By: Jim
Verdonik
Jim Verdonik
Founder of Innovate Capital Law
Contact me at:
(919)616-3225
Check our my newspaper articles at http://www.bizjournals.com/triangle/search/results/_author/Jim+Verdonik?market=triangle&_author=Jim+Verdonik&title=
Title IV of the JOBS Act directed the Securities and
Exchange Commission to issue a new version of regulation A that has higher
offering limits and other provisions that make the new Regulation A more
attractive to issuers. The new
Regulation A has been nicknamed Regulation A+.
On March 25, 2015, the SEC issued final rules for
Regulation A+ in Release No. 33-9741.
Sorry
History of Regulation A
Regulation A has been with us for several decades. When old Regulation A was initially issued, it was greeted with some enthusiasm as an exemption designed for small business issuers. But after the SEC issued Regulation D, old Regulation A entered the dust bin of history, because Rule 506 of Regulation D offered small and mid-sized issuers a much more flexible, faster and much less expensive pathway to raise capital.
The table below shows
the average number of equity offerings during a recent four-year period. Only offerings that were for $5 million or
less are included in the table for purposes of comparison, because old
Regulation A could not be used for offerings that exceeded $5 million.
Old Regulation A
|
Rule 506
(under $5 million)
|
Registered Public Offerings (under $5 million)
|
Five (5) offerings per year
|
Five Thousand (5,000) offerings per
year
|
Eighty (80) offerings per year
|
The numbers clearly
tell us that Regulation A's $5 million limitations on offering size was not the
primary reason very few issuers chose to do Regulation A offerings compared to
the two most logical alternatives:
- Rule 506 which is used by both private and public
companies to raise capital in private offerings.
- Registered public offerings, which is used to raise capital, bring private companies public and create shareholder liquidity.
We discuss the
advantages and disadvantages of new Regulation A+ compared with Rule 506 in
detail and how to combine the two types of offerings in one capital raising plan in
We compare new Regulation A+ with both public shell company mergers and self registrations to identify the best way to become a small public company in
We compare new Regulation A+ with both public shell company mergers and self registrations to identify the best way to become a small public company in
For now, let's quickly summarize the primary
provisions of Regulation A+.
Types
of Eligible Issuers
You can conduct a Regulation A+ offering, if you
satisfy all the following criteria:
- You are
a U. S. or a Canadian company; and
- You
conduct an active business or you will use the proceeds of the offering to
purchase an active business that is identified in the offering disclosure
documents (You cannot be a shell company, unless you have a specific
identified acquisition target that you describe in your offering documents);
and
- You are
not a 1934 Exchange Act public reporting company or a registered
investment company; and
- You and your affiliates have not committed one of the securities violations listed in Regulation A+'s Bad Actor rules.
Primary
Purposes of Regulation A+
Regulation A+ allows you to achieve three primary
objectives:
- You can
raise capital.
- Shareholders
(including affiliates of the issuer) can re-sell shares.
- The issuer can develop a resale market for both existing shareholders and new investors to gain liquidity after the offering.
Illiquidity is a risk. Since investors usually want to reduce risk,
liquidity (or the lack of liquidity) often affects the price investors are
willing to pay in many offerings.
Therefore, these three goals are intertwined. Liquidity and resale markets usually are
important to your ability to raise capital at reasonable valuations. But let's organize summary of Regulation A+
the resale markets are willing to pay for with these three goals in mind.
Primary
Capital Raising Provisions of Regulation A+ Provisions
The primary provisions of Regulation A+ that
directly relate to issuers raising capital include provisions that:
- Establish
two sets of rules for Tier 1 offerings of up to $20 million and Tier 2
offerings of up to $50 million.
- Allow
sales to both accredited investors and non-accredited investors.
- Allow
you to conduct a general solicitation without the accredited investor
verification procedures that apply to Rule 506 (c) offerings and without
the small maximum offering limitations imposed by proposed Crowdfunding
rules under Title III of the JOBS Act.
- Allow
more flexible sales efforts than Title III's proposed Crowdfunding rules,
because Regulation A+ marketing efforts can be conducted both through a
technology platform and off-platform through social media, as well as
in-person, telephone and other traditional marketing efforts.
- Permit
testing the market before offers are made.
- Require
filing disclosures on Form 1-A (with a choice of disclosure formats) with
the SEC before you can make all offers and require obtaining SEC approval
of your disclosures before you can close on any sales.
- Permit
continuous offerings to facilitate multiple closings for up to three
years, but you cannot have an "at the market offering" of equity
securities into an existing trading market at other than a fixed price.
- Facilitate
continuous offerings without having to requalify the offering, except to
file annual financial information and "as necessary to reflect facts
or events arising after qualification which in the aggregate, represent a
fundamental change in the information set forth in the offering
statement."
- Preempt
state securities registration laws.
Tier 2 Regulation A+ offerings preempt state securities registration
laws for both offers and sales (like in Rule 506 offerings.). Tier 1 offerings do not pre-empt state
securities registrations laws only for offers or for sales.
- Required issues to file a report on Form 1-Z about the amount of sales in the offering.
Primary
Re-Sale and Liquidity Provisions of Regulation A+
The primary provisions of Regulation A+ that
directly relate to re-sales of shares by existing shareholders and creating
liquidity for both new investors and existing shareholders include:
- That
shares sold in Regulation A+ offering are not "restricted
securities," which means the new investors who purchase in the
offerings can re-sell their shares immediately.
- Creating a pool of non-insiders who can re-sell shares is a primary part of the process of establishing a trading market. You can't have a viable trading market if no one is allowed to re-sell securities.
- That the
offering can include both securities sold by the issuer and securities
being re-sold by affiliates of the issuer (Rule 506 only allows securities
to be sold by the issuer).
- Exemption
for Tier 2 issuers from registering under Section 12 (g) of the 1934
Exchange Act when the number of record owners of securities of the issuer
exceeds Section 12(g)'s registration triggers.
- Allowing public disclosures by Tier 2 issuers (offering Form 1-and later annual and semi-annual periodic reports) to satisfy the current public information requirements provision of Rule 15c2-11 to allow brokers to quote prices and make a market.
Let's start examining these provisions in greater
detail by focusing on the differences between Tier 1 and Tier 2 of Regulation
A+.
Summary
of Primary Differences in Tier 1 and Tier 2 Regulation A+ Offerings
Regulation A+ authorizes two types of offerings:
- Tier 1 offerings allow you to raise up to a maximum of $20 million during any rolling 12-month period from both accredited investors and non-accredited investors with no limit on the amount any individual investor can purchase. Of that $20 million maximum, up to $6 million can be re-sales by shareholders who are affiliates of the issuer during any 12 month period. State registration laws are pre-empted for offers, but not for sales. Issuers do not have any post-offering requirements to file periodic reports with the SEC.
- Tier 2 offerings allow you to raise up to a maximum of $50 million during any rolling 12-month period. Of that $50 million maximum, re-sales by shareholders who are affiliates of the issuer are limited to $15 million during any 12-month period, except that for the first offering and all offerings during the first year, the offering price for affiliate re-sales cannot exceed 30% of the total offering price in the offering. Non-accredited investors can invest in a Tier 2 offering up to 10% of the greater of the investor's net worth or annual income, unless the securities will be registered on a national securities exchange. Self-certification by the investor is permitted. The issuer can accept the investor's representation about the amount of securities the investor is allowed to purchase, unless the issuer knows the representation is false. Tier 2 issuers are required to file annual and semi-annual reports with the SEC until the issuer no longer has 300 record owners of shares.
State
Registration Preemption
Both Tier 1 does not pre-empt state registration
laws for offers or for sales of securities.
Tier 2 pre-empts state registration laws for sales
of securities.
States are permitted to require issuers to file
reports of sales and pay filing fees similar to post-closing requirements in
Rule 506 offerings.
State anti-fraud rules apply to both Tier 1 and Tier
2 offerings.
One of the primary things issuers should consider
when choosing whether to make a Tier 1 offering or a Tier 2 offering is how
state securities registration laws will affect their Tier 1 offering with
respect to:
- Expenses
- Timing
- Substantive terms of the offering
Financial
Statements Requirements
Tier 1 offering financial statements do not have to
be prepared in accordance with Regulation S-X and do not have to be audited,
unless the issuer already has audited financial statements that were prepared
in accordance with either U. S. generally accepted auditing standards or the
Standards of the Public Company Accounting Oversight Board ("PCAOB")
by an auditor who is independent under the standards of the American Institute
of Certified Public Accountants ("AICPA") or Rule 2-01 of Regulation
S-X.
Tier 2 offering financial statements must prepared
in accordance with Article 8 of Regulation S-X as if the issuer is conducting a
registered public offering on Form S-1, except with respect to the age of
unaudited interim financial statements.
Tier 2 offering financial statements must be audited in accordance with
either U. S. generally accepted auditing standards or the Standards of the
Public Company Accounting Oversight Board ("PCAOB") by an auditor who
is independent (as defined in Article 2 of Regulation S-X.) The accountant does not have to be registered
with the PCAOB.
Secondary
Trading in Public Markets and Transitioning to Public Company Status
One of the primary features of Regulation A+ is that
it can help issuers transition from being a private company to becoming a
public company.
A number of provisions of Regulation A+ facilitate
issuers making this transition in several small steps rather than doing it all
at once.
Public reporting company requirements and dealing
with public trading markets can sometimes overwhelm small companies who have
not yet built an adequate compliance infrastructure that includes both people
who are experienced with public company reporting and compliance policies that
have been specifically adapted to their particular business. Deficiencies in personnel and policies create
liability risks. Fixing these
deficiencies takes both time and money.
Issuers can reduce both liability risk and compliance expenses by using
Regulation A+'s baby steps approach to going public.
Let's examine the provisions of Regulation A+ that
most directly impact the transition from being private to becoming a public
1934 Exchange Act reporting company:
- Shares sold in Regulation A+ offerings are not restricted securities. That means the buyers can re-sell the shares they purchase without complying with Rule 144. Investors who buy unrestricted securities can transfer their stock without complying with Rule 144, unless the investor is an affiliate of the issuer. Therefore, for non-affiliates who purchase shares in the Regulation A+ offering:
- The securities issued in the offering can
be issued without legends restricting transfer.
- The
securities can be re-sold without obtaining a legal opinion.
- There is no waiting period to re-sell
shares.
- There are no volume restrictions.
- There
are no requirements that current public information about the issuer be
available.
- That
the re-sale be in a brokers' transaction.
- You don’t have to report proposed re-sales on Form 144.
-
Tier 2
issuers must file with the SEC:
- Annual
Reports on Form1-K
- Semi-Annual
Reports on Form 1-SA
- Current Reports on Form 1-U
- Filings with the SEC are made electronically and are available for the public to review.
- Issuers
can choose to register a class of Securities under the 1934 Exchange Act
by filing a Form 8-A in connection with qualification (or requalification
) of their Form 1-A for their Regulation A+ offering, which expedites the
1934 Exchange Act registration.
While the 1934 Exchange Act registration is in effect, 1934
Exchange Act reporting requirements supersede Regulation A+ reporting
requirements. If the issuer who
elects to register under the 1934 Exchange Act otherwise qualifies for
treatment as an "emerging growth company," the issuer will
qualify for the abbreviated 1934 Exchange Act reporting requirements that
emerging growth company issuers are entitled to use.
Exemption
from Section 12 (g) Registration under 1934 Exchange Act
When an issuer that has $10 million in assets has
either 2,000 shareholders of record or 500 non-accredited shareholders of
record, the issuer normally has to register a class of securities under Section
12 (g) of 1934 Exchange Act.
That registration subjects the issuer (and its
executive officers, directors and large shareholders) to requirements to file
Form 10-K's, 10-Q's, 8-K's, proxy statements, Section 16 liability for officers
and directors, Section 16 reporting of purchases and sales by officers and
directors 10% shareholders, Section 13 reporting of beneficial ownership
changes by 5% shareholders and certain provisions of Sarbanes-Oxley, including
disclosure controls and internal controls over financial reporting
requirements.
- continues
to file the periodic reports required by Tier 2 of Regulation A+;
- meets
the 1934 Exchange Act's definition of a "smaller reporting
company" (which means the issuer has a public float of less than $75
million or less than $50 million of revenue if there is no public float);
and
- uses a transfer agent that is registered with the SEC under Section 17A of the Exchange Act.
A Regulation A+ issuer that ceases to qualify for
the exemption because they are no longer a "smaller reporting
company" has two years to transition to complying with all the rules that
Section 12 (g) registered issuers have to comply with.
Differences
in Trading Markets for Tier 1 and Tier 2 of Regulation A+
Tier 2 rules facilitate trading on the Over-the-Counter
Bulletin Board by allowing brokers to satisfy the public information
requirement of Rule 15c2-11 by relying on the periodic reports Tier 2 issuers
must file. Tier 2 rules also encourage
Tier 2 issuers to graduate to a national securities exchange and full 1934
Exchange Act by making it easier to list securities for trading on a national
securities exchange by filing a Form 8-A.
The SEC has also indicated that it is considering
permitting the creation of "venture exchanges" to facilitate
secondary market trading, including for Regulation A+ issuers. Such venture exchanges are likely to be
modeled on the London AIM Exchange and the Canadian TSX Venture Exchange. Future access to such venture exchanges could
become an advantage for Regulation A+ issuers.
Interaction
with Other SEC Re-sale Provisions
Let's consider the rules that apply to re-sales of
shares by three types of shareholders:
- Investors
who repurchase shares in the Regulation A+ offering who are not affiliates
of the issuer before or after the purchase.
- Affiliates
of the issuer who own restricted securities or control securities.
- Non-affiliate shareholders who did not purchase their shares in the Regulation A+ offering.
Investors purchase unrestricted securities in both
Tier 1 offerings and Tier 2 offerings under Regulation A+. Therefore, unless the investor is an
affiliate of the issuer, investors who purchase shares in the Regulation A+
offering can re-sell their shares without complying with Rule 144. Affiliates must comply with Rule 144 or
another exemption when they re-sell their shares even if they acquire
"unrestricted securities," because their shares are "control
securities".
Following both Tier 1 offerings and Tier 2 offerings
under Regulation A+, the issuer is a private company that is not required to
file full 1934 Exchange Act periodic reports.
Consequently, the private issuer provisions of Rule 144 apply to
re-sales by shareholders who did not purchase shares in the Regulation A+ offering.
Three things affect the ability of the issuer's
shareholders to re-sell under Rule 144:
- In Tier
2 offerings, an issuer who files the annual and semi-annual periodic
reports required by Tier 2 of Regulation A+ can facilitate shareholders
re-selling shares by voluntarily filing two extra quarterly reports. See Page 186 of SEC Release No. 33-9741.
- Private companies (including Tier 1 and Tier 2
Regulation A+ issuers) can facilitate re-sales under Rule 144 by posting
on their websites the information referred to in Rule 15c2-11(a)(5)(i) to
(xiv) and (xvi).
- The
public information requirements of Rule 144 (c) always apply to shares
owned by affiliates of the issuer, but non-affiliates who have held
their restricted securities for more than one year can re-sell shares
under Rule 144 without current public information of the issuer being
available.
Other articles about important Regulation A+ issues
include the following:
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Your Goals Will Determine Whether Regulation A+ Is Right for Your
Business
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Which Should You Choose: Tier 1 or Tier 2 of Regulation A+?
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Microcap
Financings: Regulation A+ Offerings Join Public Shell Company Mergers and
Self-Registrations to Create Small Public Companies
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State
Securities Law Issues in Regulation A+ Offerings
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