On October 22, 2014, the Texas State Securities Board (the "TSSB") voted to formally adopt its proposed Rule 139.25, which provides an exemption from registration for intrastate securities offerings employing a limited "crowdfunding" model. The rule, together with a number of conforming amendments, will become effective in late November.

The Texas crowdfunding exemption will allow issuers to raise up to $1 million in any twelve-month period through a website operated by a registered dealer or registered "crowdfunding portal" subject to the following requirements, among others:

• The securities must be offered and sold only to persons resident within Texas.
• The issuer must have been formed, and maintain its principal office, in Texas.
• At least 80 percent of the issuer's gross revenues during its most recent fiscal year prior to the offering must have been derived from the operation of a business in Texas.
• At least 80 percent of the issuer’s assets at the end of its most recent semiannual period prior to the offering must be located in Texas.
• No more than $5,000 can be accepted from any single purchaser that is not an "accredited investor."
• The issuer must use at least 80 percent of the net proceeds of this offering in connection with the operation of its business within Texas.

Additionally, the issuer must not, either before or because of the crowdfunding offering, be a publicly reporting company, a registered investment company, a private investment fund, or a shell company, and must not fall within any of the disqualifying "bad actor" provisions set forth in subsection (m) of the new rule.

Though crowdfunding has received an enormous amount of media attention, and the TSSB has made a concerted effort to craft a practical and accessible exemption, there are a variety of pitfalls awaiting Texas issuers looking to rely on crowdfunding:

• Because the SEC's crowdfunding rules are not yet effective, any unintended offers or sales outside of Texas are a problem. As discussed in prior e-Alerts, the SEC proposed crowdfunding rules in October of 2013. Though the initial comment period for the SEC rules expired in February of 2014, the SEC has continued to receive extensive comments and has yet to issue final rules (or to propose revised rules). Until the SEC rules are effective, any issuer conducting a crowdfunding effort that does not remain strictly intrastate will be at risk of violating federal securities laws (in addition to the securities laws of any state in which the crowdfunded securities are offered, if the offering does not fall within available registration exemptions in such state).
• Texas crowdfunding offerings still need to be made through a registered dealer or "Texas crowdfunding portal." As with the SEC's proposed rules, the Texas exemption does not allow for issuers to crowdfund on their own—an exempt offering must be conducted through either a registered dealer or website registered as a Texas crowdfunding portal. Portals are subject to their own set of registration and compliance requirements, and an offering conducted through a portal that is not in compliance with applicable rules could be at risk of losing its exemption from registration. (For example, portals must take steps to confirm Texas residency before allowing an investor to even view materials provided by a crowdfunding issuer.)
• Crowdfunding offerings still require delivery of significant disclosure materials, including financial statements. Subsections (h) and (i) of the new Texas rule set out the requirements for information to be included on the crowdfunding portal and in a disclosure statement to be made available to investors. The requirements include a full discussion of the issuer's historical and proposed business, information about the issuer's management team and principal shareholders, and a description of both the securities being offered and the planned uses for the proceeds of the offering. Additionally, though not as onerous as the financial statement requirements under the SEC's proposed rules, TSSB Rule 139.25(i)(3) requires that the issuer "provide current financial statements certified by the principal executive officer" and that if "the issuer has audited or reviewed financial statements prepared within the last three years, such financial statements must also be provided to investors."
• A pre-offering notice filing and 21-day waiting period are required. At least 21 days before the first offer is made in a crowdfunding offering, the issuer must file with the Texas Securities Commissioner a Crowdfunding Exemption Notice on a new Form 133.17, and the issuer's disclosure statement and offering summary must be made available online during that waiting period.
• Crowdfunded shares are still subject to transfer restrictions. Issuers using the Texas crowdfunding exemption are effectively relying, for federal securities law purposes, on the intrastate offering exemptions provided by Section 3(a)(11) and Rule 147 under the U.S. Securities Act. As a result, for a period of nine months following the closing of the crowdfunding offering, securities purchased in the offering may be resold only to Texas residents.
• Only available to Texas entities. As noted above, crowdfunding issuers need to both have their principal office in, and have been formed under the laws of, Texas. This would preclude use of the exemption by a Texas-based business that opted for incorporation in Delaware.
• Escrow requirement for offering proceeds. All funds received from investors are required to be held in escrow until the offering reaches its targeted offering amount as set forth in the issuer's disclosure materials.
• Anti-fraud provisions of state and federal securities laws still apply. The exemption from registration provided by the crowdfunding rule does not exempt issuers from the antifraud provisions of applicable securities laws, and the riskier nature of crowdfunding offerings—specifically the targeting of large numbers of largely unaccredited investors—means that they are likely to attract additional scrutiny from state and federal securities regulators.

More information regarding the new rule, requirements for crowdfunding portals, and related forms, can be found here.

Before considering a crowdfunding offering—or any offering of securities—Texas issuers should consult with counsel to ensure compliance with state and federal securities law requirements and to evaluate potentially superior options for private capital raising.