Washington State Equity Crowdfunding

As part of Seattle Startup Week I am giving a talk on equity crowdfunding.

The talk will be this Friday.

There is a link about the event on the Seattle Startup Week calendar.

Washington State was one of the first state’s to have a state-level equity crowdfunding law.

In fact, Washington State might have been the first state in which a state legislator proposed a state crowdfunding statute. Thank you Cyrus Habib.

Regulators in Kansas and Georgia put in place regulatory crowdfunding exemptions before the JOBS Act.

But after the JOBS Act, I think Washington State might have been the first state to have a legislator propose an actual crowdfunding statute.

Now 20+ states have put in place state-level equity crowdfunding laws. You can find a good slide showing which states have put in place state-level equity crowdfunding laws in this slide deck.

In my talk Friday, I plan to talk about a number of things, including:

  • how state-level equity crowdfunding compares to the traditional Rule 506(b) offering, and the new Rule 506(c) offering.
  • how state-level equity crowdfunding will be impacted by the SEC’s long-awaited adoption of the federal equity crowdfunding rules.
  • the requirements of Washington’s statute.
  • the future of equity crowdfunding.

How State-Level Crowdfunding Compares to Rule 506(b) and (c)

You might wonder, how is state-level equity crowdfunding different from traditional fund raising paths, and in particular Rule 506(b) and (c).

The primary difference between Rules 506(b) and (c) and state-level equity crowdfunding is the promise to be able to sell shares to non-accredited investors without a huge legal hassle.

Rule 506(b) allows sales of up to 35 non-accredited investors, but only if a company provides registered offering level disclosure. This is impractical for most companies, and so most Rule 506(b) offerings are accredited investors only.

State-level equity crowdfunding laws allow the sale to non-accredited investors. But these laws comes with a variety of challenges. For example, Washington State’s law allows the sale to non-accredits, but before you can proceed you have to do the following:

  • You have to file and have approved by the state a crowdfunding form
  • You have to have a target minimum fundraising and hire an escrow agent
  • For as long as the securities are outstanding, you have make regular disclosures to the public of executive officer and director compensation

Once the state approves your crowdfunding form, you can raise up to $1M during a 12-month period. There are individual investment limitations that mirror the same limitations in the JOBS Act.

Impact of Finalization of Federal Law

The SEC is about to adopt the federal crowdfunding rules. Will the finalization of federal equity crowdfunding negatively impact the operation of state laws?

No.

The various state-level equity crowdfunding laws that have been adopted carefully avoid the application of the federal law.

So even after the federal rules are finalized state laws will still be in place and available.

The Future of Equity Crowdfunding

Although I am excited about the SEC’s meeting on Friday to consider whether to adopt final crowdfunding regulations, the federal statute is complex. Companies will have to spend a lot of money to do a federal crowdfunding offering. State-level equity crowdfunding will be substantially less costly. This is a competitive advantage point for the state laws.

However, most companies will probably continue to pursue the traditional fundraising path–Rule 506(b).

The big problem with both the federal and at least the Washington statute is that both require significant cost expenditures before any deal is certain.

The great thing about a Rule 506 offering is you can avoid incurring much in the way of legal or accounting expenses at all until you know you have a deal. Then, if you have investor interest lined up, you can then spend the money on legal fees to prepare the final documents. In a Rule 506 offering, as long as you are selling to only accredited investors, you do not need audited financial statements.

So, for many startups and early stage companies–the idea of spending even say $10,000 to get the state to approve a crowdfunding form before you even know if you can line up investor interest doesn’t seem like a great approach. Especially when you can go and shop a 1 page term sheet with a slide deck to accredited investors for almost no legal expense at all.

Still, crowdfunding has great promise. Perhaps Washington will update and fix its statute to remove the pre-approval requirement. Oregon law does not require pre-approval, but only a pre-filing which is not reviewed. This would make the Washington law more easily usable by companies.

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