By now, the startup world has heard the news. Finance blogs are ablaze, and twitter feeds are lighting up with word that capital just became a whole lot easier to access. Entrepreneurs from coast to coast are leaning back in their chairs, greedily steepling their fingers together like Mr. Burns…or are they?
Let’s quickly review the facts: On March 26, 2015, the Securities and Exchange Commission (SEC) took action to resurrect the long-underutilized Regulation A, which previously provided limited relief to entrepreneurs raising up to $5 million in capital per year from accredited investors only, from the onerous requirements of the IPO process—but the restricted nature of the relief rendered it too costly, and as a result, it was relegated to the regulatory cemetery of dead-letter laws.
The new rules revive the promise of Regulation A by raising the cap and streamlining the involvement of state securities regulators. Under “Reg A+” companies can raise up to $50 million per year from any investor (to protect the retail investment community, investments from non-accredited investors will be capped at the greater of 10% of the investor’s net worth or annual income). If the raise is below $20 million—referred to as “Tier 1”—the state securities regulator will still review the offering (together with the SEC), but the company will not need to obtain annual audits or file regular disclosure reports (a sub-$20 million issuer is permitted, however, to opt into Tier 2). Between $20 and $50 million—referred to as “Tier 2”—Reg A+ “preempts” state securities laws—meaning that the SEC’s review process will supplant completely any state-law requirements for local review, but the companies will be required to provide audited financial statements and, if the issuer has at least 300 shareholders of the subject security, file annual disclosure reports.
Supporters tout the new rule as a bellwether for the “mini-IPO” marketplace. In the old days, fast-growing companies went public much earlier in their growth cycle (compare Apple’s IPO in 1980—which raised just north of $100 million, to Alibaba’s recent record-breaking IPO of $25 billion). In recent years, there has been an undisputed trend of businesses resisting the public markets as long as possible, both to increase the capital returns for founders and early investors, as well as to avoid the heavy regulatory burden of creating and managing a public company. Reg A+ advocates argue that the mini-IPO market will provide small business with many of the traditional benefits of the public offering process, including improved valuations relative to traditional private offerings (due to the unrestricted nature of the securities) with scaled down regulatory costs.
But critics argue that the social media buzz swirling the announcement of Reg A+ is, well, much ado about nothing. Silicon Valley lawyers at major law firms such as Wilson Sonsini and Cooley have gone on record saying that the new rules will not move the needle, at least among tech firms in the valley. Among other things, they question the value of a mini-IPO market relative to the existing private placement market, which is already a deep source of funding that is unrestrained by the disclosure, audit and filing requirements that will accompany Reg A+ capital. Others posit that Reg A+ has promise, but that we’re years away from any meaningful activity under the new rules. They argue that a vibrant Reg A+ market will only come on the heels of further developments in the technology platforms and administrative services that will facilitate these offerings—and subsequent secondary trading of Reg A+ securities—on a large scale.
Like many beginnings, questions abound and answers are speculative at best. While the offering limits have been raised, and to an extent, the overlapping state and federal regulation has been harmonized, it’s not clear yet whether these sound bites are evidence of meaningful change. At the heart of the debate is a question about trade-offs: will the combination of retail market access and preemption be a large enough carrot to fuel the Reg A+ issuer pipeline, or will firms ultimately retreat to the relative simplicity of traditional private offerings?
One thing is for sure—Reg A+ provides one of the long-missing pieces in the capital formation on-ramp—together with the now-ubiquitous Rule 506(c) offering and the pending rules on equity crowdfunding, small businesses are poised to possess a variety of capital formation alternatives for each stage of their growth.
(Editors Note: a clarification has been incorporated regarding Tier 1 & 2 qualifications versus an earlier version of the article)
Josh Kalish is General Counsel at Ingress Capital an equity crowdfunding platform based in New York City. Josh was previously an Associate at the law firm of Cleary, Gottlieb, Steen & Hamilton LLP.