Jobs creation and wages are in the spotlight again by voter demand this presidential election year and receiving attention from both Republican and Democratic parties. This begs the question whether an improved version of Regulation A under the JOBs Act of 2012 offers a practical solution for smaller companies to access capital and create new jobs. More than one year ago, on June 19, 2015, the U.S. Securities and Exchange Commission adopted an amendment to existing Regulation A allowing companies to raise up to $50 million in capital in a 12-month period from both accredited and (in some circumstances) non-accredited investors in an exempt offering. Many have designated this private placement exemption, (nicknamed Regulation A+ or just Reg A+) as a mini-IPO given the required SEC review process. Entrepreneurs have been hopeful the exemption will provide a “miracle solution” for quickly raising significant capital from the public and without the expense, complexity and detailed disclosure requirements of a traditional IPO.
The JOBS ACT of 2012
As background, the JOBs Act bill was passed and signed into law with strong bipartisan support to increase U.S. job creation and economic growth by easing access to capital markets for small business. Later, the 2015 rules were adopted by the SEC, as directed under the JOBS Act, to resuscitate a little-used offering exemption, the use of which was limited by state law roadblocks. A review of SEC filings shows Regulation A+ started off slowly but seems to have picked up some momentum. A company in the United States or Canada not already subject to on-going reporting requirements of the Securities Exchange Act of 1934 or that has not failed to file reports required by Regulation A over the last two years of the company’s existence may avail itself of Regulation A+. A company is ineligible if it:
- Is a development stage company with no business plan or purpose
- Has plans to engage in a merger or acquisition
- Has employees, affiliates, placement agents or underwriters who are considered “Bad Actors”
- Is a business development company or required to be registered under the Investment Company Act of 1940,
- Has a registration statement that has been denied, suspended, or revoked within the last five years, or
- Is an issuer of fractional interests in oil, gas or mineral rights.
Under Regulation A+ the SEC has established two tiers of fundraising with varying requirements for qualification and disclosure to the public. Each tier permits general solicitation and the use of websites and social media for potential investor communications appealing to a younger audience and an economically diverse range of offerees in the new age of investing through “crowdfunding.”
Under Tier I, an issuer may raise up to $20 million in a 12-month period with unaudited financial statements and no on-going obligation to file with the SEC other than an exit report within 30 days of completing the offering. However, if an issuer uses Tier I, the issuer must make state blue sky filings in each state where it seeks to raise capital; not a straightforward or inexpensive process. As a result, some issuers may elect a Tier II offering.
Tier II allows the issuer to raise over $20 million and up to $50 million within a 12-month period. However, Tier II offerings are subject to a restriction on the amount of investment that can be made by a non-accredited person to no more than 10 percent of the greater of such non-accredited purchaser’s (1) annual income or net worth if a natural person; or (2) revenue or net assets for such purchaser’s most recently completed fiscal year end if a non-natural person.
Additionally, the issuer must file audited financial statements for the prior two years, and file annual, semiannual and current event reports with the SEC. But it will be relieved from the rigors of blue sky laws to some extent as Tier II securities are exempt from state review as a “federally covered security.” Significantly less time-consuming notice filings may still be required by certain states for Tier II offerings.
Even more importantly, and perhaps the biggest benefit to proceeding with a Regulation A+ offering, the SEC allows the issuer to “test the waters” prior to submitting an offering circular to the SEC. This means the issuer can solicit interest from the public to determine if there is sufficient investor interest before it expends the time and money to prepare and file an offering statement with the SEC. However, the issuer is NOT permitted to accept any funds from any investor until after the SEC qualifies the offering. If an issuer receives positive indications of interest from potential investors, the issuer may then elect to file a Form 1-A Offering Statement with the SEC to obtain SEC qualification.
Once the SEC qualifies the offering, the issuer can accept funds. The issuer may elect to be quoted on the OTCBB, other over the counter platforms or listed on an exchange so that its securities are publicly tradable. If the issuer elects to take this further step, its securities will be freely tradable subject to limitations for affiliates, statutory underwriters and under state securities laws.
The benefits discussed above have caused many entrepreneurs to believe this Regulation A+ offering is a dream come true. But the reality is a bit different. There is no question that Regulation A+ has its benefits and is a great new tool available for entrepreneurs. However, Regulation A+ is definitely not an inexpensive and fast way to raise capital from the general public and achieve public reporting company status.
First, let’s discuss the cost. Conducting a Regulation A+ offering, assuming you move beyond the “test the waters” phase and submit an offering circular to the SEC, is not cheap. If you examine the legal fees charged to issuers utilizing Regulation A+ since its adoption in June 2015, you will note a range of legal fees between $75,000 and $150,000, and in some cases as high as $500,000. If the issuer selects Tier II it becomes obligated to annual on-going reporting requirements that will add legal and audit costs for as long as the company remains public. These costs are not insignificant. This is due to the Form 1-A offering statement’s disclosures and transparency, listing of potential risk factors, use of proceeds, plan distribution for the securities, related party disclosure, management disclosure, operations, capital resources and financial statements.
Further, in order to “test the waters,” you will expend some time and money on sales literature, a term sheet describing the proposed offering, and presentation materials. In addition, you will need to decide how to market your proposed offering to the public. There will not be any investors unless you can reach an audience. Thus, you may need to have a marketing firm or placement agent engaged to assist in the general solicitation. Again, this can be expensive, with no guarantee that the issuer will raise a penny. Assuming you have the ability to raise capital through a private offering under Regulation D, the private offering is likely to be much less expensive and less complex.
Another bit of reality is that a company may incur more liability exposure using Regulation A+ than other fundraising exemptions.
Needless to say, if you plan to market to the general public as opposed to a few private investors, the liability exposure under Regulation A+ to the issuer will be higher than a private offering to accredited investors under Regulation D. Since many investors identified through social media solicitations for the Regulation A+ offering could be non-accredited and unsophisticated, the potential risk to the issuer from these stakeholders being a part of the company should not be taken lightly and should be added to the company’s securities exposure.. The Regulation A+ offering will have the full risks of liability under federal securities laws with express remedies for investors for material misstatements, whereas in a Regulation D private offering the claims must rely on fraud or recklessness – a more difficult burden for the investor to meet.
If your company accepts the costs and risks described above, your executive team should next analyze whether the company has the infrastructure and personnel in place to comply with securities laws and deal with the administrative burden of having perhaps hundreds of shareholder investors, each with his or her own demands and expectations. Is your company and its management team ready to live in a fish bowl?
Will your company require future financings after the Regulation A+ offering? Will the company need to raise additional capital through equity in the future, or will debt be a viable option? If additional equity financing will be required consider the possibility that angel investors, venture capitalists and even institutions may not be willing to participate in future financings if they are unable or unwilling to deal with the risks set forth above.
Finally, if your company offers its securities to the public directly, without engaging an SEC registered broker-dealer, at the federal level it will not be a broker-dealer but the associated persons of the company (management and employees) who will need to comply with rules and interpretations to avoid acting as brokers. At the state level, some states will require your company to register as a dealer and require registration of individuals making the offer as agents of the issuer.
Regulation A+ allows emerging companies to test the waters at minimum cost before deciding to commit to a more expansive process of public disclosure. If you are interested in conducting a Regulation A+ offering, highly experienced securities counsel and auditors are critical to minimize the risks and exposures while providing the appropriate guidance and structure to maximize potential for success.
Rebecca G. DiStefano is an attorney and shareholder at Greenberg Traurig. She concentrates her practice in the areas of securities regulation, corporate finance, corporate governance, private equity, venture capital, and mergers and acquisitions law. Rebecca counsels public and private companies in areas including angel financing, debt and equity financing, registration of securities under the Securities Act of 1933, registration under the Investment Advisers Act of 1940, continuing disclosure requirements of the Securities Exchange Act of 1934, initial and continued listing of securities on the stock exchanges and electronic quotation systems and the creation and organization of non-U.S. regulated investment vehicles including private equity funds and hybrid funds. Rebecca regularly represents clients before government agencies and SROs including the Securities and Exchange Commission and FINRA.
Bruce C. Rosetto is an attorney and shareholder at Greenberg Traurig. He represents private and public companies, private equity funds, and investment banks. He has extensive experience in public company securities work, private placement financings, corporate governance, and alternate assets. His practice focuses on entrepreneurs and small to middle market public companies throughout the United States in a variety of industries, including life sciences, bio- tech, banking, real estate, environmental, manufacturers, technology, entertainment and many
others. He also advises clients in connection with raising capital for and establishing regional centers to administer, projects qualifying for investment under the EB-5 Entrepreneur Investment Visa Program.