Community-Supported Entrepreneurship (CSE) Program

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SELC’s Advocacy Success

In July 2010, The Sustainable Economies Law Center, in partnership with Make Magazine editor and crowdfunding advocate Paul Spinrad, drafted a rulemaking petition (SEC File No. 4-605) to the Securities and Exchange Commission to make it legal for entrepreneurs to raise capital from large numbers of investors, each making a relatively small investment (a process known as “crowdfunding”).

The success of web sites like IndieGoGo and Kickstarter demonstrates the desire of the public to support local entrepreneurs and projects that they believe in. However, current laws require investments to go through a costly securities registration process, unless they qualify for some exemption. Furthermore, the current registration process and available exemptions strictly limit how businesses can raise money from unaccredited (non-wealthy) investors. Because of these legal constraints, money raised on sites like IndieGoGo and Kickstarter can only be in the form of a donation. The minute a financial return is offered to investors, it becomes illegal under current securities law.

The purpose of our petition was to help small entrepreneurs access crowdfunded capital from the types of investors that would be most inclined to invest in them—community members, customers, friends, and neighbors who are mostly unaccredited and therefore generally restricted from investing in most businesses. Small entrepreneurs would save tens of thousands of dollars in legal fees, because they would not have to go through the costly and time-consuming registration process required by the SEC and state securities regulators.

Our petition caught the attention of other small business advocates who created online petitions and lobbied Congress. Congressman Darrell Issa wrote a letter to the SEC chair demanding to know why even very small offerings are not exempt from onerous regulations that cost tens of thousands of dollars to comply with. The SEC Chair wrote back and acknowledged SELC’s petition but did not indicate much support for creating a crowdfunding exemption. Congress held several hearings on this issue and heard from entrepreneurs about the challenges of raising capital under the current legal regime.

On September 8, 2011, the White House announced that it would work with the SEC to create a crowdfunding exemption as part of the President’s Startup America Initiative under the proposed American Jobs Act. A few days later, Rep. Patrick McHenry (R-NC) introduced H.R. 2930, the Entrepreneur Access to Capital Act, which would exempt crowdfunded investments from both federal and state registration requirements. This bill would allow a business to raise up to a $1 million, or up to $2 million if it provides audited financial statements to potential investors. Each individual investor could invest up to $10,000 or 10% of his or her annual income, whichever is less. Consistent with investor protections, any business using this exemption would have to comply with basic notice and disclosure requirements.

On November 2, the White House issued a Statement of Administration Policy in support of H.R. 2930. On November 3, the House passed H.R. 2930 in a 407-17 vote. The bill will move to the Senate in the next few weeks.

The Sustainable Economies Law Center looks forward to continuing to support innovative and sustainable enterprises through our legal research, education, and advocacy.

Support the Crowdfunding Exemption

Dear Friends,

For the first time in decades, we have an opportunity to reform securities laws that keep trillions of Americans’ investment dollars locked up in Fortune 500 companies and away from the small local businesses that are so essential to growing jobs, incomes, equality, entrepreneurship, smart-growth, and green communities.

A remarkable coalition has emerged, bringing together leaders of the Tea Party and the Obama Administration to push for “crowdfunding” legislation. Patrick McHenry (R-NC) introduced legislation in the House (HR 2930) that passed yesterday with a vote of 407-17. Recent changes in the bill make it very similar to reforms President Obama proposed in his jobs package in September and so earlier this week the Obama Administration expressed its support for HR 2930.

Despite this good news, passage of crowdfunding legislation is still far from certain. The key is the US Senate.

We need your support. Below are a few ways you and your organization can help:

  • Sign on to the change.org petition. Email Asher Miller and we’ll add you to the list of organizational supporters.
  • Encourage your supporters to sign the petition and contact their Senators.
  • Re-post or share Michael Shuman’s op-ed about the need for crowdfunding legislation, tying it to the Occupy Movement.
  • On Nov 17th in DC, attend the SEC’s Government-Business Forum on Small Business Capital Formation.
  • Contribute to or attend the the Occupy SEC rally, also on Nov 17th in DC.
  • Send Jenny Kassan any stories you have of entrepreneurs who would benefit from this legislation. The White House has asked for stories from the following states, in particular: AK, AR, CO, CT, DC, DE, HI, IL, IN, KS, ME, MD, MI, MN, MS, NE, NH, NJ, NM, ND, OK, SC, SD, TN, VT, VA.

thanks much,

Jenny Kassan
Sustainable Economies Law Center / Cutting Edge Capital

Michael Shuman
BALLE / Cutting Edge Capital

Paul Spinrad
MAKE Magazine

Asher Miller
Post Carbon Institute

About SELC’s Community-Supported Entrepreneurship Program

SELC’s Community-Supported Entrepreneurship Program focuses on developing resources and policies that enable local community ownership of enterprises and assets. Traditional community economic development models focus on attracting business and real estate investment from outside of a community. In addition, compliance requirements and legal barriers make it enormously difficult for the average small business to raise capital. Through education and advocacy, SELC is working to develop pathways that overcome these barriers, and make it possible for local capital to fund local projects and enterprises. In a more sustainable economy, entrepreneurs would be able to raise capital from local community members’ equity investments, micro-investments, crowd-funding, community-supported business models, and other creative means.

Current CSE Projects:

• Education: We are creating educational tools such as an on-line securities law FAQ so that communities and entrepreneurs can understand how the securities laws affect them.

For an article by SELC about securities law, please visit Shareable.

• Advocacy: SELC has drafted a letter to the Securities and Exchange Commission requesting a rule change that would enable the growth of community-owned and cooperatively-owned enterprises. Specifically, SELC has asked the SEC to grant a securities compliance exemption for investments under $100. This would allow anyone to advertise and seek investments of under $100 for an enterprise or project, which is currently next to impossible for the average person to do (due to overly complicated securities laws).

For updates on these efforts, please visit crowdfundinglaw.com

Securities Law Information

This section of our web site provides information about securities laws and how they can affect entrepreneurs and your community. Check back for more resources soon!

What is a security?

When someone sells stock in their business, the stock is considered a security and therefore is governed by federal and state securities laws. Over the years, many schemes for raising capital other than selling stock have been devised in attempts to avoid application of the securities laws. Because there are so many different ways to raise money, the federal Supreme Court has created a fairly broad definition of securities (SEC v. W.J. Howey Co. (1946)). Under the Howey test, a security is basically any scheme in which a person invests money and is led to expect profits from the efforts of someone else.

The Howey Court noted that its definition of a security “embodies a flexible rather than a static principle, one that is capable of adaptation to meet the countless and variable schemes devised by those who seek the use of the money of others on the promise of profits.”

The “investment of money” prong of the Howey test “requires that the investor ‘commit his assets to the enterprise in such a manner as to subject himself to financial loss.’”

What does it mean to create an expectation of profits? The Supreme Court defined profits as “either capital appreciation resulting from the development of the initial investment . . . or a participation in earnings resulting from the use of investors’ funds.”

The promised return may be fixed or variable and may be marketed as low-risk or “guaranteed.”
When is a note considered a security?

What if you borrow money? Can that be a security? Definitely! Loans from family, friends, and other individuals to help start or expand a business usually are securities.

The types of notes that are not “securities” include “the note delivered in consumer financing, the note secured by a mortgage on a home, the short-term note secured by a lien on a small business or some of its assets, the note evidencing a character loan to a bank customer, short-term notes secured by an assignment of accounts receivable, or a note which simply formalizes an open-account debt incurred in the ordinary course of business (particularly if, as in the case of the customer of a broker, it is collateralized).”

So, under federal law, for something to be a security, there has to be an expectation of some kind of financial return on the investment, whether it be interest on a loan, dividends on stock, an increase in value of the investment, or something similar.

To get around securities law, people sometimes devise ways to raise money that do not involve offering a financial return. For example, rather than selling investments, you may “pre-sell” a good or service such as by selling a gift certificate for your business, possibly at a discount. Under federal law such pre-sales are unlikely to fall within the definition of a security.

But, before using a strategy like this, it’s important to know what the relevant state securities laws say! State securities laws will apply in every state where you are soliciting investors. Some states have a much broader definition of a security than the federal definition.

The California Supreme Court, in a landmark case called Silver Hills Country Club v. Sobieski (1961), found that pre-sales of country club memberships were securities.
The court formulated a new test for whether something is a security, called the “risk capital test” which considers
(1) whether funds are being raised for a business venture or enterprise;
(2) whether the transaction is offered indiscriminately to the public at large;
(3) whether the investors are substantially powerless to effect the success of the enterprise; and
(4) whether the investor’s money is substantially at risk because it is inadequately secured.

The risk capital test is used by many states. Click here to see a list of those states.