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Regulatory Alert: Regulation A+ and What It Means For Startups

JOBS ActSECRegulation

Shriram Bhashyam   March 27, 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.

The Basics

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).

Secondary Transactions

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.


Eye on Washington: JOBS Act 2.0 in the Offing?

JOBS ActSECRegulation

Shriram Bhashyam   June 20, 2014

While the jury is out (NYT, Washington Post, Boardroom Brief) on whether the Jumpstart Our Business Startups Act ("JOBS Act"), passed in April 2012, has been a success, House Republicans may already have their sights on a follow-up ("JOBS Act 2.0").

Although the SEC has yet to finish adopting regulations that would fully implement the JOBS Act, including several key provisions such as the "crowd funding exemption," the House of Representatives Financial Services Committee's Subcommittee on Capital Markets and Government Sponsored Enterprises convened a hearing on June 12, 2013 entitled "Reducing Barriers to Capital Formation."  The Committee Memorandum makes it clear that the focus is on small companies:
Based on the success of the [JOBS] Act (P.L. 112-106), which President Obama signed into law on April 5, 2012, the Subcommittee is continuing its survey to identify legal, regulatory and market impediments to capital formation, particularly for small and medium-capitalized companies.

What was discussed at the hearing?

While the transcript of the hearing is not yet available, the following topics were on the agenda:
  • changing the minimum trading increment or "tick size" for smaller companies (the current system prices shares in one cent increments);
  • authorizing the creation of new equity markets to register with the SEC and then list and trade the securities of smaller companies;
  • improving market quality for smaller issuers;
  • modernizing the regulatory structure of business development companies;    
  • improving capital formation for privately held small businesses and publicly traded companies with less than $250 million in public market capitalization; and
  • and examining disclosure and corporate governance requirements that may be burdensome for smaller companies.

What could JOBS Act 2.0 look like?

While the JOBS Act primarily facilitated capital raising and crowdfunding by small businesses, it appears that JOBS Act 2.0 would have an eye towards the next frontier for small business capital formation--trading markets for securities of small and emerging businesses.  As ever, the parallel goals of facilitating capital formation and investor protection remain at tension.  Lawmakers and the regulators that implement the laws will need to strike the appropriate balance.  As noted securities law expert Professor Donald Langevoort has acknowledged, small companies have smaller market impact than large companies, and accordingly should be subject to less onerous regulatory responsibilities.

One aspect of a possible JOBS Act 2.0 that we at EquityZen are particularly interested in is a potential separate equity market for the trading of securities of small and emerging companies.  In conjunction with this, it is likely that companies whose securities are listed on this market would be subject to lighter reporting and governance standards than their NYSE and Nasdaq-listed counterparts.  In recognition of investor protection and the lighter regulatory touch on companies listed on this market, access to this market may be limited only to accredited investors.

What's next?

The next hearing on "Reducing Barriers to Capital Formation" is expected to take place in July.  EquityZen will monitor these developments and provide updates.  We also geek out on secondary markets of private company securities, so expect a follow up from us on what a separate equity market for emerging company securities may look like.  Don't forget to subscribe to Meditations to get EquityZen's take on new developments.  Feel free to post and questions or comments below.


JOBS Act Update: SEC Extends Comment Period for Proposed Amendments to Rule 506

JOBS ActSECRegulation

Shriram Bhashyam   September 30, 2013

While much of the headline grabbing news in the startup world last week revolved around the effectiveness of SEC rules allowing general solicitation, on Friday the SEC announced that it is extending the comment period of proposed rules relating to fundraising using Rule 506, the predominant way in which startups raise capital.

We have previously covered these proposals, which include advance Form D filing requirements and severe penalties for noncompliance, as well as the reaction in the startup community.
These proposals have been controversial, to say the least. The proposals were passed by a 3-2 vote among SEC commissioners and the startup community has responded with swift criticism.  The volume (over 350) and passion of comment letters played a part in the decision to extend the comment period.  As the SEC noted in its release announcing the extension:
The proposed amendments have generated a large amount of public interest. The Commission believes that providing the public additional time to consider thoroughly the matters addressed by the release and comments submitted to date and to submit comprehensive responses would benefit the Commission in its consideration of final rules.
Note that the SEC is now seeking comments on the comments, in addition to comments on the proposed amendments. Reading the tea leaves, it looks like the SEC is heeding the input it has received from the startup community and is using the extension to obtain the time necessary to revise the proposals to find a better solution to monitor private placement fundraising, ensure investor protection, and facilitate capital formation. The comment period will be extended by an additional 30 days, and will close around the first week of November (exact date to be determined).