Regulation A+, the Holy Grail for Startups!
Or, is it?
Over the past few months you may have heard some chatter about Regulation A+ and how it changes everything when it comes to crowdfunding for startups. Not surprising. In fact, Regulation A+ only went into effect just recently on June 19, 2015.
If you don’t already know, Regulation A+ is actually an amendment to the former Regulation A of the U.S. federal securities laws. This amendment comes under the JOBS Act, which was signed into law in 2012 to expand and ease methods for raising capital, and relax the regulatory burden on smaller companies.
The former Regulation A allowed companies to sell stock publicly in offerings of up to $5 million— a sort of “mini-public offering.” The main problem with former Regulation A was that, although businesses could avoid registration with the SEC, there was no state pre-emption, so they still had to register at the state level. Considering the relatively small offering size limit, this regulation was not very popular and was not widely used.
The JOBS Act came to the rescue! Title IV of the JOBS Act, Small Company Capital Formation, directed the SEC to amend Regulation A under the Securities Act of 1933 (the “Securities Act”) so that it would exempt from Securities Act registration certain offerings of up to $50 million. The SEC adopted final rules and forms implementing this directive by amending Regulation A (SEC Release No. 33-9741 (adopting release)). These final rules and forms became effective on June 19, 2015.
The Primary Elements of Regulation A+
There are two tiers of offerings under Regulation A+, and both allow you to raise money from accredited and unaccredited investors.
- Tier 1 allows for offerings up to $20 million in a 12-month period.
- Tier 2 allows for offerings up to $50 million in a 12-month period.
Accredited and Unaccredited Investors
- Under Tier 1, there are no limits on how much an accredited or unaccredited investor can invest up to the $20 million threshold.
- Under Tier 2, there is an investment limit for unaccredited investors. The investment limit is equal to 10% of the greater of: annual income or net worth (for individuals); or annual revenue or net assets (for LLCs or corporations).
Ongoing Reporting Requirements
- Under Tier 1, there are minimal ongoing reporting requirements, which include an exit report on Form 1-Z when the offering is completed or otherwise terminated.
- Under Tier 2, companies have continuous disclosure obligations analogous to those of a public company, including annual reports on Form 1-K, semiannual reports on Form 1-SA, and current reports (interim material changes) on Form 1-U. The financial statements in the annual report must be audited.
- Under Tier 1, there is no state pre-emption, which means that companies will still be required to register at the state level. This can be a challenging, costly, and lengthy process in and of itself.
- Under Tier 2, there is state pre-emption, so there is no need for registrations at the state level.
The Filing Process
Under both Tier 1 and Tier 2, the company must file an offering statement with the SEC on Form 1-A. Included with that Form 1-A, is an offering circular, similar to a PPM (private placement memorandum), which must also be filed with the SEC. The offering circular must be shared with prospective investors before they can invest, again much like a PPM.
It is important to note that the Form 1-A is subject to an SEC review and comment process that is similar in many ways to a registration with the SEC. Ultimately, the Form 1-A must be approved and qualified by the SEC before the company can actually raise any capital.
What Does All this Mean?
It’s Going to Take a While
So, what does all this mean? Well, for starters, it means that if you are planning to raise capital through a Regulation A+, you better be prepared for the filing and qualification process. For both Tier 1 and Tier 2, you will need to file an offering statement and an offering circular with the SEC, and the SEC gets to review and comment on your filing. There’s no telling how long the SEC will take to review your filing, how many comments or questions they may have, or whether and when they will actually qualify (approve) your filing. If history is any indicator, it is notable that according to the SEC, from 2002 through 2011, former Regulation A filings took an average of 228 days to qualify. And, if you choose to operate under Tier 1, you will still need to contend with the approval process at the state level, which could also take a similarly lengthy period of time.
It’s Going to Cost a Lot
And, what about actually preparing the offering statement and the offering circular on Form 1-A? Well, unless you’re a glutton for punishment, more likely than not, you’re going to need the services of an experienced securities lawyer to handle the filing process. In addition, if you choose to run under Tier 2, you will also need to engage a qualified auditor along with an experienced securities lawyer to prepare and file the ongoing reports. Clearly, these services are not going to come cheap. This type of legal service could easily come with a $50,000 or higher price tag (and probably much higher).
The Bottom Line
The bottom line, after considering all the regulation and legal costs that come with a Regulation A+ offering, is that it’s unlikely any true startup will be a position to use this new registration exemption. While it would open up the capital markets enormously for startups to be able to solicit and crowdfund unaccredited investors, the legal costs and regulatory burdens likely make Regulation A+ out of reach.
The Good News
So, where does that leave us? Well, the answer still comes from the JOBS Act. The good news is that the new Rule 506(c) under Regulation D remains the very best option for raising capital. Under 506(c), a startup company can crowdfund and use any means of general solicitation to raise any amount of money. The only limitation being that investors must be accredited. Naturally, the universe of accredited investors is much smaller than unaccredited. However, that does not mean that there are not lots of accredited investors out there. In fact, it is estimated that 8.25% of all American households, or roughly 10,108,811 households, count as Accredited Investors (as of 2013, calculated using Federal Reserve SCF microdata).
So, don’t despair. Get your business plan together, hire the right firm to prepare your PPM, and go out and do some accredited investor crowdfunding right now. Save Regulation A+ for when you’ve grown big enough to be able to afford it. Tell us what you think and click here to learn about our PPM services.
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About the Author: Erik P. Weingold
Erik P. Weingold is an entrepreneur and corporate securities lawyer with over 20 years experience under his belt. He has been practicing law since 1995, and since 1998 has been drafting PPMs that have been used to raise millions upon millions of dollars for startup companies and small businesses throughout the U.S. Erik is the founder and General Counsel to PPM LAWYERS, as well as Of Counsel to Convergent Litigation Associates, LLC (www.cla-law.com), a national law firm focused on the representation of clients through complex securities and commercial litigation.