On March 25, 2015, in a long-awaited action by the SEC, the regulatory agency finally made a bold move intended to facilitate access to capital for entrepreneurial, high tech startups and other smaller companies. Pursuant to the provisions of Title IV of the JOBS Act of 2012, the SEC has now adopted new rules known as Regulation A+, which update and expand upon the existing Regulation A by empowering growth companies to raise up to $50 million from unaccredited investors in an offering resembling a mini-IPO or IPO “lite.” Arguably, Regulation A+ benefits both investors and companies in need of capital. Unaccredited investors, eager to participate in the high risk/high reward world of high tech startups, should find that Regulation A+ democratizes access to investment opportunities offering such investors choices previously largely unavailable to them. High tech startups should benefit by enjoying increased access to capital and decreased cost of raising such capital. Entrepreneurs, innovators and other leaders of small companies may be able to forego retention of the investment banking intermediaries which historically have been important, albeit costly, gatekeepers for access to capital. Instead, such companies should find an easier path to capital raising with regulations that allow them to offer their stock directly to the general public and other key constituencies.
Historical Background/Restrictive Environment
The Securities Act of 1933, in response to the failures of a system which had too few mechanisms protective of investors and insufficient disclosure and other obligations imposed on those raising capital, created a highly restrictive capital raising system. An offeror or seller of securities must either undertake a lengthy, costly, burdensome registration process or rely on a registration exemption. One such exemption is found in the existing Regulation A that allows for unregistered public offerings by companies and existing securityholders; but the exemption contains limits on the dollar amounts that may be offered (only up to $5 million of securities in any 12-month period by issuing companies and no more than $1.5 million by existing holders). Regulation A offerings have been rare in recent years with most offerings by entrepreneurial, high tech startups and other smaller companies conducted in compliance with the private offering exemptions under Regulation D which limit not only the amount of capital that may be raised, but the very nature of the offering itself as well as the number of unaccredited investors who may participate.
Enter Regulation A+
The JOBS Act amended the Securities Act to require the SEC to update and expand the Regulation A exemption.
The final Regulation A+ rules would implement Title IV of the JOBS Act and provide for two tiers of offerings. In Tier I, issuers can raise up to $20 million in a twelve-month period; Tier II allows issuers to raise as much as $50 million. Unlike Regulation D’s significant limits on eligible investors, under Regulation A+, anyone can invest, including friends and family, employees, and others looking for investment opportunities in high growth companies, without having to meet the accredited investor requirements.
Some of the critical elements of Regulation A+ include:
- Accredited investors have no dollar limits imposed on them. In an attempt to protect unaccredited investors, however, they are limited to purchasing an amount no greater than the higher of 10% of their net worth or net income in a single Tier II Regulation A+ offering.
- Investors can self-certify by making representations and warranties as to their income or net worth for purposes of determining compliance with the above investment limit, thereby freeing issuers from extensive documentation reviews and verification procedures.
- General solicitations are allowed with issuers permitted to discuss and advertise their offerings in multiple ways, including social media.
- Unlike Regulation D, in which issuers must greatly restrict and police resales, the securities issued in a Regulation A+ offering are unrestricted and more readily transferable (even so, some issuers may elect to impose contractual transfer restrictions).
- In a costly compliance requirement, issuers must file with the SEC a disclosure document (including financial statements) which must be approved prior to any sales. This “offering circular” will be subject to the same level of review as currently exists for IPOs in registered offerings employing a Form S-1 registration statement. The drafting and review process, intended to ensure appropriate disclosure to investors, may create a barrier for many offerors.
- The smaller Tier I offerings require unaudited, but reviewed, financial statements. The larger Tier II offerings impose a requirement that issuers provide two years of audited financial statements.
- In an attempt to permit issuers to gauge the level of interest in an offering prior to incurring time and cost in crafting the offering circular, investors may preview proposed offerings and express interest in investing. No actual investments may be made, however, without completion of the SEC review process.
- Tier I issuers will be free from ongoing disclosure obligations; periodic requirements such as 8-K, 10-Q and 10-K filings are costly and too burdensome for startup technology enterprises. Tier II issuers, who will have raised far more capital, must file an annual disclosure report, a semi-annual report, and current reports. In each case, however, these disclosure requirements are simplified versions of the existing Forms 10-K, 10-Q and 8-K. While there are ongoing audited financial statement filings required, these disclosures can end after the first year if the shareholder count is less than 300.
- Unlike Regulation A, which requires compliance with state securities, or blue-sky, laws, Tier II offerings under Regulation A+ preempt state law. Tier I offerings, however, do not enjoy the benefits of state law preemption, but may be aided by a newly-created, but untested, system of “coordinated review.”
- The shareholder limits of Section 12(g) (2,000 persons and 500 non-accredited investors) will not apply under certain circumstances.
McCarter & English Assessment
In Regulation A+, the SEC has attempted to balance some of the disparate and competing needs of investors and issuers. On the one hand, it continues, at least in some fashion and to a limited degree, many of the measures intended to protect investors from unscrupulous issuers with a disclosure system designed to offer investors the information necessary to make informed investment decisions. On the other hand, Regulation A+, with its less fulsome regulatory requirements, should give investors more choices and greater access to investment opportunities, while increasing issuers’ access to much-needed capital that can drive innovation, nurture growth, create new jobs and foster wealth creation.
Whether you are a startup, early-stage or emerging-growth company in need of capital, or an investor seeking investment access to entrepreneurial or tech or tech-enabled enterprises, consult with sophisticated corporate and securities law counsel to learn more about Regulation A+ and its impact on your company or your investment portfolio.