Intrastate Crowdfunding and the 499 Shareholder Problem

Intrastate CrowdfundingIn prior posts I have lamented the problems with the federal crowdfunding law.  The SEC is still behind on finalizing rules implementing the crowdfunding provisions of the JOBS Act. In the meantime, Washington State and a handful of other states have pushed forward with crowdfunding laws of their own that are meant to offer a less expensive and more practical and usable alternative to the federal crowdfunding law.

The Basis of State Crowdfunding – The Intrastate Exemption

State-level equity crowdfunding laws allow a company to equity crowdfund without having to comply with the federal crowdfunding law.  To accomplish this, states designed their equity crowdfunding laws that rely on the intrastate exemption from registration under the Securities Act of 1933 (the “33 Act”).

Section 3(a)(11) of the 33 Act exempts from registration any security that is part of an offering sold only to persons residing within a single state if the company is also doing business in that state.   So, as long as a company complies with the federal intrastate exemption, it only needs to be concerned with the state’s crowdfunding rules when conducting a crowdfunding offering; it won’t also have to comply with the federal crowdfunding law.

The 12(g) Issue

Although state crowdfunding laws make it easier for a company to crowdfund (so long as the company complies with the intrastate exemption), companies need to watch out for other federal laws that can trigger reporting requirements.  One of the more historically notorious rules is Section 12(g) of the Securities Exchange Act of 1934 (the “Exchange Act”).

Section 12(g) of the Exchange Act requires a company to register its securities with the SEC if the company has (A) more than $10 million in assets and (B) a class of securities that is held by either 2,000 persons or 500 persons who are not accredited investors.

So if a crowdfunded company has equity investments from 500 persons who are not accredited investors or from over 2000 persons (whether accredited or unaccredited), the company may be required to start filing expensive periodic reports with the SEC and go through the full expense and rigmarole of being a public company.

Some Recent History on 12(g)

Section 12(g) has also been called the “Facebook Rule” because of Facebook’s widely-reported on experience with the rule.

The JOBS Act made Section 12(g) was made less onerous:  Section 12(g) used to require that if a company had more than 500 shareholders of record (whether accredited or unaccredited) and over $10 million in assets, the company would need to register with the SEC (the idea being that there was an active trading market for a company with more than 500 shareholders and investors needed to be protected ).  The JOBS Act increased this threshold so that a company needs to register only if it has either 2,000 or more shareholders of record in total or 500 or more unaccredited shareholders and over $10 million in assets.

Even with the amendments from the JOBS Act, however, because the 500 threshold for unaccredited shareholders remains, this rule remains a potential barrier to companies hoping to access state-level equity crowdfunding statutes without having to comply with significant regulatory obligations and expense.

Does Federal Crowdfunding Have the Same Problem?

No, the federal crowdfunding exemption avoids the 12(g) problem: Based on the SEC’s proposed rules, persons holding securities issued under the federal crowdfunding exemption will be exempted from the calculation of the number of shareholders of record under 12(g). See page 275 and following of the proposed Crowdfunding rules.

Practical Advice and Suggestions

Below are some tips and advice for avoiding accidentally surpassing the 12(g) cap:

  • Don’t go anywhere near bringing into your company 500 non-accredited investors.
  • Include in your company’s organizational documents stock transfer restrictions.
  • Obviously, keep careful track of your stock records and share register.
  • Obtain and keep good documentation showing the accredited investor status of investors (if they are accredited).

Conclusion and Grounds for Optimism

Intrastate crowdfunding has hope. We need the SEC to fix its overly restrictive Compliance & Disclosure Interpretations. See The SEC Needs To Fix Its Intrastate Crowdfunding Guidance. And we may need the Congress to amend Section 12(g) to accommodate larger intrastate crowdfunding offerings. But, even if the SEC doesn’t back off its C&DIs, and Congress does nothing more to Section 12(g), state-level equity crowdfunding should still be helpful to companies.

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How Does Private Equity Develop M&A Investment Strategies?

M&A STRATEGIESPlease join us for the Pacific Rim M&A Institute’s Q3 session. This session will address questions such as:

  • How does private equity develop M&A investment strategies?
  • What is the investment life cycle of various different types of investments?
  • How does private equity think about and apply M&A?

The program will feature a panel discussion on the M&A process from the perspective of financial buyers of venture capital. The panel, moderated by Professor Jarrad Harford of the Foster School of Business at University of Washington, will include:

About the Pacific Rim M&A Institute

PRMAI was founded by Davis Wright Tremaine, the University of Washington School of Law, and the University of Washington Foster School of Business. The mission of PRMAI is to create best practices and interdisciplinary knowledge sharing in the M&A community. Join the conversation at


Thursday, Sept. 18th, 2014
7:00 – 8:00 AM Registration & Continental Breakfast
8:00 – 9:00 AM Panel Discussion

Davis Wright Tremaine LLP
1201 Third Avenue, Suite 2200
Seattle, WA 98101

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WTIA Tech in Focus: Crowdfunding

WTIA crowdfundingThe Washington Technology Industry Association (WTIA) is hosting an event that brings together industry experts to answer questions for startups regarding the new Washington state crowdfunding law.

Washington’s new crowdfunding bill will allow companies to up to $1 million from both non-accredited and accredited investors. However, there are strict rules that need to be adhered to in order to correctly execute a crowdfunding campaign.

Topics Discussed Will Be:

  • The contents of the crowdfunding bill
  • How to actually use the new bill
  • Implications to the startup community

Panelists include:

Joe Wallin | Attorney & Partner | Davis Wright Tremaine LLP

Bill Beatty | Securities Administrator | Washington State Department of Financial Institutions

Casey Dilloway | Co-Founder & President | Community Sourced Capital

Mitch Gitelman |Studio Manager & Co-Founder | Harebrained Schemes

 Moderated by:

 Cyrus Habib | State Representative | Washington State Legislature

Register Here

When: Tuesday, September 9, 2014
4:00 pm – 6:00 pm

Cost: Free For Members, $25 for non-members

Where: Clark Nuber
10900 NE 4th St #1700, Bellevue,WA 98004

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