Jim Verdonik
Founder of Innovate Capital Law
Contact me at:
(919)616-3225
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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.
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:
COMPANY GOALS
|
WHY REGULATION A+ HELPS
ACHIEVE THE GOALS
|
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
|
|
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