Tag: Regulation A

The Proposed New Regulation A for Fundraising

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Title IV of the Jumpstart Our Business Startup (JOBS) Act mandated changes to the moribund Regulation A offering process. That law raised the bar from $5 million to $50 million and prodded the SEC into making changes. The SEC issued the proposed rule with enough interesting treats that it may be worth exploring. The SEC is treating it like an IPO-lite as opposed to the wary eye cast on private placements.

The proposal splits Regulation A offerings into two baskets. Tier 1 offerings can be for up to $5 million a year. Tier 2 offerings can be for up to $50 million per year. By stepping up to Tier 2, the company’s financial statements must be audited and company must file semiannual reports and updates similar to public company reporting.

The part the SEC got right is that Tier 2 offerings would be exempt from state registration. The existing Regulation A’s failure to preempt the state blue sky laws is a major reason it is not used. I don’t see why the SEC would even bother with an offering type that does not preempt state blue sky laws. Tier 1 offerings under Regulation will likely continue unused.

The real nasty part is that investors are limited to purchasing no more than 10% of an investor’s net worth or annual income. That’s a big red flag. However, the SEC took the smart approach and did not turn that into a compliance requirement. The company needs to make investors aware of the 10% restriction, but can rely on a representation from the purchaser. The investor does not have to disclose personal information to verify compliance.

The proposal makes Regulation A a quirky middle ground to private placements and public offerings.

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The Rebirth of Regulation A Offerings

The Jumpstart Our Business Startups Act requires the Securities and Exchange Commission to amend Regulation A, raising the threshold for use of that exemption from $5 million to $50 million. From the numbers I’ve seen, Regulation A was rarely used as a source of raising capital. It seemed strange that it was included in the JOBS Act. But there were many strange things in the JOBS Act.

Section 402 of the JOBS ACT required the GAO to study the impact of state securities laws on Regulation A offerings. The GAO released its study: Factors That May Affect Trends in Regulation A Offerings.

The report confirmed the lack of use of Regulation A in capital raising. The number of Regulation A offerings filed with the SEC decreased from 116 in 1997 to 19 in 2011. Similarly, the number of qualified offerings dropped from 57 in 1998 to 1 in 2011.

The big difference is that Regulation A offerings are still subject to state securities laws. In contrast, Rule 506 offerings under Regulation D are not subject to the state securities law.

To contrast, there were 15,500 initial Regulation D offerings for up to $5 million in 2010 and 2011, compared to the 8 qualified Regulation A offerings during the same period.

One aspect of a Regulation A offering compared to a Regulation D offering is that it is subject to review, comment, and qualification by the SEC. According to the GAO report 20% of Regulation A filings were abandoned during the SEC comment process.

Another aspect of Regulation A is that the securities’ sales are not limited to accredited investors. So there is a larger pool of potential investors.

On the state side of the process, all states conduct a similar disclosure review as the SEC. Apparently some states will also engage in a merit review to determine if potential investors are getting a good deal. According to the report, businesses are generally advised by legal counsel to avoid Regulation A offerings in states that have a merit review.

So where does this leave Regulation A offerings in the new world of capital formation after the JOBS Act? I would guess in the same place. The big advantage of Reg A offerings over Reg D offering is that they can be sold to non-accredited investors. That comes with a lot of cost and lost time to go through the review process. I would guess that the new crowdfunding offering would be a more attractive alternative to reaching non-accredited investors. Of course, the regulations on crowdfunding do not yet exist and the mandatory equity crowdfunding portals do not yet exist.

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