Tuesday, May 12, 2015

Summary of Key Provisions of New Regulation A+


 
By: Jim Verdonik

I'm an attorney with Ward and Smith PA. I also write a column about business and law for American Business Journals, have authored multiple books and teach an eLearning course for entrepreneurs.  You can reach me at JFV@WardandSmith.com or you can check out


or my eLearning course at  http://www.youtube.com/user/eLearnSuccess or you can purchase my books at http://www.amazon.com/Jim-Verdonik/e/B0040GUBRW

 
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 






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.

 Regulation A+ issuers can choose to avoid registering under Section 12 (g) of the Securities Exchange Act (which requires full public reporting described above) for as long as the issuer:

    • 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.

 Trading in the shares of Tier 1 issuers is likely to be limited to trading on private platforms, because Tier 1 issuers are not required to file the periodic reports with the SEC that allow brokers to satisfy Rule 15c2-11's requirement that public information about the issuer be available.   SecondMarket and SharePost are two examples of platforms that facilitate re-sales of securities of private companies.  These platforms have usually focused on larger private companies (especially during the years immediately before the private company's IPO).  But many platforms that sell securities in Regulation A+ offerings, Rule 506 (c) offerings and state crowdfunding offerings are building the software that will be able to facilitate secondary market trading on their platforms.

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.
At the beginning of this article we showed statistics that indicated the old Regulation A was not used nearly as often as Rule 506 or registered public offerings.  Clearly, the new Regulation A+ provisions we discussed above offer issuers many more advantages than the old Regulation A did.  But issuers will not be choosing between the new Regulation A+ and the old Regulation A.  Issuers will be comparing new Regulation A+ to the advantages and disadvantages of Rule 506, registered public offering rules and crowdfunding rules when they choose their offering exemptions.
 


Other articles about important Regulation A+ issues include the following:



If you would like to learn more about learning how to grow your business or other issues important to your success, you can reach me at JFV@WardandSmith.com or  you can check out my newspaper articles at http://www.bizjournals.com/triangle/search/results/_author/Jim+Verdonik?market=triangle&_author=Jim+Verdonik&title=



 

 
 

 

 

 

 

 

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