The promise of the JOBS Act may finally be fulfilled, thanks to a new Regulation A+ rule that goes into effect today. Private companies can now use Reg A+ to raise up to $50 million from the general public without conducting a full blown initial public offering. They can also “test the waters” before they take the plunge.
This is potentially big news for entrepreneurs and investors alike. As growth companies delay IPOs and continue to raise money on the private market, the Reg A+ exemption gives everyday investors a chance to participate in deals that were previously the exclusive domain of wealthy investors and venture capitalists. Not everyone is happy about it though: the states of Massachusetts and Montana have mounted a legal challenge to the law, which pre-empts state review for offerings above $20 million. (Yes, Massachusetts, the same state that blocked its citizens from investing in a “risky” four-year old company called Apple Computer when it went public in 1980!) Even as that case wends its way through the legal system, companies are starting to use the revised law today.
Sara Hanks and Andrew Stephenson of CrowdCheck offer their view and insights on the revised rule.
Revisions to the SEC’s Regulation A (nicknamed “Regulation A+”) went into effect this morning, and there’s been the usual mixture of breathless hype and bored yawns. Some people say this is the biggest change to securities law since the Jurassic age, while others say that no-one is going to make use of the revised Regulation. As is so often the case, the truth is somewhere in the middle.
The enthusiasts are saying the SEC has opened up investment to a whole new class of investors. That’s not exactly true. Regulation A has been around since 1936. It’s an exemption from registration with the SEC for companies which are raising a limited amount of money and which undergo an SEC review of their offering materials. Under Regulation A you have always been able to make public offers to non-accredited investors. The SEC hasn’t opened up access to a whole new class of investors, because those investors have always been there.
The problem with Regulation A in the past was that it was not attractive to companies seeking investment. In 1996, Congress “preempted” state review of offerings that were registered with the SEC (such as IPOs) and offerings made under the private placement rules (such as Rule 506 offerings made to accredited investors). Regulation A was not included in this preemption, and so offerings under Regulation A continued to have to go through the review process at the state, as well as the federal level, adding to the cost and complexity.
Understandably, especially when you consider that offerings under Regulation A were limited to $5 million in size, companies decided to raise funds using options that did not require state review, and Regulation A became little-used. In recent years, there have been only a handful of filings every year. One of those successful filings was made by the real estate platform Fundrise. The securities were offered to people in Fundrise’s home market (DC, Virginia and Maryland) and the offering was very popular, but took a long time and serious legal fees.
The JOBS Act in 2012 ordered the SEC to adopt rules raising the limit on Regulation A offerings to $50 million. The SEC revamped the rules completely, creating two “tiers,” and completely preempting state regulation for some offerings.
How it Works
In Tier 1 offerings, issuers may raise up to $20 million over a 12 month period, including no more than $6 million on behalf of selling securityholders (such as founders looking for liquidity). Issuers begin the process with the SEC by filing an “Offering Statement,” which includes a prospectus-like “Offering Circular,” on Form 1-A. These materials are subject to review by the SEC and any state in which the company is planning to offer its securities. This procedure is essentially the same as for the current version of Regulation A, but with a larger offering limit.
In Tier 2 offerings, issuers may raise up to $50 million over a 12 month period, including no more than $15 million on behalf of selling securityholders. While the issuer completes the same Form 1-A and Offering Circular as in Tier 1 offerings, the only review will be by the SEC. The price for this preemption is that companies will be required to provide audited financial statements in a specified format and be subject to ongoing reporting requirements. Additionally, individual investors in Tier 2 offerings who are not “accredited investors” will be limited to investing up to 10% of the greater of their annual income or net worth.
With the ability to “test the waters,” Regulation A offers a relatively risk-free way of determining whether to go ahead with the offering.
Tier 2 also offers an extensive ability to “test the waters” to see whether there’s enough investor interest to warrant engaging lawyers and accountants, which means that companies can use the power of the internet and the power of their crowd to make an informed decision when it comes to weighing capital-raising alternatives.
Costs: Reg A versus an IPO
As Regulation A is a public offering of securities, it is not without its costs. The most appropriate comparison is to the costs of conducting an IPO rather than an offering under Rule 506 of Regulation D, because there are express disclosure requirements and SEC review of the filing. According to a 2012 report from PricewaterhouseCoopers LLP, the average costs incurred for public offerings raising up to $50 million, excluding the underwriter discount, is $2.1 million. That includes $600,000 for auditing fees, $1 million for legal fees, and $500,000 for printing costs, filing fees, and miscellaneous costs.
In contrast, all-in for a Regulation A offering will likely be around $100,000. That includes the accounting fees, and legal fees. This does exclude the fees paid to any underwriter or securities intermediary. When doing the math, a Regulation A offering of only $2.4 million will have the same percentage cost as the average IPO of less than $50 million.
Still, Regulation A likely will be most useful for capital intensive growth companies, such as bio-tech and clean energy, that are looking to raise over $10 million. But that’s not to say that any company seeking to raise more than a few million dollars but less than $50 million would not benefit from Regulation A.
A Regulation A offering can’t be made without the assistance of a securities lawyer experienced in making SEC filings, and companies will also need accountants (even in Tier 1 offerings, some states require audited financials). But with the ability to “test the waters,” Regulation A offers a relatively risk-free way of determining whether to go ahead with the offering. Today, Regulation A becomes a viable option for capital-raising by early-stage and small companies offering to a wide range of investors.
Sara Hanks is co-founder and CEO of CrowdCheck, an Alexandria, VA-based firm that provides disclosure and due diligence services. Andrew Stephenson is the CrowdCheck’s Director of Research Operations and Client Services.