This week will mark three months since revisions to the SEC’s Regulation A (popularly known as “Regulation A+”) went into effect. It’s still early, but there have been a couple of dozen filings made under the new regs. What can we learn from these early filings?
A lot of people are not getting A+ grades, for a start.
When you look at some of the filings made recently under Regulation A, you might get a negative impression with respect to Reg A companies and their advisers. Some Offering Circulars look less than professional, and that’s putting it tactfully. It might help if you think of Regulation A companies in three categories:
The zombies. There are some filings that are internally incoherent, offering securities that make no sense. Some of these are holdovers from the old Regulation A regime. In general, a filer that isn’t doing anything new or complex and that is now on its sixth amended filing (meaning that the SEC Staff reviewing the filing has given the issuer comments six times and the company still hasn’t gotten it right) is not ever going to get “qualified” by the SEC (which is the step that has to take place before any securities can be sold).
The opportunists. There are a few new filers that seem to be viewing Regulation A as an opportunity to get risk-free money from the Internet. Set up a company, pitch an idea and see if anyone wants to throw in some money to fund it. If these people have no skin in the game, why should investors fund them.
The real companies. There are electric car companies, real estate developers, marketing companies and software companies. Some of them are very new, but they do have teams with solid experience and properly thought out business plans.
We have to hope that the real companies, which will be the only ones who actually get qualified by the SEC and sell their securities, will form the backbone of this new market.
With that, here are some additional insights and lessons from the front lines of Reg A+.
Is anyone being stealthy?
The rules permit first-time filers to file confidentially. You may wish to do this for a number of different reasons, such as not alerting your competitors. We don’t know how many companies might have filed confidentially, but we will see them as they come out of stealth mode, because they have to be publicly filed for at least three weeks before the SEC will “qualify” them, which is the step that has to happen before binding sales of securities can be made.
You can’t do this without a lawyer
Seems like some people are trying to do this on the cheap. You really do need a securities lawyer to do this. Some filings have been made following the requirements of Regulation A as it used to exist, prior to June. That doesn’t work. Some filers don’t seem to understand what dilution means. Others seem to think that they can provide information to potential investors on a confidential basis. They can’t. This is a public offering and all potential investors have to see the same information.
And some folks seem to be missing legends (the compulsory warning language) on the cover page—and the SEC cares about its legends, that’s why they are compulsory. There are legending requirements in at least three different places in the rules and the Form 1-A, so you have to know where to look. You shouldn’t have to pay a lot for a lawyer, but you do have to have someone who knows how to do SEC filings.
Regulation A filers who engage an experienced lawyer will avoid making mistakes like saying that they are “public companies” (they are not; that term applies only to companies that have fully registered with the SEC) or “registrants” (ditto). Copying text from other filings with the SEC doesn’t really work in this context; you have to understand that Regulation A is an exemption from full registration and the disclosure requirements are scaled down,
Don’t file an incomplete document
When the SEC requirements say “substantially complete” they mean “complete in substance,” not “mostly finished.” The only things that can be omitted are details with respect to underwriting arrangements and pricing. You can’t put information about the company in brackets or leave blanks.
Financials are required from the beginning
Tier 1 of Regulation A (which is the version of Reg A where you have to file with the SEC and the states) doesn’t require audited financial statements (although some states do). Tier 2 (filing with the SEC only) requires audited financials. This means that if you check the box in Form 1-A to say you are filing under Tier 2, you need to attach audited financials. A couple of filers have done that wrong, and seemed to assume that because they had no operations, they didn’t have to get an audit. Nope. There are no special exceptions for newly-formed companies, but you can file a balance sheet “as of inception” if you are a relatively new company. That means you get an audit for the day your company was formed, and of course this will include only the balance sheet, because there will be no income or cashflows to record. That should be relatively cheap. Bear in mind that future audits will of course be more expensive.
The audited financials and the auditors’ consent to their being included in the filing must be filed as part of the first filing with the SEC. Other “exhibits” to the filing can be filed later, but not the auditors’ consent. If you file without financials (audited where required) and consent you will get a call from the SEC filing desk telling you that the SEC will not even look at your filing until the financials and consent are properly filed.
Get to know EDGAR
You file with the SEC on the EDGAR filing system. EDGAR was built in 1984. He’s old and he’s cranky. You don’t just upload documents onto EDGAR, first they need to be EDGARized – put into a file format that poor old EDGAR can digest. There’s a dumbed-down HTML option, or if you are still playing the original version of Mario Brothers and don’t care what your filing looks like, you can use ASCI. You should care what your document looks like, because you should be using social media to send potential investors to see your filing on EDGAR. Be patient with EDGAR and do not click the “submit” button twice because then you will have filed twice and you will have to file a withdrawal request for the duplicate version.
How many risk factors do you really need?
Not that many. I know it’s tempting to throw in every risk factor you’ve ever seen (including stuff that clearly does not apply to your company), but 25 [sic] pages of risk factors is getting a bit much. You overwhelm and bore the reader and if the potential investor thinks that this is all boilerplate he’ll ignore the whole section and risk missing something he should be focussing on. The best disclosure is disclosure that is read and understood. We know that if a meteor hits the earth the company will be adversely affected. We might not know the extent to which the company is dependent on the availability of tantalum. Tell the reader things he does not already know.
Reg A is for startups
There was initially some debate about whether Regulation A would be appropriate for complete startups. Would it be too expensive? It seems like the answer to that is “no.” There are some very early-stage companies making offerings under Regulation A, many of them under Tier 2.
We are still waiting for the first of the companies filing under the revised rules to be qualified by the SEC, which should happen within the coming month. (Groundfloor, a real estate crowdfunding platform, recently had its Regulation A offering qualified by the SEC; however, it started the process in 2014 under the old Reg A regime). Once that happens, sales to investors can be made. That’s when we can start assessing whether this market is a success.
Sara Hanks is cofounder & CEO of CrowdCheck, a company that provides due diligence and disclosure services for crowdfunding and online investments.