“A+” for New Crowdfunding Rules
Back in October, I asked my partner and securities lawyer, Dick Schmalzl, to write about the current status of equity crowdfunding in “SEC Takes Baby Steps Towards Equity Crowdfunding.” Here’s Dick’s update on two new developments of particular interest to Tri-State businesses and investors.
March was a busy month on the equity crowdfunding front. Kentucky adopted the “Kentucky Intrastate Crowdfunding Exemption,” and the SEC finalized its new “Regulation A+” rules.
Moving at warp speed (as measured in government time), a crowdfunding bill was introduced in the Kentucky legislature on January 6, 2015, unanimously adopted by both houses in March, and signed into law by Governor Beshear on March 19. Beginning July 1, 2015, Kentucky’s new securities law exemption will allow startups and other small businesses to raise up to $2 million a year by selling their securities to the public over the Internet.
Similar to intrastate crowdfunding exemptions enacted by a dozen or so other states, quite a few conditions have to be met. Most notably: the business must be formed in and doing business in Kentucky; all investors must be Kentucky residents; the maximum investment from any single non-accredited purchaser is $10,000; the securities must be sold through a Kentucky-registered intermediary; all subscription proceeds have to be escrowed with a Kentucky-located financial institution until the targeted offering amount is reached; an offering disclosure document is required; and quarterly reports must thereafter be made available to purchasers and filed with the Kentucky Securities Division. By no means simple, but all in all, kudos to the Commonwealth!
In stark contrast, federal crowdfunding laws have moved at a snail’s pace, but at long last the SEC has taken a huge leap forward. While garnering much less attention than the SEC’s still pending, October 2013 proposed rules for equity crowdfunding, the SEC also proposed in December 2013 to amend existing Regulation A pursuant to Title IV of the Jobs Act. The primary impetus for amending Regulation A was to make it easier for medium sized companies—too small to conduct an IPO but more seasoned than a typical start up—to raise capital in meaningful amounts. On March 25, the SEC adopted final rules that accomplish these objectives, and then some.
Cleverly nicknamed “Regulation A+” because they are so much better than plain old Regulation A, the new rules will become effective in mid-to-late June. Although Regulation A has been around for over 20 years, it is seldom used despite having some very attractive features. Regulation A allows a company to publicly offer its securities, so there is no prohibition on general solicitation and general advertising. Sales are not limited to wealthy accredited investors, but can be made to anyone, which is the ultimate crowdfunding objective. And, the securities purchased under Regulation A are freely tradable. Nonetheless, these advantages have been outweighed by two major problems. Under old Regulation A, a company’s stock sales were limited to a maximum of $5 million (only $1.5 million of which could be sold by existing stockholders), and the offering documents needed to be reviewed by the SEC and by state securities regulators in each state where the offering would take place. That’s a lot of time, uncertainty, paperwork, filing fees, and professional fees, all to raise a relatively small amount of capital.
Skipping the gritty details (of which there are many), “Regulation A+” now allows two types of offerings which keep the good parts of old Regulation A and largely fix the bad parts. A “Tier 1” offering pretty much mirrors the old Regulation A except that a company now can raise up to $20 million in a 12 month period, including up to $6 million of stock sales by existing stockholders. To ease the state securities law burdens, the North American Securities Administrators Association has created a new coordinated review program. It’s untested but every little bit helps.
Where “Regulation A+” really begins to sizzle is with its brand new “Tier 2” offering. A company can raise up to $50 million in a 12 month period, with up to $15 million sold by stockholders. “Regulation A+” then gets even better by preempting Tier 2 offerings from state securities law registration requirements, thereby eliminating those expenses and potential delays. The tradeoff for a Tier 2 offering is that the company must provide audited financial statements with its required disclosure document, and must file ongoing annual, semiannual, and current event reports with the SEC. The good news is that the offering document is less detailed than an IPO-type prospectus and the ongoing periodic reports are substantially scaled down from the 10-Ks, 10-Qs and 8-Ks that public companies must file.
In essence, a Tier 2 offering is “IPO-lite,” providing the company with many of the same benefits as an IPO, but without becoming an SEC reporting company or subject to Sarbanes-Oxley requirements. Given that even the smallest IPOs today are generally far north of $100 million, many well established, privately held companies should find a Tier 2 offering to be very enticing. If the company later decides it wants to become a full blown public company, it can file a simple Form 8-A with the SEC and seek listing on the NYSE or Nasdaq.
In addition, Tier 2 offerings could become a very effective crowdfunding capital raising tool for newer and much smaller companies. Unlike the pending SEC crowdfunding rules that would limit a company’s stock sales to $1 million a year and impose numerous other restrictions similar to those in the Kentucky Intrastate Crowdfunding Exemption, Tier 2 offerings have no minimum offering size and fewer hoops to jump through.
Investors benefit from “Regulation A+” too. Ordinary people will have more opportunities to invest in high growth startups and other attractive privately held companies that were off limits in the past. And because securities sold under “Regulation A+”, whether in a Tier 1 offering or a Tier 2 offering, are freely transferable, investors will have liquidity. Angel investors, venture capitalists, private equity firms, and even owners of family held businesses may find that Regulation A offerings provide a new exit alternative in lieu of the traditional IPO or sell the company options.
Implementing “Regulation A+” in practice may reveal some obstacles that could prevent its potential benefits from being fully realized. But for now, “Regulation A+” should energize capital raising for private companies and crowdfunding advocates alike. Well done, SEC!