The SEC’s Small Business Capital Formation Advisory Committee (SBCFAC) met this week to discuss Regulation A.
Regulation A or Reg A+ is a securities exemption that received an update under the JOBS Act of 2012 – the legislation that legalized online capital formation (investment crowdfunding). Prior to the JOBS Act, few firms used Reg A. The update was meaningful as it pre-empted (Tier 2) state review for primary offerings. While there was a lot of enthusiasm out of the gate, the securities exemption has been in decline over the past couple of years partly due to the challenging economic environment.
Currently, an issuer may raise up to $75 million using Reg A in a securities sale that requires a scaled level of disclosure. Offering documents must be qualified by the SEC prior to the sale, but once approved, a firm may sell securities to both non-accredited and accredited investors. These offerings may be promoted online. An issuer may also choose to allow the securities to trade via an exchange or marketplace following the completion of an offering. This characteristic has led some to describe the exemption as a mini-IPO type vehicle.
At the SBCFAC meeting, Daniel Forman, a partner at Lowenstein Sandler, shared a presentation on Reg A. He outlined what works and what may need to be improved.
Regarding the advantages of using Reg A, Forman bulleted out the following:
- Offering Size ($75 million – Tier 2)
- Scaled Disclosure
- More manageable financial statement requirements
- Access to a broad investor base
The firms that are a good fit for Reg A:
- Companies with strong brand recognition
- Companies with a loyal and engaged user base
- Firms that are good at self-marketing
- Companies that are not ready for an IPO
- Real estate platforms or small REITs
- Companies that have maxed out Reg CF ($5M funding max)
Must take into consideration if pursuing a Reg A offering:
- Reg D is easier and remains the funding exemption of choice
- If you do a Reg A, it can complicate future funding down the road
- There is a high upfront cost
- While disclosure is simplified, it remains a complex system to navigate
- Marketing or promoting a Reg A can be difficult and lacks the infrastructure of a traditional IPO
What should be done to improve Reg A?
- Deal with state preemption concerning secondary sales
- Build a stronger ecosystem and market to support the exemption
- Reconsider tiers and reasons why a firm may use the exemption
- Reg A could be a path to fix the small IPO market
Forman stated that the cost to do a Reg A securities offering may range from $100,000 to $500,000, which is a substantial amount. Repeat issuers can reduce this cost. Once again, Reg D is far easier and less costly than pursuing a Reg A, as you just need to submit a notice filing.
State blue-sky preemption on Secondary trading is a no-brainer. Policymakers made a mistake when they only pre-empted primary offerings when Reg A received its update. Unfortunately, state securities regulators will seek to block this because they intensely guard their relevance, using FUD to sway opinion away from common sense.
An increase in the funding cap is probable and legislation has already been submitted to increase the funding cap from $75 million to $150 million. This could make the exemption more appealing for larger, more established firms.
As alluded to by Forman, Reg A could emerge as a vehicle to reanimate the moribund IPO market, which has been in decline for years. Today, going public is more of an exit than an entry point. Successful private firms seek to stay private for as long as possible, thus cutting out most of the retail investors from the capital gain opportunity.