Securities Straight Talk Vol. 3: Keeping it Local—Changes to the Rule 147 Intrastate Offering Exemption
By Vela Wood
Positive changes are in store for companies wishing to raise capital from local investors. As mentioned in the blog below, the SEC has adopted final rules to revise the exemption for intrastate offerings (offerings conducted entirely within one state) by amending Rule 147 and adopting new Rule 147A.
Both Rule 147 and Rule 147A will be effective on April 20, 2017.
As a bit of background, Section 3(a)(11) of the Securities Act provides an exemption from registration for securities that are offered and sold only to persons located in the single state where the issuer resides, or is incorporated, and does business. Because where a purchaser is “located” and where an issuer “does business” can get a little murky, the SEC adopted Rule 147 as a safe harbor, meaning if the requirements of the rule are satisfied, the company qualifies for the exemption.
The current Rule 147 requires that:
(1) The issuer is incorporated, organized, or has its principal office, or, for an individual, resident in the state of the offering;
(2) The issuer “does business” in the state of the offering by
- deriving 80% of its gross revenues from the state,
- holding at least 80% of its assets within the state,
- using at least 80% of the net proceeds from the offering within the state, and
- locating its principal office within the state;
(3) All offers and sales be made to entities whose principal office or individuals whose principal residence is within the state (e.g., “residents” of the state);
(4) For a period of nine months from the date of the last sale of securities, all resales of securities be made only to residents of the state; and
(5) The issuer provides certain precautions against interstate offers and sales (basically, state to state offers and sales).
What’s different about new Rule 147A?
The SEC, wishing to facilitate capital formation by smaller companies, amended Rule 147 and adopted Rule 147A to modernize the intrastate offering exemption. These changes have liberalized the Rule 147 safe harbor and expanded the exemptions available for local securities offerings. The amended Rule 147 and new Rule 147A are largely identical, except for a few distinct differences.
Specifically, the elements of the amended Rule 147 include:
The issuer must be incorporated or organized and have its principal place of business—meaning the location where the officers, partners, or managers primarily direct, control, and coordinate activities (although conceptually similar, the change from “principal office” to “principal place of business” provides consistency with the new Rule 147A, Exchange Act, and the Investment Advisers Act), or for an individual, be a resident, in the state in which the offering is conducted;
An issuer that has moved states, and who has previously conducted an offering pursuant to the intrastate exemption, must wait six months before conducting an offering in a different state.
“Doing Business” Requirement:
The issuer must satisfy at least one of the following four requirements demonstrating the in-state nature of the issuer’s business (as opposed to having to satisfy all three threshold requirements in the current rule):
- At least 80% of its consolidated gross revenue is derived from the operation of business or services within the state;
- At least 80% of its consolidated assets are located within the state;
- At least 80% of the net proceeds from the offering will be used in connection with the operation of a business, real property, or services within the state; or
- A majority of the issuer’s employees are based in the state.
In-State Purchaser Requirement:
All offers and sales must be limited to in-state residents. “Residence” for non-natural persons is defined as the entity’s principal place of business.
“Reasonable Belief” Standard:
The issuer may now rely on a reasonable belief standard in determining the residence of a purchaser at the time of the sale of securities. This means that, unlike the current rule, the issuer does not lose the exemption if they reasonably, although mistakenly, believe a purchaser to be an in-state resident.
The issuer must obtain a written representation from each purchaser as to his or her state of residency.
For a period of six months following the date of sale by the issuer to a purchaser, resales by that purchaser may be made only to residents of the state in which the offering is conducted.
The issuer must provide certain disclosures, including legend requirements, to offerees and purchasers about the limits on resales.
General Solicitation and Advertising:
General solicitation and advertising is permitted only within the state where the offering is conducted.
Unlimited Offering Amount:
There is no limit to the amount of securities that may be sold under the intrastate offering exemptions.
The new Rule 147A is nearly identical to amended Rule 147, except:
The “residence” of the issuer is determined solely by its principal place of business. This provision is gold: it allows entities that would otherwise satisfy each residency requirement of Rule 147, except that they are incorporated in another state, to now qualify for the intrastate offering exemption. For example, under the current rule, a small Delaware startup that has its principal place of business in Texas, does all of its business in Texas, maintains all of its assets in Texas, and intends to use all proceeds from the offering within Texas, is not eligible to use the Rule 147 exemption because it happens to be incorporated in Delaware. The new Rule 147A allows such an entity, that is essentially intrastate, to benefit from the intrastate exemption.
Offers may be made to out-of-state residents, so long as sales are limited to in-state residents. This allows issuers to engage in general solicitation and advertising using any form of mass media—for example, via crowdfunding websites—and still qualify for the intrastate exemption, assuming no actual sales are made to out-of-state investors.
The changes made to the intrastate offering exemption provide more flexibility for small businesses looking to raise capital and allow for a greater number of companies to qualify for the exemption. The exemption is especially beneficial to companies in large states, such as New York, California, and Texas that have a large pool of in-state investors. Additionally, there are no federal notice filing requirements or filing fees associated with the intrastate exemption.
Although the SEC is loosening the reigns on small businesses conducting local securities offerings, issuers must still abide by state securities laws. The offering must be registered with the state or qualify for a state exemption. Therefore, while there may be no restrictions on general solicitation or the amount of the offering under federal law, for example, there may be some imposed by state law. And odds are, your state securities regulator is going to require a notice filing and filing fee.
Overall, Rules 147 and 147A are designed to facilitate capital formation, accommodate modern business practices, and expand avenues for smaller companies to raise money. So the next time you’re contemplating a capital raise, consider keeping it local.