Raising Capital Through Small Contributions from a Large Number of Investors

Introduction

If you’re an entrepreneur in need of capital for your business, one option you may wish to consider is doing a crowdfunding offering. In Washington, an exemption from securities registration is available to allow a business to raise up to $1,000,000 in capital in a twelve month period by selling equity (ownership) interests in your business, or by selling debt instruments (such as promissory notes) that convert into equity interests in the future (“convertible debt”). This webpage does not address other types of crowdfunding, such as donation or rewards based crowdfunding.

Please note that the crowdfunding exemption is an option separate from the rules for raising capital through the Small Company Offering Registration (SCOR). If the requirements for conducting a crowdfunding offering do not match your company’s needs, you may instead be able to do a SCOR offering to raise up to $1,000,000 in capital for your business. For more information about SCOR, please visit our SCOR webpage.

Because the crowdfunding exemption is premised upon the offering qualifying under one of two  specific exemptions for “intrastate” offerings of securities under federal law, this webpage will first discuss the requirements of those federal exemptions. The remainder of this webpage will discuss the basic requirements for using the crowdfunding exemption under Washington law. Please note that the text of this webpage contains hyperlinks to other sources of information you may wish to study.

Summary of Requirements

There are several requirements an offering must meet for the Washington crowdfunding exemption. The general requirements for conducting a crowdfunding offering are discussed below.

What are the federal requirements for doing a crowdfunding offering under Washington law?

In order to be able to raise capital under Washington’s crowdfunding exemption, the company must be able to establish that the offering qualifies for one of two federal exemptions from registration: (1) the federal exemption from registration under Section 3(a)(11) of the Securities Act of 1933 and Rule 147 adopted thereunder; or (2) federal Rule 147A.

Federal Section 3(a)(11) and Rule 147

Section 3(a)(11) provides an exemption from the securities registration requirements under federal law for offers and sales of securities that are made to residents of a single state where the issuer is organized and doing business within that same state. Rule 147 provides further guidance as to the availability of this exemption. In summary, Rule 147 provides that this exemption is available where:

  • The issuer of the securities is incorporated or otherwise legally organized, and has its principal place of business, in the state in which all of the offers and sales of securities will take place; and
  • The issuer meets one of the following requirements:
    • The issuer must derive at least 80% of its gross revenues from the operation of a business located within the same state;
    • At least 80% of the issuer’s assets are located within the same state;
    • The issuer uses at least 80% of the funds raised in the offering for the operation of the business within the same state; or
    • A majority of the issuer’s employees are based in such state or territory.

It is important to note that while this is an abbreviated summary of federal Rule 147, all of these requirements must be satisfied to rely on this federal exemption and to be able to structure an offering under the Washington crowdfunding exemption.

You should also note that the ability to advertise a Rule 147 crowdfunding offering on a website is limited by federal law. See U.S. Securities and Exchange Commission, Securities Act Rules: C&DI Questions 141.03, 141.04, and 141.05.

Rule 147A

Similar to federal Section 3(a)(11) and Rule 147, federal Rule 147A provides an exemption from securities registration requirements under federal law for sales of securities that are made to residents of a single state.  However, Rule 147A allows offers to be accessible to out-of-state residents (so long as sales are made only to in-state residents) and for issuers to be incorporated or organized out-of-state.
Rule 147A provides further guidance as to the availability of this exemption.  In summary, Rule 147A provides that this exemption is available where:

  • The issuer of the securities has its principal place of business in the state in which all of the sales of securities will take place; and
  • The issuer meets one of the following requirements:
    • The issuer derives at least 80% of its gross revenues from the operation of a business located within the same state;
    • At least 80% of the issuer’s assets are located within the same state;
    • The issuer uses at least 80% of the funds raised in the offering for the operation of the business within the same state; or
    • A majority of the issuer’s employees are based in such state or territory.

It is important to note that while this is an abbreviated summary of federal Rule 147A, all of these requirements must be satisfied to rely on this federal exemption and to be able to structure an offering under the Washington crowdfunding exemption.

If the offering may otherwise qualify under one of these federal provisions, the next step is to understand the state level requirements for offerings under the Washington crowdfunding exemption. These requirements are discussed below.

What types of companies may use the Washington crowdfunding exemption?

The Washington crowdfunding exemption is available only to a corporation or centrally managed limited liability company or limited partnership that is resident and doing business within Washington at the time of any offer or sale of securities.

Further, the exemption is generally not available to certain types of issuers. The crowdfunding exemption provides for the use of a simplified offering document (the Washington Crowdfunding Form) that is designed to prompt an issuer to provide adequate disclosure to investors concerning the issuer, the securities offered, and the offering itself. Certain issuers may not be able to make adequate disclosure using the simplified form and will, therefore, be unable to utilize this exemption. The following issuers and programs will not be allowed to utilize the crowdfunding exemption unless written permission is obtained from the Securities Division based upon a showing that adequate disclosure can be made to investors using the Washington Crowdfunding Form:

  • Holding companies, companies whose principal purpose is owning stock in, or supervising the management of, other companies;
  • Investment companies subject to the Investment Company Act of 1940, including private equity funds;
  • Portfolio companies, such as real estate investment trusts;
  • Development stage companies that either have no specific business plan or purpose or have indicated that their business plan is to engage in merger or acquisition with an unidentified company or companies or other entity or person;
  • Companies with complex capital structures;
  • Blind pools;
  • Commodity pools;
  • Companies engaging in petroleum exploration or production or mining or other extractive industries;
  • Equipment leasing programs; and
  • Real estate programs, except entities formed to invest in a single, income-producing real estate property.

What types of securities may be sold in an offering under the Washington crowdfunding exemption?

The Washington crowdfunding exemption is available only to equity or convertible debt securities offerings by the issuer of the securities. The exemption is not available to non-convertible debt offerings or for resales of securities.

How much can an issuer raise in an offering under the Washington crowdfunding exemption?

The aggregate purchase price of all securities offered by an issuer in an offering made pursuant to the Washington crowdfunding exemption may not exceed $1,000,000. The offering may be declared exempt for a maximum of twelve months, and may be renewed for one additional twelve-month period.

Must the crowdfunding offering be made online or otherwise use a crowdfunding portal?

An offering under the Washington crowdfunding exemption is not required to be conducted online. Neither must an issuer use a funding portal or other intermediary to conduct the offering. The exemption may be used by an issuer to make a direct public offering of its own securities.

What is the Washington Crowdfunding Form?

Issuers eligible for the crowdfunding exemption are required to use the Washington Crowdfunding Form to provide disclosure to investors in the offering. This form includes both “check-the-box” and question and answer formats for simplicity. It is designed for use by start-up companies and other small business issuers whose principals may prepare the form themselves without relying on the expertise of attorneys and accountants. The questions presented in the form are designed to elicit specific types of information of special relevance to start-up companies and other small businesses. Examiners from the Securities Division may review and comment on the disclosure provided and may request revisions or additional disclosure before the offering is declared exempt.

One unique aspect of the form is that its questions present issues that a start-up or other small business may need to address to become successful. Thus, in providing responses, a company is compelled to create a business plan describing its anticipated steps to success. If the form is filled out properly, the assumptions and weaknesses in the plan should be evident, and these should be prominently disclosed as risk factors in the offering.

The Washington Crowdfunding Form may be downloaded on the Forms webpage. The Form is a Microsoft Word document that contains macros. When asked whether to enable macros in the document, you must select “Enable” in order for the Form to function properly.

What are the financial statement requirements under the Washington crowdfunding exemption?

The issuer must include its financial statements as of the end of the most recent fiscal year. If the date of the most recent fiscal year end is more than ninety days prior to the date of filing, the issuer must also submit a balance sheet and statement of income or operations for the issuer's most recent fiscal quarter. While the financial statements need not be audited by an accountant, they must be prepared in accordance with generally accepted accounting principles in the United States (“U.S. GAAP”). If the company lacks the requisite accounting expertise to prepare financial statements in accordance with U.S. GAAP, we strongly encourage the company to obtain a compilation or review from a qualified accountant to ensure the proper preparation of the financial statements.

Are there any ongoing reporting requirements under the Washington crowdfunding exemption?

For as long as securities issued under the crowdfunding exemption remain outstanding, the issuer is required to provide an annual report to the issuer's shareholders no later than one hundred twenty days after the end of the fiscal year covered by the report. . The report must contain the following information:

  1. Executive officer and director compensation, including specifically the cash compensation earned by the executive officers and directors since the previous report and on an annual basis, and any bonuses or other compensation, including stock options or other rights to receive equity securities of the issuer or any affiliate of the issuer, received by them;
  2. The names of the issuer's owners of twenty percent or more of a class of outstanding securities, directors, officers, managing members and/or other persons occupying similar status or performing similar functions on behalf of the issuer; and
  3. A brief analysis by management of the issuer of the business operations and financial condition of the issuer.

An issuer may provide the report to its shareholders by posting a copy of the report on the issuer’s website.

What filing requirements apply under the Washington crowdfunding exemption?

To use the Washington crowdfunding exemption, an issuer must first make a filing with the Securities Division. The issuer must wait to commence the offering until it has received notice from the Securities Division that the offering has been declared exempt.

The filing requirements include:

  • Completed copy of the Washington Crowdfunding Form;
  • Copy of the issuer’s articles of incorporation or other charter documents pursuant to which the issuer is organized and all amendments thereto;
  • Copy of the issuer’s bylaws or operating agreement and all amendments thereto;
  • Copy of any resolutions by directors or members concerning the securities to be issued in the offering;
  • Financial statements for the most recent fiscal year and, if applicable, those for the interim period, prepared in accordance with U.S. GAAP;
  • Copy of any agreement with a broker-dealer or other intermediary;
  • Copy of the escrow agreement with an escrow agent located in Washington concerning the offering proceeds;
  • Copy of the subscription agreement for the offering;
  • Copies of any planned advertising; and
  • A check in the amount of $600 for payment of the filing fee. Checks should be made payable to the “Washington State Treasurer.”

The Securities Division may request additional documentation after reviewing these materials.

What is the target minimum offering amount?

An issuer is required to set a minimum target offering amount and deadline to raise the minimum target offering amount in the Washington Crowdfunding Form. The minimum target offering amount must be sufficient, together with other sources of financing, to implement the business plan of the issuer. If the proceeds are insufficient, the Securities Division may require a revised minimum target offering amount. The deadline for raising the minimum target offering amount may be no longer than twelve months from the date the offering is declared exempt by the Securities Division. All funds raised in the offering must be deposited with an independent escrow agent until the minimum offering amount has been raised.

May an investor cancel their investment prior to the time the minimum offering amount is raised?

An investor in a crowdfunding offering may cancel an investment commitment for any reason until such time as the target minimum offering amount has been raised. If there is a material change to the terms of the offering or to the information provided by the issuer in the Washington Crowdfunding Form before the minimum target offering amount has been raised, the issuer must send to any investor who has made an investment commitment notice of the material change and notice that the investor may cancel an investment commitment for any reason until such time as the target minimum offering amount has been raised.

What are the investment limitations per investor under the Washington crowdfunding exemption?

Under the Washington crowdfunding exemption, the aggregate amount of crowdfunded securities sold to any investor during the twelve months preceding the date of the sale, together with the securities to be sold to the investor in a particular crowdfunding offering, may not exceed the lesser of:

  • $2,000 or 5% of the annual income or net worth of the investor, whichever is greater, if either the annual income or the net worth of the investor is < $100,000; or
  • 10% of the annual income or net worth of the investor, up to $100,000, if either the annual income or net worth of the investor is > $100,000.

An investor’s net worth is calculated by subtracting his or her total liabilities from the value of his or her total assets excluding the investor’s primary residence. The issuer must have a reasonable belief that these limits have been satisfied which is generally accomplished by obtaining a representation from the investor that these limits are satisfied as long as the issuer has no reason to question such a representation.

These individual investment limitations do not apply to “accredited investors” as the term is defined under the Securities Act of 1933.  “Accredited investors” include any natural person whose individual net worth, or joint net worth with that person’s spouse, exceeds $1,000,000, exclusive of the value of the person’s personal residence. See: Accredited Investor Definition

Word of Caution

Undertaking a securities offering is a serious matter. It can be costly and will take time away from running your business. For more information on the general implications of conducting a securities offering, please consult our Raising Capital webpage.

In addition, while company personnel can prepare the information requested on the Washington Crowdfunding Form and file the appropriate documents with the Division, it is often beneficial for the company to seek the assistance of counsel experienced in securities law issues. Although assistance of experienced counsel adds a transactional cost to the company for the offering, the dollars invested may return important dividends in terms of more timely resolution of regulatory issues and achievement of an earlier offering date than would be the case without the assistance of experienced counsel.

The purpose of this document is to acquaint the small business person with the possibility of raising capital through the crowdfunding exemption. It SHOULD NOT be relied upon to actually make a securities offering. There are many additional important issues, of which a person making a securities offering should be aware. This document summarizes only some of the issues involved in conducting a crowdfunding offering.

Other Programs of Interest

SCOR

The Small Company Offering Registration (“SCOR”) offers an optional method of registration that utilizes a question and answer disclosure document and enables corporations and limited liability companies (LLCs) to raise up to $1 million during a period of up to 12 months through the sales of securities to the public.

There are many advantages of seeking registration of a securities offering through a SCOR registration. First, the SCOR registration was designed to minimize costs for small businesses seeking to raise capital through a securities offering. The question and answer disclosure document utilized in a SCOR offering was designed so that it may be completed without the expertise of attorneys and accountants who are securities experts. The form may be copied and is used as the prospectus in soliciting investors.

Second, ”merit” standards used by the Securities Division to review these registrations are somewhat more relaxed than those applied to larger public offerings.

Third, SCOR offerings are designed to be exempt from registration under federal securities laws by virtue of Securities and Exchange Commission (SEC) Rule 504 of Regulation D or Section 3(a)(11) of the Securities Act of 1933 and Rule 147 promulgated thereunder, so registration with the SEC is not required.

Finally, companies may use commissioned selling agents or sell the securities to the public themselves through classified ads or other means of mass solicitation, such as the internet. Investors are not limited as to number or type, nor is there any restriction on the amount that may be sold to any one person.

There are other registration and exemption provisions that may be used to raise capital. To acquaint yourself with the various options available in Washington, please review the Offering Options webpage.

Further Information

If you have additional questions about using the intrastate crowdfunding exemption in Washington, you should review the Crowdfunding FAQs available on our website. You should also review the text of the rules applicable to the Washington crowdfunding exemption. The Division has other resources available to aid the small businessperson in evaluating the possibility of conducting a securities offering in the State of Washington through the Small Business Assistance section of our website. You may also contact us by telephone at 360-902-8760. You may also want to review the Securities and Exchange Commission's Small Business Guide.

For more information on incorporating your business in the State of Washington, contact the Corporations Division of the Secretary of State:

Secretary of State
Corporations Division
P.O. Box 40234
Olympia, WA 98504-0234
(360) 725-0377
Website: www.sos.wa.gov/corps

The State of Washington maintains a home page on the Internet providing access to sources of information concerning the operation of businesses in the State of Washington. The website is located at www.access.wa.gov.

Information on how to prepare a business plan may be available through Small Business Development Centers which are located throughout the state. You can locate your local Small Business Development Center online at www.wsbdc.org. The U.S. Small Business Administration also may be able to provide assistance to the entrepreneur. Regional offices are located in Seattle and Spokane. The organization maintains a website at www.sba.gov.