Revisiting Regulation A+: A Few Considerations
The ability to successfully fundraise is typically a significant factor in an early technology venture’s success. While most seek to raise capital from a small number of wealthy individuals or institutions, such as angel investors or venture capital firms, entrepreneurs are increasingly seeking the ability to raise capital through larger groups of investors, each offering a smaller financial contribution. Until recently, startup financings have typically fallen under Regulation D, a set of three rules – 504, 505, and 506 – which carve out exemptions to the registration requirements of the Securities Act of 1933, as described in this prior post. However, “Reg D offerings” are not without limitations – offerings conducted under Rule 504 are capped at a modest $1M, while offerings under 505 and 506 significantly limit the number of unaccredited investors. Although still a popular option, Reg D offerings often do not give capital-starved ventures the ability to sell to a much larger pool of interested investors, especially one including unaccredited investors..
It is not surprising then that there was significant excitement within the entrepreneurial community when the SEC finalized amendments to Regulation A in June 2015. Similar to Regulation D, the existing Regulation A provided an alternative set of exemptions to the Security Act of 1933, but these exemptions did not include limitations on the number of unaccredited investors. However, prior to this recent amendment, due to the fact that Reg A offerings were capped to $5M per sale and subject to burdensome “blue sky” security laws of individual states where securities would be sold, Reg A offerings have failed to take off. The new amendments to Regulation A, dubbed “Regulation A+,” created buzz by raising the dollar limit from $5M to $20M and $50M for each of the respective Tier 1 and Tier 2 offerings. Combined with a new coordinated review process for Tier 1 offerings and blue sky law exemptions for Tier 2 offerings, Regulation A+ gives entrepreneurs the ability to raise much more per sale while bypassing the time and financial costs associated with blue sky law compliance.
Since June 2015, the SEC has received many filings and have qualified around a dozen sales to date. A few examples of recently qualified offerings include:
- Sun Dental Holdings, LLC – A traditional dental device manufacturing company that also focuses on digital scanning, cloud-based data management system and 3D printing to produce dental devices.
- Sun Dental filed and qualified a Tier 2 offering for $20 million (9/3/15 – 12/1/15).
- Disclosed costs include $330K in legal fees, $380K in audit fees, and $950K in underwriting fees.
- Groundfloor Finance Inc – An online investment platform designed to source financing for real estate development projects.
- Groundfloor has had two Tier 1 offerings qualified, the first for $545K (3/23/15 – 8/31/15) and the most recent for $1.5M (10/7/15 – 10/29/15).
- Disclosed costs for the first offering included $458K in legal fees, $30K in audit fees.
- Elio Motors – An automobile company planning on manufacturing low-price, compact cars for a fraction of the price.
- Elio filed and qualified a Tier 2 offering for $25M (8/28/15 – 11/20/15).
- Disclosed costs include $110K in legal fees, $25K in audit fees.
While Reg A+ offerings have been gaining some traction, there are still significant obstacles in pursuing this financing option. Some issues entrepreneurs should consider before proceeding include:
- Cost. The first obstacle to Reg A+ has been the fees associated with completing and filing the application. While not as costly as an actual IPO, Regulation A+ still requires a dedicated team of lawyers and accountants to produce the offering circular and the financial statements (audited, if conducting the more lucrative Tier 2 offering). Recent filings have put legal fees anywhere from the low thousands up to $485K, and auditing fees typically add on another $20K to $30K. Due to the complexity of securities law and filing requirements, experienced counsel and the associated fees are essential to the process.
- Administrative Burden. In addition, the venture must be prepared to handle the administrative aspect of filing and selling securities under Regulation A+. Developing the substance of the offering circular will be time consuming, and companies conducting a Tier 2 offering will be on the hook for ongoing reporting requirements. For a leanly staffed team, the administrative burden might be a significant worry.
- Liability. Sellers of Regulation A+ securities are liable for any material misleading statement or omission made in an offering circular or oral communications, and anything said in the offering circular could be used in litigation down the road. As such, entrepreneurs must be careful to engage with experienced counsel in developing their circular.
- Impact on Future Investors. Experienced attorneys have brought up concerns surrounding the impact of introducing many unaccredited investors into a company’s cap table. There appears to be a consensus that VCs and other institutional investors tend to shy away from companies that have “crowded cap tables” because it can be difficult and risky to invest in a early-stage company with such a composition.
- Public Disclosure. Entrepreneurs will need to provide significant disclosures about their business and financials in its offering circular. This can sometimes be an issue for a venture that prefers to keep certain facts about its technology or financials internal until a more appropriate time.
While brimming with potential, Regulation A+ offerings can hardly be considered “easy money.” These very real obstacles are substantial, and should give any prudent entrepreneur pause to entertain other, more traditional financing methods. Those who do decide that they have the appetite to pursue a Regulation A+ offering should do so with ample resources, experience counsel, and a clear understanding of the difficulties involved in the process.