Tuesday, January 24, 2017

Startling Increase in Regulation A Offerings Validates Crowdfunding Reforms and Technology

By:  Jim Verdonik

Jim Verdonik is an attorney with Ward and Smith, P.A. in Raleigh and the Author of Crowdfunding: A Legal Guide to Investment & Platform Regulation. 

Reach Jim at jfv@wardandsmith.com
(This article is based on an article appearing in Triangle Business Journal on February 3, 2017)

In 2012 America began a bold experiment to determine whether:
  • Less is more.
  • Addition by subtraction works.
    The experiment tested whether reducing government regulation would produce better economic results.  The eliminated regulations were securities law prohibitions against businesses using the Internet, Social Media and other technology to talk with investors.
    Breaking the Money Gate Keeping Monopoly – Capitalism without Capital Does not Work
    The JOBS Act of 2012 re-wrote most of the old regulations about how most American businesses raise capital, because: 
  • Capitalism doesn't work without capital
  • How can you raise capital if you can't talk with investors?
    The JOBS Act's remedy is what I call the "Seven Fingers of the Crowdfunding Fist" that American businesses are using to pound down the doors that lock up capital in traditional financial institutions – commercial banks, investment banks, venture capital, private equity and mutual funds.  Securities laws restricting communications gave these gatekeepers a monopoly on deciding where ordinary Americans invest.  Crowdfunding gives ordinary Americans tools to decide: 
  • Where to invest their money
  • Whether gatekeepers should continue to make decisions
    Seven Fingers of Crowdfunding Fist
    The tools people are using to directly invest their money in private companies include:
  • Two types of Rule 506 offerings
  • Two types of Regulation A offerings
  • Two types of State Crowdfunding offerings
  • Section 4 (a) (6) Regulation Crowdfunding offerings
    All these rules permit using the Internet and other means to talk directly with potential investors rather than going through institutional gatekeepers.
    Of course, people have been Internet shopping for more than two decades, including for big ticket items like cars and houses.  Securities laws prevented Americans doing the same when shopping for investment opportunities.  
    Startling Regulation A Initial Results
    This new freedom raised the question, will Americans invest online?  Or is investing inherently different from shopping?
    The SEC's November 2016 report definitively answers this question with statistics about the first 16 months after the SEC amended Regulation A.
Before the JOBS Act, Regulation A was like a bridge to nowhere - during the two previous decades, America averaged only five Regulation A offerings per year.  Now the SEC reports that during its first 16 month after amending Regulation A:
  • 147 Regulation A offerings were filed seeking to raise $2.6 Billion
  • 81 offerings were approved by the SEC seeking to raise $1.5 Billion
  • $190 Million was reported raised (this understates the actual amount raised, because issuers are only required to report sales after their offering terminates)
  • $18 Million was the average offering maximum size
  • 60% of approved offerings were for Tier 2 offerings
  • Two thirds of issuers had no revenue and only 20% were profitable
  • The median offering took 78 days to complete the SEC's review process
  • Most offerings were best efforts and self-underwritten by issuers who had previously raised capital in private offerings.  That means that American businesses were not using traditional
The bottom line is that American investors are walking through the capital raising door that Crowdfunding opened and are taking charge of where their money is going.

Reasons Why Regulation A is Popular 
So, why is amended Regulation A becoming so popular?

Issuers like Regulation A, because issuers:

  • Can test the market before filing documents with the SEC
  • Can sell to both accredited and unaccredited investors
  • Can use Social media and other advertising to sell their offering instead of paying large investment banker fees
  • Can raise up to $50 million each rolling 12-month period
  • Make continuous offerings over long time periods by updating disclosures instead of starting a new offering every year
  •  Can provide liquidity to existing shareholders by letting shareholders sell in the offering
  • Can avoid becoming a full SEC reporting company, because Regulation A incudes exemptions from Section 12 (g) public registration requirements (issuers in Tier 2 offerings do have to file semi-annual reports with the SEC)
  • Can reduce pressure from investors to sell the business before maximum value is achieved, because issuers can provide liquidity to investors, by facilitating private trading markets, because shares sold in the Regulation A offering are not "restricted securities"