Equity Crowdfunding: The 12(g) Problem

You might be wondering what I am talking about when I say that there is a 12(g) problem with equity crowdfunding.

What is Section 12(g), anyway?

Section 12(g) is a section of the Securities Exchange Act of 1934 that requires companies to start reporting as a public company if they allow themselves to have too many stockholders and too much in assets.

Right now, a private company has to start reporting to the SEC if it has over 2,000 securities holders of record, or 500 persons who non-accredited investors and more than $10M in assets.

Here is how the SEC put it in the Final Crowdfunding Rules:

As amended by the JOBS Act, Section 12(g) requires, among other things, that an issuer with total assets exceeding $10,000,000 and a class of securities held of record by either 2,000 persons, or 500 persons who are not accredited investors, register such class of securities with the Commission.

You see the problem. In an equity crowdfunding  you may very well bring on more than 500 non-accredited shareholders. And if you raise $1M in cash, you may well be on your way to the $10M threshold.

Congress saw this problem too, and provided an accommodation for issuers that crowdfund under Title III. But Congress’s accommodation says nothing about issuers who crowdfunding under state equity crowdfunding laws. When the JOBS Act was being put together, I don’t think anyone anticipated state-level equity crowdfunding at all. 

In the final crowdfunding rules, the SEC summarized the final rule’s approach to this issue as follows:

Holders of these securities do not count toward the threshold that requires an issuer to register its securities with the Commission under Section 12(g) of the Exchange Act if the issuer is current in its annual reporting obligation, retains the services of a registered transfer agent and has less than $25 million in assets.

But this isn’t so great, really. A successful equity crowdfunded company will probably exceed the 500 non-accredited investor threshold and if it is a successful company exceed the $25M in assets test before too long. So, one thing issuers are going to have to consider carefully as they prepare to do an equity crowdfunding offering is how they may be effectively putting themselves on the path to having to report as a public company.

Here is how the SEC described how a company in this situation would have to proceed:

An issuer that exceeds the $25 million total asset threshold, in addition to exceeding the thresholds in Section 12(g), will be granted a two-year transition period before it will be required to register its class of securities pursuant to Section 12(g), provided it timely files all its ongoing reports pursuant to Rule 202 of Regulation Crowdfunding during such period. Section 12(g) registration will be required only if, on the last day of the fiscal year the company has total assets in excess of the $25 million total asset threshold, the class of equity securities is held by more than 2,000 persons or 500 persons who are not accredited investors. In such circumstances, an issuer that exceeds the thresholds in Section 12(g) and has total assets of $25 million or more will be required to begin reporting under the Exchange Act the fiscal year immediately following the end of the two-year transition period. An issuer entering Exchange Act reporting will be considered an “emerging growth company” to the extent the issuer otherwise qualifies for such status.

I am not sure $25M was the right threshold to set, but it is what was done.

This is just something companies are going to keep in mind as they consider equity crowdfunding as a financing alternative.

Download PDF
  • I’m trying to imagine having 500 investors in a startup which has raised $999,999. The logistics of that would be crazy. No doubt the portals will use special-purpose-vehicles (SPV) to help simplify it, but they’ll then have to send out 500 K-1s. With or without the SPV, someone has to send out and keep track of 500 subscription agreements. Docusign is nice, but gets overwhelming with a dozen agreements.

    That is all doable, but the time and expenses of having so many investors is crazy. Generating 500 K-1’s would cost thousands of dollars. Sending out one shareholder notice on paper would be ream of paper and thousands of dollars just in postage.

    I thus think you point out a problem, but not the biggest problem with 500 shareholders.

    • joe.wallin@gmail.com

      Great point Luni. Yes. This is a fundamental and big problem.

    • nicktommarello

      The logistics can be made simple. Wefunder has funded over 110 startups that increased in value $5 billion for “accredited crowdfunding” using SPV’s. We have sent thousands of K1’s and stored thousands subscription agreements. It’s all pretty cheap; we wrote our own accounting and electronic signature software to automate most everything.

      (SPV’s are currently not allowed for Title III… yet. But we have other solutions.)