As has been covered in prior posts, startups that need access to financing can oftentimes be stymied by the intersection between federal securities laws and capital raising transactions. Remember: all offerings and sales of securities are either registered under the Securities Act of 1933 (i.e., “going public”), exempt from registration, or else they are illegal.
While Regulation D under the ’33 Act and its related rules (particularly Rule 506) remain far and away the most commonly relied-upon exemption from registration for private offerings, Regulation A provides for a very rarely used exemption from registration for public offerings that do not exceed $5 million in any 12-month period. Regulation A offerings historically have been unpopular due, in part, to the lack of federal preemption with respect to state-level blue sky securities laws (meaning that companies utilizing a Reg. A exemption must still contend with securities registration and qualification requirements on a state-level basis for each state in which the offering is conducted, which can be time-consuming, confusing and expensive, as compared with Rule 506 offerings, which enjoy federal preemption – thus, obviating the need for state-level registration and qualification).
When the Jumpstart Our Business Startups (JOBS) Act was signed into law in April 2012, the U.S. Securities and Exchange Commission (SEC) was required, in part, to study and write rules that would ease smaller-sized companies’ access to capital. One result of this mandate was the revision and expansion of Regulation A. These final rules, known as “Regulation A+,” were finalized in March 2015 and now allow companies to fundraise under two categories (or “tiers”) of offerings:
- Tier 1 permits offerings up to $20 million in a 12-month period, with no more than $6 million that may be secondary offerings (or “resales”) by selling shareholders that are affiliated with the company (e., officers, directors and large shareholders).
- Tier 2 permits offerings up to $50 million in a 12-month period, with no more than $15 million that may be resales by company affiliates.
Things to know if your startup is considering a Reg. A+ offering:
- You can (probably) sell shares to your neighbor. Under Regulation A+, offers may be made to investors who are not accredited. This provides a much greater degree of flexibility to smaller companies or startups that are seeking to raise capital from friends, family members or acquaintances. (Note, however, that investors in a “Tier 2” offering who are not accredited cannot purchase securities comprising more than 10% of their annual income or net worth, whichever is greater.)
- Blue sky law is preempted for “Tier 2” offerings, as in Rule 506 offerings. State securities law registration and qualification requirements are preempted for Tier 2 offerings. While companies conducting a Tier 1 offering still will be subject to state securities law registration and qualification requirements, they can take advantage of the coordinated review program developed by the North American Securities Administrators Association (NASAA) for filing in multiple states.
- Non-affiliates will not be subject to resale restrictions. Purchasers in a Regulation A+ offering who are not affiliates of the company issuing the shares will receive unrestricted (e., freely tradable) shares.
- You will have to comply with SEC disclosure requirements now… Companies must file an offering statement with the SEC via EDGAR, the SEC’s online electronic reporting system. The offering statement must be on Form 1-A, which is available on the SEC’s website, and includes requirements to provide financial statements (which must be audited in the case of a Tier 2 offering), the material risks of the offering, the intended use of proceeds, a description of the company’s business, and information regarding the company’s executives and directors (including their compensation). The offering statement must be “qualified” by the SEC; however, companies can “test the waters” and use certain solicitation materials to approach investors before filing and qualification (note that close attention should be paid to the rules surrounding “test the waters” activities both pre- and post-filing). Additionally, companies can submit draft offering statements for non-public review by the SEC before filing their offering statement publicly.
- …and you may be subject to ongoing SEC reporting requirements later. Tier 2 offerings will trigger an ongoing reporting requirement with the SEC, through which companies would have to file annual, semi-annual and current reports with the SEC.
- Regulation A+ is available to U.S. and Canadian companies only. Under Reg. A+, only companies organized in and having their principal place of business in the U.S. and Canada are eligible for the exemption.
- No “blank checks.” Companies seeking to utilize the Reg. A+ exemption must have a specific business plan or purpose.
- No “bad actors.” The Regulation A+ exemption is unavailable to companies that are disqualified under the “bad actor” rules, which are substantially similar to those included under Rule 506.
Regulation A+ provides for potentially greater flexibility to startups and small companies seeking to raise capital. Nonetheless, companies should consider the time and expense of preparing the offering materials before proceeding with a Reg. A+ offering, as well as the ongoing reporting expenses associated with Tier 2 offerings. Companies also should consider the applicability of Exchange Act requirements, in addition to Securities Act requirements, when contemplating an offer or issuance of securities.