offering be communicated through a regulated internet intermediary, thus limiting an entrepreneur's ability to communicate directly about the investment opportunity, making it more costly, and making the process impersonal. This is impractical because many entrepreneurs and investors alike find that person-to-person communication is vital because it enables an entrepreneur and a potential investor to get to know one another. Read more about our take on the JOBS Act and the value of state-level crowdfunding legislation such as LESA here.
How is this different from what is already happening on Kickstarter, Indiegogo and other online crowdfunding platforms?
Many crowdfunding campaigns hosted on popular websites, such as Kickstarter, offer rewards to people who contribute money to some project. Typically, these campaigns are asking people to donate and receive some kind of reward as a thank you gift, where the reward is of relatively small value compared to the donation made. Sometimes, the campaign is asking someone to purchase a product and there is little to no risk that the person contributing money will lose money because the campaign involves a simple purchase of a product, rather than a true investment. However, some crowdfunding campaigns ask people to contribute money in order to later receive a product or service that is still in development at the time of the payment, such that the person contributing money is taking some risk because the development of the product or service may not go as planned and the person contributing money may not receive the product. Some of these situations are arguably securities offerings under California law, and they should arguably be regulated by the DBO. Typically, however, online crowdfunding campaigns are simply donation-based, so they do not fall under the scope of securities regulation. This proposed bill seeks to make it easier for businesses and organizations to organize true investment crowdfunding campaigns, which generally allow businesses to raise larger amounts of money and allow investors to share in the profits if the enterprise is successful.
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