Crowdfunding Comes to North Carolina

On July 22, 2016, the Governor signed a bill to enact the North Carolina Providing Access to Capital for Entrepreneurs and Small Business Act (PACES Act), which received broad bipartisan support to make crowdfunding possible for businesses in North Carolina. In total, 35 states now have similar crowdfunding laws in place. This new law was considered by many to be a victory for entrepreneurs and economic development across the state.

According to the National Small Business Association, about 73% of American small businesses used some form of financing in 2015. The vast majority relied on personal savings, personal credit cards, and loans from family and friends. For some of these businesses, crowdfunding could offer a more attractive financing option. So what is crowdfunding exactly and what does it mean for North Carolina businesses and investors?

Crowdfunding Comes in a Variety of Forms

You might be thinking, wasn’t crowdfunding already happening in North Carolina through websites like kickstarter.com and gofundme.com? For years, these sites have helped businesses in (and outside) North Carolina raise capital through online campaigns. And as we pointed out in a recent post, forms of crowdfunding have been used in North Carolina since the late-1800s. What’s different about the PACES Act is that it permits debt- and equity-based crowdfunding, which allow North Carolina businesses to publically solicit investments from average North Carolinians without registering those investment offerings with the federal or state government.

In its recent history, crowdfunding has taken many forms, including:

1. Donation-based crowdfunding campaigns involve no monetary incentive for participation from funders. These sorts of campaigns rely only on the altruistic motivations of funders who hope to support a business’s purpose and are prepared to make a voluntary donation toward that end. (example: justgiving.com)
2. Reward-based crowdfunding campaigns motivate funders through non-financial rewards, like tokens of appreciation or the pre-purchase of goods or services. Reward-based crowdfunding has the largest number of online platforms and is one of the fastest-growing forms of crowdfunding. (example: kickstarter.com)
3. Debt- (or Lending-) based crowdfunding involves lenders providing capital to a business and expecting to be repaid, along with some fixed interest. (example: prosper.com)
4. Equity-based crowdfunding campaigns offer investors an interest in the business in the form of equity or some profit sharing agreement. (example: wefunder.com)

The first two types of crowdfunding are not restricted in North Carolina or other states. But debt- and equity-based crowdfunding are governed by state and federal securities laws since investments are being offered and sold. The PACES Act establishes a framework for the use of debt- and equity-based crowdfunding within North Carolina.

The PACES Act Makes It Easier for Small Businesses to Find Investor

Prior to passage of the PACES Act, average North Carolinians wanting to invest in a startup company were limited in their ability to do so, while small businesses and startups were similarly limited in their ability to attract investors.

In order to protect investors most vulnerable to investment fraud, federal and state securities laws differentiate between “accredited” and “unaccredited” investors. Under current federal definition, an “accredited” investor is generally anyone with at least $1 million in assets (excluding equity in a primary residence) or an annual income of at least $200,000. Anyone else is generally considered an “unaccredited” investor. Securities laws generally place more stringent compliance burdens on businesses that solicit investments from unaccredited investors because the federal and state government consider these investors more vulnerable to fraud and less able to bear the potential financial downside associated with business investments.

The PACES Act provides a mechanism through debt- and equity-based crowdfunding for businesses and small-time, unaccredited investors to more efficiently find each other. It does so by offering North Carolina businesses the opportunity to publically advertise and solicit investments, in limited amounts, from any North Carolinian (including unaccredited investors) without registering their investment offering with the federal or state government. This investment registration process is often expensive and frequently considered a significant obstacle for small businesses hoping to raise capital.

Under the new law, North Carolina companies are allowed to raise up to $1 million during any 12-month period from investors who are North Carolina residents. Companies will be required to provide a business plan, financial information, and a description of risks. The 12-month limit can be increased to $2 million if the company has undergone a financial audit and makes that documentation available to prospective investors. During this 12-month period, non-accredited investors may invest up to $5,000 in any one company's offering.  Accredited investors are not limited in their investments, but their investments will count toward a company’s total 12-month limitation.

Is there a Place for both Federal and State Crowdfunding Systems?

With North Carolina’s new legislation in mind, it is important to understand the federal government’s crowdfunding system in order to understand the full context of the crowdfunding landscape. On April 5, 2012, the President signed the Jumpstart Our Business Startups Act, which established the framework for a nationwide, inter-state debt- and equity-based crowdfunding system. However, SEC regulators did not publish rules governing this program until October 30, 2015, leaving it unimplemented for years. In response to this slow implementation process, states started taking matters into their own hands, establishing crowdfunding programs at the state level.

After the SEC's crowdfunding rules were published, some thought that state crowdfunding rules would no longer be necessary. But the PACES Act continued to advance through the General Assembly and North Carolina’s crowdfunding system will soon serve as an alternative to the federal system. Both programs could very well find valuable places in the fund-raising toolkit for North Carolina businesses, based on their differences.

Some businesses may prefer to use the federal crowdfunding system because it allows a company to solicit investors from across the country (not just North Carolina residents, as limited by the NC system). On the other hand, the North Carolina system allows businesses to raise up to $2 million during a 12-month period, while the federal system limits companies to $1 million. The North Carolina system may also involve less stringent reporting requirements and lower compliance costs, but that won’t be fully understood until the NC Department of the Secretary of State publishes its final rules implementing this program (possibly early 2017).

In the end, crowdfunding will certainly offer new avenues for entrepreneurial innovation and business creation through new opportunities for North Carolina businesses and investors alike. LEAD looks forward to exploring this program in the future and examining its impacts on the North Carolina businesses that choose to participate.