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May 16, 2016

Fed crowdfunding law takes effect: What does it mean for Maine?

Courtesy / Maine Office of Securities Judith Shaw, securities administrator at the Maine Office of Securities.

News Analysis

After four years of debate, the federal government’s 685-page crowdfunding law, passed last Oct. 30, takes effect today, offering yet another fund-raising and investing option to companies and individuals in Maine and nationwide.

The new law is being met by a “wait-and-see” response in Maine, which has had its own state crowdfunding rule, called Fund-Me, in effect since Jan. 1, 2015.

“There won’t be that big of an impact in Maine on Monday. There won’t be a stampede,” Joel Shaw, an attorney at Bernstein Shur who helped draft Maine’s crowdfunding rule, told Mainebiz. “Given the low level of people trying to do issuances here, the real test will be what will happen over the next year.” Maine has not had any fund-raisings under its rule to date.

“There’s not going to be an immediate, direct impact,” added Judith Shaw, securities administrator at the Maine Office of Securities. “From my perspective, the federal law and Maine’s crowdfunding law complement one another.”

Experts noted that both crowdfunding regulations have their pros and cons, and since they are both untested in Maine, test cases are needed to see how well each crowdfunding option works.

Lowering hurdles

Fund-Me stalled out of the gate for two main reasons, according to an earlier Mainebiz story in February analyzing why there were no takers in the first year.

One reason is the requirement for an impoundment fund, a type of escrow account in which a bank or credit union must hold raised funds until at least 30% of the offering is reached, then release them to the issuer. The problem is, no Maine banks or credit unions offer such accounts, and they are nervous about taking on the risk of a failed crowdfunding effort.

The second hurdle is the cost for an issuance. The filing fee is only $300, but costs can add up to several thousand dollars with legal and other fees, said Bernstein Shur’s Shaw, scaring off early-stage companies or those raising too little money to warrant the expense.

The Maine Office of Securities is in the process of rectifying both issues, Securities Administrator Shaw said.

“We are looking to modify the impoundment, because it’s the biggest hurdle,” she said. “It’s an unfortunate hurdle and we will be fixing it.” There will be a public comment period for the fix, which she said she hopes will be out within the next couple months.

She added that Maine companies looking to use Fund-Me can use out-of-state banks that are able to handle impoundment accounts.

She said the Maine Office of Securities also will try to work with people in the entrepreneurial and small business communities to educate them about Fund-Me, so they might be able to complete as much of the application process as possible without needing as much legal help, thus saving costs.

John D. Hancock, a partner at Foley Hoag LLP in Massachusetts, wrote about similar concerns in April’s Boston Bar Journal.

“Both the federal and Massachusetts crowdfunding exemptions offer novel but untested means to raise funds from a broad section of the public,” he wrote. “As companies and investors gain experience with the exemptions, regulators should augment their usefulness by eliminating requirements that prove to be burdensome, costly or impractical.”

Pros and cons

Both the federal program, known as Regulation Crowdfunding, and Maine’s Fund-Me program cap the offering amount at $1 million over a 12-month period.

Fund-Me limits the amount one person can invest to $5,000 in 12 months, unless they are an accredited investor with an annual income of $200,000 or more or a net worth of at least $1 million. If an investment is made out-of-state, the issuer has to comply with that state’s regulations.

Under federal crowdfunding, anyone with an annual income or net worth of less than $100,000 can invest $2,000 or 5% of the lesser of their annual income or net worth over a 12-month period. If their annual income and net worth are $100,000 or more, then they can invest 10% of the lesser of their annual income or net worth. Federal crowdfunding can be done across state lines because it is covered by federal, not state, regulations.

During the 12-month period, the aggregate amount of securities an investor can buy through all crowdfunding offerings is capped at $100,000.

Fund-Me requires documentation from businesses, including an offering circular with a detailed business plan, part of the prior year’s financial statements and a discussion of risks.

Regulation Crowdfunding also requires paperwork, including an offering statement and an annual report, but not the detailed Maine state paperwork.

Still, issuers may balk at the annual report requirement..

“Private companies, especially those under $1 million in size, may not want this information made public,” Bernstein Shur’s Shaw said.

Portals: help or hindrance?

One of the biggest differences in the federal and Maine programs is the federal requirement for third-party “portals,” which typically are broker/dealers who are responsible for making sure the offering is up on their portal’s website along with nominal marketing or advertising to get investors motivated by the offering, attorney Shaw said. Disclosure materials from issuers and other information will be on the portal.

One advantage to a portal setup, he said, is that the broker/dealers, in addition to banks and credit unions, can hold the impoundment, offering more potential outlets for issuers to hold the raised money.

Regulation Crowdfunding does preempt states from requiring a robust filing from a company, as the filing is with the federal government’s program, not the state’s.

However, states can require a “notice filing” from the companies. Securities Administrator Shaw said Maine does plan to require the notice, and hopes to have that provision ready in the next couple months.

“One thing that does get preserved for state regulations is our fraud enforcement authority,” she said. That means if an entrepreneur raises money through Regulation Crowdfunding or Fund-Me for a new product, but instead uses it for other purposes, such as a personal vacation, the state could enforce its fraud rules.

The U.S. Securities and Exchange Commission is relying on the portals to protect investors from companies that go out of business, as an estimated 50% of U.S. small businesses fail in their first five years, and the number is predicted to be even higher with start-ups using crowdfunding.

“The funding portals were established with the primary purpose to serve as a classic gatekeeper and it is vital that they strongly function as such,” SEC Chairwoman Mary Jo White said during a March speech at Stanford University. “We are counting on brokers and funding portals to be bulwarks of investor protection in this space, and we will hold them to that responsibility.”

Securities Administrator Shaw sees Maine’s lack of requiring a portal a positive for issuers, which can use their own website to offer information to potential investors without the cost of a third party.

Cost is a downside of portals, she said. “A portal could cost $45,000 to $50,000 to raise $1 million for their infrastructure or technology,” she said. “So that’s a positive with Maine’s program.”

Read more

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