Regulatory Alert: Regulation A+ and What It Means For Startups
Mar 27th, 2015
The SEC voted Wednesday to adopt final rules for amendments to Regulation A, referred to informally as Regulation A+, making relevant a capital raising tool that had long grown dusty on the shelf of deal structures. Think of Regulation A+ as "IPO Lite", allowing companies to raise up to $50 million with disclosure and ongoing reporting requirements that are less burdensome than a full-blown IPO. However, a Regulation A+ offering will require a bit more from the company than a Rule 506(b) private placement, the most common way for startups to raise money. So where will Regulation A+ fit into the landscape? We offer up some preliminary thoughts.
Prior to the amendments, Regulation A offerings were capped at a $5 million raise, too small to serve as a meaningful "IPO Lite" or small-cap IPO, but too burdensome to compete with a private placement for a seed or Series A round. Accordingly, Regulation A was seldom used. As part of the sweeping reforms meant to ease small company capital formation, Congress mandated amendment of Regulation A in Title IV of the JOBS Act.
Regulation A+ will be effective in 60 days. Below are the main parameters of a Regulation A+ raise:
- Two Tiers with Higher Caps. Under Tier 1, a company can raise up to $20 million in a 12 month period; and under Tier 2, (we'll explain the distinctions below), the cap is $50 million over that same period. These are meaningful increases over $5 million, and makes Regulation A+ worth taking seriously.
- Light Disclosure. A company seeking to raise via Reg. A+ will need to provide a Offering Circular, which is lighter in disclosure than an IPO registration statement (S-1), and which will be subject to review by the SEC. Additionally, companies raising capital via a Tier 2 offering will be required to provide audited financials along with the Offering Circular. Since a Reg. A+ offering is a public offering, startups can shout from the mountain tops that they are raising. There are no general solicitation issues here.
- Non-Accredited Investors. Unlike 506(b) private placements, companies raising via Reg. A+ are not limited to the accredited investor universe. Anyone can invest in a Reg. A+ offering.
- Investment Limits. For Tier 2 offerings, non-accredited investors are limited to investing the greater of 10% of their annual income or 10% net worth.
- Ongoing Disclosure. Companies raising via a Tier 2 offering will be required to provide semi-annual, annual, and current event reports (lighter versions of 10-Q, 10-K, and 8-K reports, respectively)
- Sorry VCs. VCs can not use Reg. A+ to raise funds (query whether they'd want to anyway).
Interestingly, an important distinction between Reg. A+ and standard 506(b) offerings are the implications for secondary liquidity, a subject near and dear to our hearts here at EquityZen. We're trying to fix the broken secondary markets for venture-backed equity in a way that appeases all stakeholders--the shareholder, the investor, and the company. It's an uphill battle, but one worth fighting.
Securities issued via Reg. A+ are not "restricted securities," meaning they are freely transferable. Unless contractual restrictions are put in place, liquidity should not be an issue. To be sure, this ought to be done in an orderly manner in which the company's interests are accounted for. The development of exchanges serving the Reg. A+ market is in the offing. No doubt, we're paying close attention and will provide further commentary as all of this evolves.
What Does Reg. A+ Mean for Startups?
Early adoption of Reg. A+ by startups is unlikely. Currently, access to capital via private markets is plentiful across stages. At the early stage, new micro VCs and seed funds pop up daily, and raising your seed round is easier today than in years past. Further, the monetary and time costs associated with a Reg. A+ offering do not make sense for the amount of capital raised at seed or A rounds.
At the later stages, capital also abounds, especially with mutual and hedge funds increasingly investing in late- and growth-stage. And this capital is available at favorable valuations. There are nearly 80 "Unicorns" now (35 US companies raised at Unicorn valuations in 2014 alone). Until that spigot dries up, there's not much incentive to be an early adopter of Reg. A+. To be sure, Reg. A+ is a step in the right direction, and can be a viable alternative to the mid- to late-stage funding rounds. Bubble or not, should interest rate increases or another catalyst close the private funding window, startups may look to the public markets once again, via Reg. A+, for capital.