It's been 457 days since the Securities and Exchange Commission proposed regulations under Title IV of the JOBS Act but now emerging growth companies will have the ability to raise money from any kind of investor without needing an expensive investment bank. On March 25, all five SEC commissioners voted to approve the much debated new rules of Regulation A+, which allows issuers to raise up to $50 million a year from both accredited and non-accredited investors. Additionally, issuers won't be required to use crowdfunding portals or broker-dealers to sell the opportunity to invest in their companies.
Investors, start-up CEOs, securities lawyers and even the head of OTC Markets, who spoke to Growth Capital Investor, are buoyed with hope about the impact of the new "IPO-lite" offering option because they believe the opportunities for small business capital formation have just expanded exponentially. Those same market participants are also privately jumping up and down feeling victorious that a nasty campaign led by the North American Securities Administrators Association (NASAA) to not allow state preemption in Reg A+ offerings failed.
Only two days after the rules were announced, crowdfunding attorney Mark Roderick of Flaster/Greenberg told Growth Capital Investor he is already preparing books and offering documents.
"By opening the door to tens of millions of additional potential investors Reg A+ also promises to transform the entire Crowdfunding ecosystem in ways the none of us can predict," says Roderick on his popular blog.
The JOBS Act mandated two kinds of offerings within Reg A+: Tier I and Tier II. Tier I is basically the old Reg A but with the offering limit increased from $5 million to $20 million. An issuer raising $20 million or less can still use Tier II, which offers the blue sky law preemptions that many believe are critical to creating a viable "public venture capital market."
Instead of soliciting regulatory permission in every state in which they wish to offer securities, Reg A+ issuers will file one registration statement for approval by the SEC. Issuers will need to be prepared to give up some confidentiality about their business, such as the salaries of their top three executives, which will have to be disclosed in audited financials filed with the agency every six months. But in return companies will be able to raise up to $50 million annually.
SEC Commissioner Daniel Gallagher, a strong proponent of Reg A reform, said during the rule vote he will be encouraging the SEC to increase that amount after two years when the Commission is allowed to revisit the rules.
Congress, in crafting the JOBS Act, decreed that the average American should be able to invest in emerging growth companies regardless of their income or wealth. In that spirit, Reg A+ allows non-accredited investors to self-report their income and net worth. In a Tier I offering there is no limit to the amount that can be invested, while in Tier II there are some limits tied to income and net worth. Unlike Reg D, where the issuer has to make reasonably sure they have an accredited investor buying the security, investors are now in charge of self-verifying.
In a Tier II offering that will not be listed on a national exchange, a non-accredited investor is limited to investing the greater of 10% of their annual income or 10% of their net worth, excluding their principal residence. That's a per-offering limit, not a per-investor limit. So a high school teacher making $75,000 per year with a net worth of $250,000 can invest $25,000 in a local real estate development and another $25,000 in a new tech app company that helps students apply for colleges in the same year.
Crowdfunding portals which charge issuers a listing fee, or if they are a broker-dealer a commission on money raised, can also help issuers sell Reg A+ securities. But many portals interviewed since the rules were approved say while they are excited to see the SEC make these new rules they are still focused on Reg D offerings. Primarily this is because they have already built their technology platforms to sell that type of offering and the time and cost of mounting a Reg D offering is still less; leaving very small issuers more capital from their offerings (and more money to pay a portal to raise it.) Portals do have to be prepared for the fact that the JOBS Act exemption from broker-dealer registration does not apply to Reg A+ offerings, according to Roderick.
One market player is more thrilled than most about Reg A+ because they believe they will be the ultimate beneficiary of the movement to creat a "venture exchange" to trade the securities issued by Reg A companies. According to OTC Markets Group CEO Cromwell Coulson, OTC Markets is already fielding calls from companies trying to learn how to list their Reg A securities. He told Growth Capital Investor he can't wait to see the effect six months from now, and hopes the Reg A market comes to see OTC Markets as the primary venue for secondary trading in the future.
Roderick points out unlike the so-called "Title II" crowdfinanced offerings under the JOBS Act, which are subject to Rule 144 limits on resales for a certain period of time, Reg A+ offerings are fully registered and may be resold the very next day, depending on issuer-placed restrictions and lock-ups.
Cromwell Coulson noted Reg A+ heralds the abandonment of a fundamental premise of publicly registered offerings in the U.S. — mainly, that it must be executed and immediately listed on a public stock exchange. Coulson told Growth Capital Investor, "We now have decoupling of securities offerings with blue sky preemption from the requirement of a listing on a national securities exchange."
Coulson said he thinks issuers interested in listing Reg A+ securities at OTC Markets will be a good fit since Tier II offerings require audited financials. "There are over 660 small companies now verified for trading on our OTCQB Venture Marketplace, which is bringing visibility to smaller and development-stage companies and has become America's venture market. Optimizing public markets for growing small companies is a good idea and one we have pioneered here at OTC Markets Group. "
The one group who is apparently not pleased with the SEC's Reg A+ rules is the organization that lobbies for state securities administrators, NASAA. NASAA had lobbied the agency and Congress to retain state review of all Reg A offerings, advocating for a new streamlined multi-state review process that was intended to counter the widely-held belief that state review was precisely the issue that had made Reg A so ineffective at raising capital for small companies in the past.
The current president of NASAA, William Beatty, said in an announcement immediately after the SEC voted on Reg A+, "We appreciate that all five Commissioners recognize the efforts of state securities regulators and NASAA to successfully implement a modernized and streamlined Coordinated Review program for Regulation A offerings to help small and emerging businesses raise investment capital. The program has been lauded for effectively streamlining the state review process that promotes efficiency by providing centralized filing, unified comments, and a definitive timeline for review."
Growth Capital Investor previously reported on the first company, Groundfloor Finance, that had been through NASAA's coordinated review for a $5 million Reg A offering focused on real estate investment. Groundfloor, who said the review process was surprisingly swift and efficient, is still waiting for SEC approval of the deal.
During the past year's campaign over the Reg A+ rule proposals NASAA officials were readily available to the press, offering interviews and comments while rallying a group of Congressmen to write comment letters to the SEC supporting their agenda by warning how dangerous state preemption would be for investors. Now that the rules are final, NASAA has been less vocal on Reg A+, with Beatty offering only that, "It appears that the SEC has adopted a rule that fails to fully recognize the significant benefits of this program to issuers and investors alike. We continue to have concerns that the rule does not maintain the important investor protection role of state securities regulators and must look more closely at the final rule as we evaluate our options."
Flaster/Greenberg's Roderick warned clients this month that Beatty's remark about "evaluating their options" could mean back room negotiations with the SEC to tweak some of the final rules before Reg A+ is officially filed in the National Register; a process that can take up to 60 days. Roderick wrote in a primer on Reg A+ that, "NASAA's furious opposition is what delayed adoption of the final Regulation A+ rules, and they will likely file a lawsuit within the next several weeks alleging that the regulations are invalid because the SEC overstepped its bounds." The thought among other attorneys interviewed for this story is NASAA will try and argue Congress did not intend to give the SEC power to preempt the states when it passed the JOBS Act.
OTC Markets' Coulson said he has heard that argument before. "If NASAA tries that legal recourse the simple defense is the Commerce Clause."
D.J. Paul, of DJP&Co., a financial services consulting firm specializing in investment crowdfunding regulation, said, "If the States are foolish enough to sue over Reg A+ they will soon be made aware of the impact of the Commerce Clause. The sale of securities on the internet, which Reg A+ will allow, is the definition of interstate commerce."
Paul says, "NASAA already did its negotiations with the SEC, which is why we had to wait so long for these rules and in my view the SEC did give them a carrot with their stick by creating the Tier I offering."
Benji Jones, a partner at North Carolina-based law firm Smith Anderson who helped introduce a new equity crowdfunding bill in the North Carolina legislature, said, "If NASAA sues and a judge issues a temporary restraining order it could kill the market's momentum behind Reg A+."
Jones says she has been flooded with questions from clients trying to figure out how Reg A+ can help them and how soon they can get started with an offering. She believes Tier I won't be used much because it's not efficient even though the SEC created incentives such as no audited financials or semi-annual reporting. Jones also fears since the states are not preempted from reviewing Tier I offerings they could introduce rules forcing issuers to file audited financials, overriding the SEC's intentions. Jones believes issuers will need to raise more than $5 million for Reg A+ to make sense from a cost of capital perspective.
Sunny Barkats, of the JSBarkats law firm, and Roderick feel differently. Roderick says attorney fees for a Reg A+ offering will likely be between $35,000 - $50,000, and the cost of an auditor initially could be around $25,000; for a total estimate of $75,000. Barkats' firm is unique in that it has completed nine Reg A offerings in the past few years, which he says took from three to five months to get approved. He told Growth Capital Investor the new Reg A+ rules are "a true democratization of capitalism at every level." Barkats feels issuers looking to raise $3-5 million will be the median of Tier II offerings in the beginning and it's "absolutely going to cost less much less than $100,000 in total to get it done." Barkats thinks the low cost marketing opportunities of the internet, and ability to forgo paying fees to a broker-dealer to sell an offering to accredited investors will significantly aid issuers in holding down offering costs.
When asked if volume in Reg D offerings will slow down now that Reg A+ is available, attorney Roderick said no because, "the pie for small business capital raising is just going to get bigger and even more so once we have a robust secondary market to sell these securities."
Roderick recently wrote to clients that Reg A+ can also be combined with other offerings. "You can raise money in the U.S. using Regulation A+ while at the same time raising money overseas using Regulation S. And should Title III ever become effective, you will be allowed to raise money using Reg A+ while simultaneously raising money using Title III. On top of that if you just did a Reg D / Title II offering you can immediately begin a Reg A+ offering."
With all that preparation of filing financials with the SEC and getting used to investors knowing your business plan, Roderick and OTC Markets' Coulson believe Reg A+ is going to be the perfect onramp for emerging growth companies to accelerate into traditional IPOs when they are finally ready.