It would be an exaggeration to say that the SEC purposely sabotaged the Jobs Act, a rare bipartisan law adopted by Congress in 2012 in light of an almost 10% unemployment rate. It would be more accurate to say that the SEC, purportedly in the name of investor protection, decided to create expensive and burdensome disclosure requirements which significantly undermined the objective of job creation, in most cases long after the deadlines contained in the Jobs Act. However, the SEC did leave some significant loopholes to avoid its expensive disclosure regime which will be useful to CFOs, particularly in the case of Regulation A+ and securities crowdfunding under Section 4(a)(6) of the Securities Act of 1933. As I have detailed in my book, a few of these loopholes are as follows.
Users of Tier 2 of Regulation A+ can avoid expensive SEC ongoing reporting requirements by making certain that there are less than 300 shareholders of record in their offering. The purpose of keeping the shareholders of record in a Tier 2 offering below 300 is that all the expenses are confined to the year of the offering and can be financed out of the proceeds of the offering, with no ongoing reporting obligation. Tier 2 preempts state review required by Tier 1 of Regulation A+. Merit review states (such as Pennsylvania) could require, in a Tier 1 offering, impounding of offering proceeds, lock-in or escrows of promotional shares, restrictions on insider loans and advances, restrictions on unequal voting rights, limitations on underwriter compensation and expenses, etc. as a condition of state registration. Moreover, that condition could apply to the entire offering regardless of which state in which it is offered or sold. Therefore, Tier 1 offerings, while appearing less expensive, may in fact be completely unsuitable.
A loophole in the SEC crowdfunding regulations is the fact that amounts raised in nonsecurities crowdfunding (which offer t-shirts, products, etc. to contributors) are not integrated with amounts raised in subsequent securities crowdfunding. This permits startups and other crowdfunders to minimize the amount of capital they must raise in the subsequent securities crowdfunding, to limit the subsequent securities crowdfunding to debt securities, or to even postpone the securities crowdfunding until the company’s valuation has increased. More important, nothing in the SEC rules prevents a securities crowdfunder from inserting a provision in its offering permitting redemption by the company of these securities at their fair market value. Such redemption avoids the expensive, ongoing SEC reporting requirements for securities crowdfunders and also permits the elimination of the securities crowdfunding investors if they are objectionable to a private equity fund or to other subsequent private investors.
Both Regulation A+ offerings and securities crowdfunding offerings are much more attractive to investors if they believe that a liquid marketplace will be established as such time as the securities can be sold. Therefore, it is helpful to have a designated broker-dealer that would be willing to make a market in these securities pursuant to SEC Rule 15c2-11 once they are saleable. Compliance with this SEC rule does not require expensive periodic filings with the SEC and can be accomplished very inexpensively.
Even using loopholes will not necessarily reduce the cost of the first securities offering to a reasonable expense figure. However, the same or a similar disclosure document can be used in future offerings, which will make such subsequent offerings much less expensive.
It is unfortunate that job creators must look for loopholes in complex and burdensome SEC disclosure rules in order to avoid having their expenses use up much of the offering proceeds. For an example of when this occurred in a Tier 1 offering, see the GroundFloor Finance Inc. Tier 1 offering discussed in this article on Crowdfund Insider. The only way to avoid such an unfortunate result is for the CFO to carefully plan the overall financing strategy with a sophisticated securities lawyer.
Frederick D. Lipman, Esq. is a partner in the Philadelphia office of Blank Rome LLP. Mr. Lipman recently authored a book on crowdfunding and other new financing methods, titled “New Methods of Financing Your Business” (March 2016). Mr. Lipman advises a wide range of clients in corporate and securities issues such as: IPOs; corporate governance; mergers and acquisitions; securities, venture capital, and public offerings; corporate litigation and other business issues; international commercial transactions; banking, bankruptcy, regulatory, loans, and workouts; and insurance matters.