Tuesday, May 12, 2015

Your Goals Will Determine Whether Regulation A+ Is Right for Your Business

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

The SEC approved Regulation A+ on March 25, 2015 in SEC Release No. 33-9741.

Regulation A+ occupies a middle ground between Rule 506 offerings and registered public offerings.

This article answers two questions:

  • Who would want to do a Regulation A" offering?
  • Why would they want to do a Regulation+ offering?
The first response to any new rule or regulation should always be:

  • Does this change affect me?
  • Is the change a threat or an opportunity?
  • How should I change what I normally do to adapt?
  • How do I take advantage of the opportunity?
  • How do I protect myself from the threat?
Regulation A+ Opportunities

Regulation A+ doesn't harm any business and will help businesses that:

  • Are among the large group of businesses that are legally eligible to use Regulation A+.
  • Have a compelling business case that can attract medium to large amounts of capital (up to $50 million).
  • Have specific business objectives that specific features of Regulation A+ can help achieve.
What Won't Regulation A+ Help You Do?

Regulation A+ offerings:

·         Won’t be very useful for raising seed and early-stage capital, because of the time aqnd expense.
·         Won't replace big underwritten IPOs.

Profile of Regulation A+ Issuers

Let’s develop a profile for companies that should seriously consider a Regulation A+ offering. 

Legal Eligibility to Use Regulation A+

We'll start by listing the types of issuers who are legally allowed to conduct Regulation A+ offerings:
  • US and Canadian companies;
  • That conduct an active business or that will use the proceeds of the offering to purchase an active business that is identified in the offering disclosure documents;
  • That are not yet public reporting companies or registered investment companies; and
  • That have not committed a list of securities violations under Regulation A+'s Bad Actor rules.
That's a lot of companies.  But business and other factors will prevent most companies from doing successful Regulation A+ offerings even if they legally are allowed to use Regulation A+. 

So, let's narrow the list to create a profile for issuers who should seriously consider Regulation A+ offerings.

Business Case Required to Attract Investment

Because Regulation A+ offerings can be expensive and can raise large amounts of capital, most Successful Regulation A+ offerings will be conducted by issuers that:

  • Are beyond the start-up phase.
  • Probably have raised money before in other offerings primarily from individual investors.
  • Have either proven their business model by generating revenue or have secured valuable intellectual property protection. 
  • Can show investors that a large capital infusion will cause the company to achieve major value milestones that will increase value substantially.  Most companies either can't use large amounts of capital or can't grow value fast enough to provide the ROI investors want.
  • Have potential to either become a full pubic reporting company or be sold within a few years.
Most companies either can't use large amounts of capital or can't grow value fast enough to provide the ROI investors want.

The general types of companies that will most likely satisfy the business case requirements to attract capital include:

  • Companies with high growth potential that would normally be able to attract mid-to late stage venture capital investors.  A biotechnology company that has good results from early clinical trials, but is still in the clinical trials process would be a good example.
  • More mature companies with a revenue and profits history in a growing market that can use capital to expand into new markets is another type of good candidate for Regulation A+ offerings.
If your company has a good business case for attracting capital, then whether you should choose a Regulation A+ offering depends on your goals.

Business Motivations of Potential Regulation A+ Issuers

The six business objectives of companies that should be most interested in considering Regulation A+ offerings include one or more of the following objectives:

  • Asset Diversification.  Most business owners have too much of their net worth tied up in their businesses.  But they still want to control their businesses.  They don't want to work for someone else.  It's difficult for company founders to sell a minority interest in their businesses.  Regulation A+ can allow founders to sell part of their business without giving up control.
  • Partial Liquidity for Impatient Investors.  Most businesses that tell investors they are likely to be able to cash out after five years run into delays.  Even long-term investors become impatient to cash out at some point.  Impatience can be expensive.  One way that Private Equity Funds often generate high returns at relatively low risk is to buy companies before their value peaks from investors who want liquidity.  Liquidity is usually an all or nothing game.  Your options are usually limited if shareholders want to partially cash out by re-selling shares, but also want to retain a significant interest in the business to capture upside potential.  Regulation A+ offers existing shareholders a pathway to gaining partial liquidity. 
  • Acquisition Financing.  Companies that have identified specific acquisition targets are permitted to use Regulation A+ to raise capital to finance the acquisition.  Such issuers should lock in the purchase price and other acquisition terms by obtaining an option to buy the business.  Capital raised through a Regulation A+ offering can be combined with debt financing from banks and other lenders.
  • Higher Valuations.  Regulation A+ can help companies that have good growth prospects raise capital at higher valuations and on better other terms (like voting control) than the terms offered by venture capital and similar institutional investors.
  • Diversify Investor Base.  Regulation A+ allows companies that want a diversified group of small to mid-sized investors to conduct a general solicitation to retail investors, including non-accredited investors.  Regulation A+ allows such investors to obtain liquidity, because they are buying unrestricted securities.

  • Stepping Stone to Going Public.  By facilitating a trading market while the company makes only limited public disclosures, Regulation A+ establishes a space where companies can enjoy some of the benefits of being public without the full compliance obligations of public reporting companies.  This can help companies to make gradual changes as they transition in stages from being totally private to becoming a public company.  A staged approach to going public can both limit liability risk and lower compliance costs.
One or more of these six general objectives is likely to motivate most Regulation A+ issuers.

Let's talk about the last goal of becoming a public company. 

New Market Places Deliver Some Investor Liquidity at Lower Regulatory Cost

The fundamental requirement to make crowdfunding in all its forms work over the long term is to create a quasi-public company marketplace that provides some type of liquidity to investors who purchase shares in crowdfunding offerings.  It makes no sense to build a system that is predicated on average people tying up their limited assets in investments that they can't sell if they need money.  So, some type of marketplace for secondary trading is important to the survival of the new securities laws.

That marketplace does not need to be as efficient as NASDAQ or the New York Stock Exchange.  Investors who buy the shares of big public companies pay high prices for hat level of liquidity.  But a functioning market that reflects the discounted prices investors pay for private companies and quasi-public companies is important.

 Regulations that govern such new markets need to provide disclosures to investors, but not require the same level of compliance expense and liability risk that full 1934 Exchange Act reporting companies currently face.  As we'll see in the tables below, Regulation A+ helps prepare businesses to participate in such new markets.

But how will scaled down disclosures protect investors?

The dirty little secret of securities laws is that many disclosure requirements for public reporting companies are driven by political considerations more than a desire to protect investors. 

For example, the extensive disclosures about executive officers' compensation are both expensive and time consuming to produce.  If compensation is accurately reflected in a business' financial statements, how much particular individuals make or why the Board of Directors decided to grant stock options doesn't tell investors very much about the company's value.  Such disclosures are required, because of the political battle over income inequality. 

If we eliminate such political based disclosure requirements, issuers can deliver meaningful disclosure at much lower cost.

Company Goals Determine the Best Regulation A+ Candidates

Now, let's start defining the specific business goals and strategies that Regulation A+ is most likely to be able to help businesses achieve based on the things Regulation A+ permits you to do.  One or more of the following statements will probably be true about your typical Regulation A+ issuers:

The company is open to raising money in small to mid-sized amounts over an extended time period rather than needing one big immediate cash infusion.
Most companies cannot deploy $20 million within a reasonable time.  So, they raise money they will need for several years
Raising large amounts of capital in a single closing usually requires a mature established company or a cutting edge leader in a very hot growth industry.
Tier 1 of Regulation A+ allows you to raise up to $20 million during any 12 month period.
Tier 2 of Regulation A+ allows you to raise up to $50 million during any 12-month period
Although Regulation A+ does not prohibit single closing underwritten public offerings, Regulation A+ permits a continuous best efforts offering using technology platforms that are suitable for multiple closings over time.
Keeping the offering alive by either updating the existing offering documents or starting a new offering is relatively easy and inexpensive.
The company wants the possibility of a partial immediate liquidity event for major shareholders, but does not need to immediately cash out all its shareholders.
Tier 1 of Regulation A+ allows shareholders who are affiliates of the issuer to sell up to $6 million during any 12-month period.
Tier 2 of Regulation A+ allows shareholders who are affiliates of the issuer to sell up to 30% of the securities sold in the offering, but not more than $15 million during any 12-month period.
The company wants to develop a trading market over time to provide ongoing liquidity and is willing to consider (i) trading on new technology platforms or (ii) traditional micro-cap and small-cap market places like the Pink Sheets and the Over-the-Counter – Bulletin Board.
Securities sold in all Regulation A+ offerings are not "restricted securities."  Unless the securities are purchased by an affiliate of the issuer, the securities sold in the offering can be issued without legends and can be re-sold immediately.  This makes Regulation A+ securities attractive to technology platform operators that want to facilitate re-sales in a market that their technology platform creates.
In a Tier 2 Regulation A+ offering, the post offering reports issuers are required to file with the SEC provide brokers with sufficient information about the issuers to allow brokers to quote buy and sale prices to create a market.
The company wants to avoid concentrating stock ownership in a few institutional investors by selling to a wide range of retail investors.
Regulation A+ offerings can be sold to both accredited investors and to non-accredited investors and the ability to make a general solicitation allows issuers to use technology to communicate with millions of potential investors for a low price.
The company wants to create a bridge period to transition from being a totally private company to being a full public reporting company.
The company is willing to do limited public reporting after the closing without immediately incurring all the expense of being a full 1934 Exchange Act public reporting company.
Tier 2 Regulation A+ issuers must file:
-Form1-Z that discloses sales in the offering
- Form1-K Annual Report
- Form1-SA Semiannual Report
- Form1-U Current Reports (like a Form 8-K, but for fewer events than Form 8-K requires)
The required disclosures are less extensive than what small issuers make in full 1934 Exchange Act reports and Regulation A+ issuers must file reports less often.
The company wants to exercise greater control over its offering than when dealing with traditional underwriters.
Unless you are a hot issuer, when underwriters do a traditional "firm commitment" underwriting, the underwriters dictate how the offering will be conducted.  Last minute changes to price and the numbers of shares are not uncommon events.  In a continuous Regulation A+ offering, issuers can test whether investors will be willing to pay the value the issuer thinks is justified.
The company wants to take advantage of technology platforms and social media to replace traditional underwriters.  The primary value many underwriters add is the ability to sell a large dollar amount of securities in a short time period to their existing customers.  These sales are often to institutional investors who then profit by flipping the shares at higher market prices.  Institutional investors who purchase from underwriters profit from the IPO bump not the issuer. 
By doing a best efforts type of offering that continues over an extended time period, the issuer can choose to sell through a combination of multiple platforms that charge different rates.  The issuer can also drive its own sales outside of platforms by using social media. 
The company is able to pay legal and accounting expenses for the offering in the range of $50,000 to $100,000. 
The expenses of Regulation A+ offerings  may be an impediment for many businesses, but new investor groups are forming that are willing to pay upfront offering expenses in exchange for equity.  The SEC estimates that a Regulation A+ offering is likely to cost about 75% of what a registered public offering costs in fees to outside advisers.

If your company shares several of the goals described above, then you are a candidate for a Regulation A+ offering.

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

Summary of Key Provisions of New Regulation A+
Is Title III Crowdfunding Already Obsolete? Regulation A+ = Supercharged Crowdfunding
Which Should You Choose: Tier 1 or Tier 2 of Regulation A+?
Why Choose?  Why Not Do Both A Rule 506 Offering Followed by a Regulation A+ Offering?
Microcap Financings: Regulation A+ Offerings Join Public Shell Company Mergers and Self-Registrations to Create Small Public Companies
State Securities Law Issues in Regulation A+ Offerings

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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