Stock Option Exercise Checklist

Congratulations, you’ve gotten your company off the ground.  You’ve incorporated, issued founder shares and filed 83(b) elections, adopted a stock option plan, granted stock options, and been working on your business for a while.  Now an employee who has been with you since the start wants to exercise a stock option that has vested in part.  What do you do?

Recommended Steps

I recommend that you take the following steps as you process each option exercise:

  • Review the stock option exercise notice; confirm that it is completed correctly and executed by optionee.
  • Make sure that you have all of the optionee’s original stock option paperwork signed and in the files (meaning, the notice of grant of stock option or stock option agreement).
  • Confirm that option was approved by the Board in minutes and/or a Board consent.
  • Confirm that your Rule 701 math was correct, and that you are operating within Rule 701's limitations and conditions.
  • Was the optionee terminated and in connection therewith did the optionee execute a release of all claims?  If so, did the release terminate the stock option?
  • Confirm the tax status of the option being exercised—nonqualified stock option (NQO) or statutory (incentive) stock options (ISO)?  Is it in part an ISO and in part an NQO?
  • Make sure the optionee is only exercising with respect to vested options or options that are not vested but immediately exercisable.
  • Confirm Blue Sky securities law compliance. (In which state does the optionee reside? Are securities filings required?)
  • Does the Company have a repurchase option with respect to the shares?  Will the Company exercise its repurchase option?
  • Determine whether the Board of Directors needs to make a new determination of the fair market value of the shares to determine the tax withholding or ISO adjustment amount.
  • Calculate the tax withholding (including but not limited to federal income and federal employment) if the option is an NQO (if the option is an ISO, make sure employee understands AMT tax consequences and be sure to send notification of ISO gain to employee and IRS).
  • Make sure to obtain from the exercising optionee the strike price plus the tax withholding, if tax withholding is required.
  • Consider providing the optionee with disclosure of some of the material risks of buying the securities.  A bullet point list of risk factors, financial statements, for example.
  • Have Company counsel prepare a stock certificate and stock certificate receipt.
  • Update the Company’s capitalization table.
  • Make sure payroll is aware of the exercise and properly reports the exercise on wage statements/Forms W-2, or ISO adjustment notification.


Don’t rush through this process and miss an important step!

Top Reasons to Grant NQOs Rather Than ISOs

Companies frequently have to confront this question: should they grant nonqualified stock options ("NQOs") or incentive stock options ("ISOs") to their employees? (ISOs cannot be granted to non-employee consultants or directors.) For the differences in the tax treatment of different types of equity awards, see the below table.

I generally recommend that private companies issue NQOs rather than ISOs for a variety of reasons. Let me tell you why:

  1. NQOs are simpler than ISOs. Simpler is not always better, but it frequently is better. How are NQOs simpler than ISOs? Well, for one, ISOs have more complex holding period requirements to qualify for their advertised benefits than NQOs have. Another reason NQOs are simpler than ISOs: the spread on the exercise of an ISO is an alternative minimum tax ("AMT") adjustment, requiring an employee to consult with his or her personal tax advisor to completely ascertain and appreciate the magnitude of the tax consequences of exercise. The spread on the exercise of a NQO does not involve a foray into the alternative minimum tax, which is a complex minefield. Employees frequently underestimate the impact of the AMT. In fact, many, many taxpayers get in trouble with the AMT through the exercise of ISOs. Employees exercise ISOs, and then when their taxes are calculated at tax return time, they discover that they owe more in taxes than they can pay. This problem got so bad after the dot-com bubble that Congress passed a special tax act relieving people of AMT liability for ISO exercises that they couldn't pay--but it was only a one-time tax reprieve. I would be very surprised if Congress ever did this again. This problem of employees not realizing the tax liability they are creating on the exercise of a stock option isn't very likely to occur with NQOs because tax withholding is due on exercise. For this reason, I say that NQOs are more transparent than ISOs.
  2. The tax consequences of NQOs are easier to determine than the tax consequences of ISOs. NQOs are subject to ordinary income and employment taxes on exercise. Tax withholding is required. You calculate the tax withholding on exercise, and it is determinable with little difficultly. An optionee does not have to try to run mock tax returns to determine the tax impact of the AMT adjustment, which is a good idea for an optionee at the time of an ISO exercise.
  3. The tax consequences of ISOs are frequently misunderstood. People frequently believe that ISOs only have favorable tax consequences, and forget that on exercise the spread is an AMT adjustment which can give rise to very significant tax payment obligations.
  4. The tax consequences of ISOs are frequently far less favorable than anticipated. The AMT consequences of an ISO exercises can result in a significant tax being owed. Many people have made the mistake of exercising ISOs only to discover when it came time to pay their taxes that they owed more in taxes than they could pay.
  5. The primary potential tax benefit of ISOs is actually not very frequently realized. To qualify for the primary tax benefit of an ISO--capital gain tax treatment on the sale of the ISO stock--an optionee has to meet two holding periods. An optionee must hold the stock for one year from the date of the exercise of the option, and for two years from the date of the grant of the option. Very frequently employees never satisfy these holding period requirements because they wait to exercise their options until in connection with a liquidity event, and thus don't qualify for the one of the primary purported ISO tax benefits--a capital gain on ultimate sale of the ISO stock.
  6. ISOs are not tax deductible to the employer. The spread on the exercise of an NQO is tax deductible to the employer. The spread on the exercise of an ISO is not tax deductible to the company. The tax benefits of NQOs to companies can be very significant for profitable companies.


Is there some potential tax benefit for employees that is left on the table if you use NQOs rather than ISOs? Yes (including employment tax savings), but again, for simplicity's sake, and clarity, and transparency, and to reduce the likelihood of misunderstandings, and to preserve for companies the tax deduction, I recommend NQOs.

Exercising an NQO: The Tax Math

Exercising a stock option is not always as straight forward as you might expect. The reason? Taxes.

When you exercise a nonqualified stock option (an "NQO"), and there is a "spread," you have to pay income and employment taxes in addition to the exercise price to exercise your options.

“Spread” means the positive difference between the fair market value of the stock underlying the option and the strike price.

Let’s do a math example. Suppose you have a nonqualified stock option to purchase 50,000 shares at a strike price of $0.05 per share. The current fair market value of the common stock is $3.75, according to the company’s latest Section 409A calculation. Meaning, the spread is $3.70 a share.

If you exercise your option in full, you will have to write a check for 50,000 x $0.05, for the strike price – for a total of $2,500.

However, when you exercise a nonqualified stock option, not only do you have to pay your employer the exercise price per share, but you also have to pay your employer the employee tax withholding due. This includes your income tax withholding and employee side FICA.

Thus, you will also have to pay the company an amount equal to the income tax and employee‑side FICA tax withholding on the spread. The “spread” here is 50,000 shares x (3.75 – 0.05), or 3.70 per share x 50,000, or $185,000. Income and employee‑side FICA on $185,000, assuming you are over the FICA cap, is going to be approximately $48,932.50. (This according to Randy Harris, payroll consultant (@getthepayroll). Thank you, Randy!, calculated as follows:

$185,000 x 25% (supplemental withholding rate for pay under $1 million) = $46,250 $185,000 x 1.45% (Medicare tax) = $2,682.50 $46,250 + $2,682.50 = $48,932.50

(Warning: Randy and I did this math a little while back--last year I think--and the exact withholding has probably changed by now.) 

But watch out, annual earnings over $113,700 will be exempt from the Social Security Tax of 6.2% BUT due to the Affordable Care Act, as of January 1, 2013, income over $200,000 will require an additional 0.9% Medicare Tax Withholding.

In addition, please see the attached link for a breakdown of tax rates applicable to other situations, and be sure to consult your accountant/advisor for specifics:  2013 Fast Wage & Tax Facts.

Finally, also be aware that this tax withholding satisfies the employer’s obligations, but may not satisfy the employee’s tax obligations in full. That depends on the employee’s other tax items. The employee may need to make additional tax deposits to avoid an underpayment penalty. The optionee should consult with his or her own tax advisor on this issue.

State Income Tax Consequences

This blog post doesn’t address potential state income tax withholding issues.


When you are planning to exercise, consult your company’s chief financial person. He or she can help you work through the tax math of the exercise. The numbers change on a regular basis as Congress modifies or changes the supplemental wage withholding rate.

Common Stock Financing Term Sheet (Example)

I am a fan of 1 page term sheets when it comes to company financings.

I think probably the best example of this is the Series Seed Term Sheet, which you can find here: 

Why is it important or nice that a term sheet be short? It helps accelerate a discussion of the deal. The fundamental material deal points ought to be able to be captured in one page--at least in a seed stage financing transaction.

You could argue the Series Seed Term Sheet, although 1 page, isn't really 1 page--because it references the underlying definitive documents. And that is true. I like the way the Series Seed Term Sheet does that.

If you are looking for a common stock term sheet for a financing, I've attached one at the link below. I had a friend call me this morning and tell me she couldn't find a good, short common stock term sheet online. This makes sense, because common stock financings are uncommon. I hope you find the attached helpful.

Example Common Stock Term Sheet


The Delaware Tax Scare

Delaware apparently likes to scare people. Here is how it works. They send you an invoice for keeping your corporation alive which shows you owe $91,000. Or something ridiculous. You know it can't be right.  You are a startup. You don't even have any revenue yet.

But still, you received the invoice, so you freak out. You email your lawyer this message:

"This estimate just scared the #$@&*( out of me. It says we owe $90k or so. Please advise."

What does your lawyer say:

"Turn the form over, and calculate your taxes using the assumed par value capital method. The bill should be around $400."

I suppose Delaware likes to scare people is just the way they have been doing it forever?

I don't know, but it is certainly not a good customer service experience, if you think of it that way.

But you could also view it as a test of your startup skills. Certainly you have to be able to handle situations like these. The lesson? Don't freak out. Stay calm.

Delaware has published helpful information here: 

The First Time - Guest Post by Swatee Surve

They say you always remember the first time. And this was true in my case. Firing someone. There is a unique flavor to terminations in start ups. Unlike corporate where you have a lot of processes that can make it easy to depersonalize and you have a large organization around you, start ups are a lot more unstructured and personal. And that's because typically people especially in an early stage start-up aren’t paid and they join for the passion and mission.

Wrong fits/bad hires are commonplace. Finding good people to work in a start-up is very tough. And it’s a myth that you won’t have problems if you pay someone. The worse part about paying someone is you’ve lost money AND didn’t get work done. One the things you learn is to cut bait fast when things aren’t working out. It’s pretty easy to identify when a person is doing really well or really poor.  But what happens when they fall in the middle? How much time do you give them? How much do you put up with a bad attitude? How much support do you give v.s. being a hardnose? What happens when their life circumstances change and they can’t give you the time they committed?

That first one is traumatic. You work long hours together driving towards goals, making progress, and sharing disappointments. Along the way you start to build a personal rapport. It’s that rapport that can make it difficult when performance starts to slip. In my case, the employee was banking on our personal repore to cover for the lack of performance.

So what do you do? Leadership styles vary - some of my fellow CEOs keep all the interactions focused on work and that’s it. Others have forged strong personal connections and built teams who ended bonding cohesively and helped each other through difficult times. 

The points to keep in mind are:

  1. Have an approach you can live with and aligns with the culture you want to create.
  2. Regardless of style you chose - be clear and upfront and communicate immediately when expectations aren’t being met. If and when it comes to the point you have to part ways, both parties have a clear understanding of why.
  3. Ultimately the buck stops with you so you have to make the call that’s right for your business.

Swatee Surve is founder & CEO of Litesprite, a company that builds game to help people manage chronic health conditions. Prior to starting Litesprite, she worked at Microsoft, Nike, T-Mobile, Premera Blue Cross, and Kodak building technology-based business that disrupted healthcare. These efforts led to several commercialization efforts and patents including Nike's first wearable technology patents.  

The 5 things startups should know about doing PR

by Bill Hankes

You’ve got the next big startup idea, but how do you get the word out? The trick is knowing when and how to do it. Here’re some guidelines to think about if you want to get some press.

  1. You get one shot, make it count. The mistake many startups make is trying to get attention too early, and often for the wrong reasons, like to attract investor attention. Build your product or service, get user feedback, and gain some traction. Then think about PR. There’s no penalty for waiting, but there are many for going too early. Companies change or pivot. Becoming a media darling before a pivot just means a spotlight will be cast on your strategy changes. Tipping your hand to the competition in favor of some early buzz is another mistake. And setting expectations in the press that don’t pan out later may harm your chances of gaining further attention down the road. Wait till you’ve built some success. That makes a good story.

  2. What’s your story? Think about what you want people to be saying about you in a year, and figure out what proof points, customer wins and technology developments you’ll need between now and then. With this “story arc” you can plan out the individual stories you want to tell along the way

  3. Know what’s news, and what isn’t. Because you have a new product or deal or executive may be good news for your company, but that doesn’t make it newsworthy in the eyes of journalists. It’s up to you to make the announcement relevant. Does it tie into a bigger trend, like the shared economy or Internet of Things? That helps. Is your product disruptive? Better yet. That creates tension that makes a story interesting. Have your founders done something relevant in the past, like created a massive exit or help found a breakthrough technology. All of these are elements that help shape a story.

  4. Timing is everything. Don’t put out a blog on Friday afternoon and expect coverage. Similarly, don’t contact a reporter about “news” the day after it was news. If you really want news, plan it around a reporter’s schedule. Contact appropriate journalists a few days ahead of time and if he or she decides to write, then agree to post your blog at the same time.

  5. Pitch perfect. There are a lot of wrong ways to pitch a reporter. Don’t send your announcement or a long email. Don’t assume your targeted reporter will write. Instead, send a short note, “Hey [name], I see that you often write about [subject]. My startup is working on something [similar/disruptive/additive]. Is this the kind of thing you’d be interested in discussing?” One of three things will happen. You may hear nothing because reporters get a lot of these emails, but the fact that you approached the reporter respectfully and without assumptions increases the chance that you’ll hear back. The second thing that can happen is that you may get a request for more information. That’s when you send the announcement or the long pitch explaining why your news is, in fact, news. Finally, you may get a response declining your announcement. But this is a win too because now you have the beginning of a relationship. Follow up the next time you have something relevant, or drop the reporter a note if you like something he or she has written—which implies that you’re reading this reporters work, which you should be.

Bill Hankes is founder and CEO of Sqoop, a news discovery service for journalists. Before entering the startup world, Bill worked in public relations for more than 20 years, serving most recently as director of Bing Public Relations at Microsoft, and before that vice president of Corporate Communications at RealNetworks.


The Taxation of Stock Awards: The Law Needs a Fix

If you are a worker rights advocate, I have an issue for you: the taxation of employee stock awards.

I know, this doesn't sound like your typical worker rights issue. This isn't the minimum wage. Or workplace conditions. 

But workers suffer because of how stock compensation is taxed. They suffer a loss of wealth because of the current tax rules. 

Let me explain. Suppose you work for a private company that wants to give you an equity award. The company wants to give you 100,000 shares of stock, which represents less than 1% of the issued and outstanding shares of the company. The company recently had a 409A valuation done and the company's common was valued at $1 a share. 

You can't accept the stock, because you can't afford it. What do I mean? If the company issues you 100,000 shares at $1 a share, you will have $100,000 of taxable income. And because you are an employee of the company, you will have to write a check to the company so the company can do what the law requires--withhold your share of income and employment taxes. 

Most private companies do not have the cash to pay your taxes for you. And if they did, that would also be taxable income to you, compounding your tax problem.

The tax withholding on $100,000 of income is significant. You will have to write a check to the company in the amount of about $30,000 (and maybe more). Most workers don't have this kind of money laying around. So, the worker can't take the stock. The worker misses out. This is bad public policy. 

But wait, you say, can't the worker get a stock option? Sure, but an option is not as good as a fully vested stock award. Why? Because options expire, typically 90 days after a worker quits providing services to a company. And if the worker doesn't have the cash to pay the exercise price and taxes by then, the option expires and the worker misses out.

I think the startup and early stage company ecosystem would be improved if Congress quit taxing transfers of illiquid stock to workers. Workers would benefit. These transaction are illiquid--meaning Congress is not missing out on taxing any cash transfers. The worker could take a basis in the stock equal to what the worker paid for the stock--zero--so that Congress could tax the entire gain later.

What would the benefits of such a fix be?

  • Companies could more readily share actual stock ownership with workers
  • Workers would be more likely to share in liquidity transactions in a more significant manner
  • Worker welfare would be increased.

Congress, could you get on this?

Angel Capital Association Conference Panel Thoughts

I participated in a panel discussion at the Angel Capital Association conference in San Diego today. We talked about Reg A+, general solicitation, the accredited investor definition, and other public policy ideas.

A few things came out of the talk that I wanted to share:

  • When the moderator, Mike Eckert, the Chair of the ACA's Public Policy Committee, asked the room of angel investors which angel groups participated in 506(c) offerings--there were only 2 hands that went up. Almost all angel groups are doing 506(b) offerings only these days.
  • Bill Carleton made a a few great point about 506(c) offerings:
    • In Bill's words, "There is something qualitatively different from a risk perspective in doing a 506(c) as opposed to a 506(b) offering." And I can't quote Bill for the rest of his thought, but his points were:
      •  In a 506(b) offering, an angel certifies he or she is accredited. If the company's belief that the angel is reasonable, that angel will have somewhat of a hard time arguing later that he or she wasn't accredited and is entitled to his or her money back. However, in a 506(c) offering, if the investor wants his or her money back, and claims he or she wasn't accredited--they will be able to argue, if the company didn't do the additional verification work: "The company didn't even obtain the required evidence that I was accredited. The company just took my money."
      • Bill also pointed out that once you do a 506(c), you can't fall back on 4(a)(2), which you can in a 506(b) offering.
  • Kiran Lingam also made great points about 506(c) offerings. The gist of it was--506(c) offerings are in some sense more conservative than 506(b) offerings--because at least the path to compliance in 506(c) offerings is clear. You do the additional verification work.
  • Kiran indicated that SeedInvest discovers that about 10-20% of the companies that come to SeedInvest to do a 506(b) offering can't do one--because they have already generally solicited via a press release, or Tweet or something.
  • How do you make sure you don't inadvertently turn your 506(b) offering into a 506(c)? Be careful. Don't check the box on AngelList to make your solicitation public. Don't Tweet or FaceBook post your offering. Don't issue a press release about your offering. Don't talk to reporters about your offerings.
  • Dan Rosen made the point that if you let non-accredited friends and family into a convertible note round, the fixed price round can't be a 506(c) because 506(c) offerings have to be all accredited only.

In any event, it was a fun panel discussion, and I was glad to participate.


Your Pitch Deck: Suggestions from a Prolific Angel Investor

Pitch decks are a key document in your fundraising effort. When an investor sits down to look at your deck, don't miss the chance to tell your story in the most compelling way possible. Tell a story someone would want to join in. But keep in mind the expectations of your reader. Investors expect a certain format. Pitch decks are their own genre. 

My IP/Tech Transactions guru and partner Mike Schneider and I recently had the chance to sit down with super active angel investor Gary Rubens for a podcast. 

You can listen to Gary on the podcast. But I've also captured what he had to say here about pitch decks. 

First, Gary gave these overarching pieces of advice:

  • Do not have more than 20 slides. Shoot for 12-15.
  • Explain what you are doing in the first 1 or 2 slides.
  • I really like this quote from Gary: "Your deck should stand on its own without you having to talk to it." 

Here is Gary's guide to your slides.

Slide 1. Start with the problem. Explain the problem. Who are you solving it for?

Slide 2. Then explain your solution. 

Slide 3. Include a demo. Angels love demos. 

Slide 4. Market size.

Slide 5. Your go-to-market strategy. 

Slide 6. Your financial model. How do you make money? 

Slide 7. Current traction. User. Sales. Subscriptions. Etc. Whatever it is you are selling. 

Slide 8. Financial slide.  

Slide 9. Team.

Slide 10. Intellectual Property.

Slide 11. The Ask. What do you need? Money. Advisors. Etc.

Gary's guidelines are helpful. If you are looking for more tips on your slide deck, also see these resources:

Cannabis Conundrum – How Do I Protect My Brand?

This is a guest post from Ashley Long.  Ashley has been working with clients on trademark issues related to the newly legalized cannibis industry in Washington.  Ashley was also our guest on The Law of Startups Podcast this week.  

Cannabis Conundrum – How Do I Protect My Brand?
By Ashley K. Long
Washington, Oregon, and Colorado – three states that have given the green light (pun intended) to recreational cannabis.  As cannabis retailers and processors crop up around these states, business owners want to know: how can we protect our brands? 
Federal trademark registration for cannabis specific goods and services is not yet permitted.  However, several regions appear to be permitting registration of trademarks at the state level. 
Oregon and Colorado law permit registration of trademarks for goods or services which are “in use” in those states.  In other words, businesses already selling or producing cannabis branded products in those jurisdictions can apply for state level trademark registrations.  If you haven’t had retail activity around a cannabis brand, you may not yet be eligible for state trademark registration in either of those jurisdictions. 
Washington will allow you to reserve a trademark name for up to a year.  Once your trademark is being used in the state, and before the expiration of the reservation period, you have to make certain to file for the state registration of your trademark.  Otherwise, you’ll lose your place in line.
A quick note on federal trademark registration – even if a business can’t apply directly for cannabis related goods and services, they may be able to seek registration of their trademark for ancillary goods/services.  For example, if the business sells a brand of cannabis and non-cannabis edibles, it may be able to get a state registration for the cannabis products and a federal registration for the non-cannabis products. 
The landscape of cannabis law is changing rapidly.  As more states authorize recreational marijuana use and sale, other areas of the law will continue to evolve.  If you’re interested in learning more about how to protect your cannabis brand, make sure to consult your legal counsel. 

Law of Startups Podcast - Request for Questions and Feedback

Joe and I have been recording the podcast on Monday mornings.  We would love for people to submit questions they have about legal issues facing startups, and we will try to answer/discuss them on the show.  We have to stop short of giving actual legal advice, but if your question isn't too fact specific, we will try to address it on the show.  Let us know what you want to hear about and if you have any feedback on the show.  You can listen on the Podcast page here on or by subscribing through a podcast client.  We also have a forum set up on the Startup Forums Page where you can give us feedback and discuss topics from the podcast.  

Tax Issues on Corporate Formations

You might be wondering, "If I contribute my business to a new corporation in exchange for founder stock, is that a taxable exchange?" Somewhere in the back of your mind you might be recollecting something one of your professors said in college...

For example, say you have been running a software as a service business as a sole proprietor for a couple of years (sole proprietorships are a bad idea in this context, by the way). You are making somewhat decent progress. Maybe you have 500 subscribers at $10 a month. You've talked to some friends, and they've told you that you have to form a corporation or LLC to protect your individual assets. You've decided to form a corporation because you hope to raise angel or venture capital, and you want to grant stock options to advisors and workers.

When you contribute your software and IP and customer contracts and everything else relating to the business to the new corporation for your founder stock, will you trigger a tax?

You should not trigger a tax for federal income tax purposes in this situation. Under Section 351 of the Internal Revenue Code, as long as the property contributors (in this case, just you), hold at least 80% of the stock of the corporation immediately after the exchange, the exchange of the property for the stock is tax deferred. Meaning, your basis in your stock will be the basis of the property contributed. Your holding period should carryover as well. You have to attach a report to your first corporate tax return. Obviously, always consult tax counsel in these situations. There are a variety of special rules that could disrupt the happy answer.

Tax CPA Jordan Taylor has this to say about it:

“Non-recognition of gain under IRC 351 is a valuable avenue for companies and their founders to avoid unintended tax consequences, but a careful evaluation of the facts and circumstances as well as the order of events is crucial to achieving the goal of not paying tax” – Jordan Taylor, founder of

But what about Section 83(b) elections? Do you need to file one if you have contributed property in exchange for your stock? Doesn't Section 83(b) only apply if you are receiving stock for services?

Be careful! Just because you contributed property in exchange for stock doesn't take you out of Section 83(b).

If your shares are subject to service based vesting conditions--meaning, the corporation could purchase them back at the lesser of cost or FMV which repurchase right was lapsing over a service period--you will still want to file an 83(b) election.

Just because you contributed property for your stock does not take you out of Section 83(b).

But what if your shares are not subject to vesting at all--but three years later investors demand that your shares be put on a vesting schedule? Do you have to file an 83(b) then, when you have owned the shares for 3 years? There is a helpful IRS revenue ruling in this context which says no ( even then a protective election could be a good idea--because you won't owe any tax in any event. Always consult legal or tax counsel in these situations.

Be careful out there.

Crowdfunding a Revenue Loan

I was talking to a friend last night, and he was telling me he was trying to raise $100,000 for his venture. He is working on something that would be widely supported in the community. I blurted out, "Crowdfund it with revenue loans under the Washington equity crowdfunding law!"

And he reminded me that we can't do that. That issuing debt is not allowed under Washington's equity crowdfunding law.

But before we got to that--if you don't know--a revenue loan is a loan that typically has the following characteristics:

  • The monthly payment amount is a percentage of the business's revenue in the preceding month. This is why revenue loans are sometimes referred to as royalty based financing. The monthly repayment amounts look like a royalty payment, because they are a percent of revenue. And the revenue base looks a lot like gross revenue--save for a few deductions like customer returns, discounts, etc.
  • The loan is repaid in full when the lender gets a multiple of the amount loaned. Typically anywhere from 1.5X to 3X the amount of the loan.

But to get back to the question--why can't we crowdfund a revenue loan in Washington State under the Washington State equity crowdfunding law?

Because when the Washington State Department of Financial Institutions was finalizing the regulations for equity crowdfunding it concluded that loans were not an appropriate security to sell in an equity crowdfunding offering.

Here is the rule in which the DFI disallowed crowdfunded debt offerings:

(4) The crowdfunding exemption is available only to equity offerings by the issuer of the securities and is not available to any affiliate of that issuer or to any other person for resale of the issuer's securities. The exemption is not available to debt offerings.

What can we do about this? Well, we can all beseech our elected representatives to try to change this rule. In any event, I still think the Washington State crowdfunding law is a good one. But you can't sell debt in that type of offering.

Accredited Investor Definition

On March 9, the SEC's Advisory Committee on Small and Emerging Companies had this to say:

1. As the Commission reviews the definition of “accredited investor” in Rule 501 under the Securities Act of 1933, the primary goal should be to “do no harm” to the private offering ecosystem.  Accordingly, any modifications to the definition should have the effect of expanding, not contracting, the pool of accredited investors.  For example, we would recommend including within the definition of accredited investor those investors who meet a sophistication test, regardless of income or net worth.  As a further example, the tax treatment of assets included in the calculation of net worth should be disregarded. 
2. To take into account the effect of future inflation, on a going forward basis the Commission should adjust the accredited investor thresholds according to the consumer price index.  
3. Rather than attempting to protect investors by raising the accredited investor thresholds or excluding certain asset classes from the calculation to determine accredited investor (which we believe are measures of dubious utility), the Commission should focus on enhanced enforcement efforts and increased investor education. 
4. The Commission should continue to gather data on this subject for ongoing analysis.  

I agree the SEC should do no harm. The same can be said for the SEC's proposed Reg D and Form D rules.

83(b) Elections and Substantial Risks of Forfeiture

You might be nervous. Maybe you didn't file an 83(b) election and now you think you should have. The 30 day deadline has long since passed. 

You talk to your accountant. He tells you that you didn't have to file. You feel somewhat reassured, but you are still nervous. You start reading articles on line and you can't find any solace.

What do you do?

If you want to get a definitive answer on whether you should have filed an 83(b) election or not, and the time is passed, here is what I suggest:

1) Gather all of the documents pursuant to which you received your shares. This would include perhaps a stock purchase agreement. There might be provisions in the company's bylaws that impose rights of first refusal. Maybe you received your stock pursuant to stock options. In that case, you will want to gather all of the stock option plan documents.

2) Once you have gathered the documents, all of them, put them together along with a list of all of them to send them to an attorney or a CPA familiar with these rules.

3) Your attorney or CPA can move through the documents the pretty quickly once they are all gathered and in one place. What he or she will be looking for is this:

  • A buy back right in favor of the company at cost, or perhaps at the lower of cost or FMV.
  • It doesn't matter if you paid FMV for your shares when you purchased them. What matters is whether there were service based vesting conditions on your shares.
  • The most typical service based vesting condition is a repurchase right in favor of the company, at the lower of cost or FMV, which repurchase right lapses over a service period.
  • For example, in the famous Alves tax case, the executive purchased the shares at a dime a share, and the company had the right to buy back a certain number of shares at a dime a share if the executive wasn't still working for the company 4 years later. The executive didn't file an 83(b) election, and disaster struck.

4) Missing an 83(b) election is a terrible mistake, but if the time for making the election has passed, and you are looking for reassurance that you didn't have to file, don't panic. Gather the documents and go see an attorney or CPA familiar with these rules.


Crowdfunding is one of those terms that can mean many different things.

It can refer to non-equity crowdfunding (e.g., Kickstarter) or equity crowdfunding.

In the equity crowdfunding bucket there are a bunch of different possibilities:

  • Title III Equity Crowdfunding under the JOBS Act--which is not yet available.
  • Rule 506(c) all accredited investor crowdfunding--either directly to the public or through portals such as CircleUp.
  • State level equity crowdfunding under various state laws that have been passed in the last several years (e.g., the Washington equity crowdfunding law).

Since Title III Equity Crowdfunding under the JOBS Act is not yet available, private companies wondering about whether equity crowdfunding can help them are really asking about either 506(c) or state equity crowdfunding alternatives.

A quick summary of the pros and cons of 506(c) and state-level equity crowdfunding:


  • No limit on the amount of funds that can be raised.
  • No pre-filing requirement or pre-approval from any securities regulators required.
  • Accredited investors only.
  • Advertising allowing.
  • Form D filing required within 15 days of first taking money.

State Level Equity Crowdfunding

  • Typically there are caps on how much you can raise (e.g., $1M under the Washington law during any 12 month period).
  • Both accredited and non-accredited persons can invest.
  • Pre-approval of securities regulators is frequently required.
  • These offerings can be "integrated" with all accredited investor offerings that are ongoing or within 6 months before or after the crowdfunding offering, blowing those offerings securities law exemptions.

Is equity crowdfunding right for your business? It might be. 506(c) offerings are becoming more commonplace. State level equity crowdfunding offerings are still rare. Time will tell how these two different types of crowdfunding offerings develop. 

In general I think state level equity crowdfunding offerings are going to be best suited for companies that would have historically attempted to raise a friends and family offering from both accredited and non-accredited family members. The new state laws will allow these types of offerings to proceed in a legally compliant manner.


General Solicitation

It used to be that you could not "generally solicit" or "generally advertise" your private company's securities offering. 

This changed with the JOBS Act and the ensuing SEC regulations.

You now can generally solicit or generally advertise your securities offering, but doing so gives rise to additional limitations and work.

The big things that happen when you generally solicit are:

  • You have to take steps to verify the accredited investor status of your investors. You cannot rely on a simple certification from your investors that they are accredited. Instead, you have to ask for their financial statements, or tax returns, to verify that they are. You can also use certain third parties to do this for you.
  • You can only accept investments from accredited investors.
  • You have to check the box on your Form D that you were relying on Rule 506(c). When you check this box, you may draw additional scrutiny from securities regulators.

There are also proposed SEC regulations that would require a bunch of other things, like pre-filing your Form D, filing your offering materials, and other requirements. But those rules are only proposed and not yet final.

The bottom line--there is a reason there hasn't been a rush to do this. But things are changing. 500 Startups generally solicited for investors for its last fund. And the BufferApp company generally solicited its last round. These are probably indications of a trend towards greater use of this alternative in the future.