Unlike the dark days that prevailed during 2008 through 2010 for many capital-starved companies, the current environment of ample liquidity may become more so based upon recent rule making by the Securities and Exchange Commission (SEC).
On March 25, 2015, the SEC issued its final ruling amending Regulation A, an existing exemption from registration requirements for smaller issuers of securities. The new rules, commonly referred to as “Regulation A+,” were first proposed in December 2013 under Title IV of the Jumpstart Our Business Startups (JOBS) Act (subscription required). Regulation A+ is expected to increase access to capital markets for small companies that do not report to the SEC by exempting registration requirements for securities offerings of up to $50 million annually.
The new regulation aims to amend certain weaknesses in Regulation A that led to its limited use as a capital raising tool. The original $5 million ceiling under Regulation A was considered by many to be too low relative to the costs for a small offering, and not worth the burden of complying with the blue sky state laws in each state in which the offering was conducted. The expansion of the offering limit and more reasonable filing requirements under Regulation A+ will create new opportunities for mature, private companies that wish to raise capital without going public or asking permission from state regulators. The new rules create a two-tiered offering structure with differing requirements based on the size of the offering.
- Tier 1 consists of securities offerings of up to $20 million in a 12-month period, with no more than $6 million in offers by selling security-holders that are affiliates of the issuer.
- Tier 2 consists of securities offerings of up to $50 million in a 12-month period, with no more than $15 million in offers by selling security-holders that are affiliates of the issuer.
Both tiers are subject to the same basic requirements of Regulation A, including issuer eligibility and disclosure, but with additional requirements and exemptions under each tier that aim to solve some of the limitations of Regulation A. In effect, the rules for Tier 1 will be the same as the current Regulation A, but are now limited to a greater aggregate offering of $20 million over a 12-month period. The issuer can elect whether to proceed under Tier 1 or Tier 2 for offerings up to $20 million. However, there are no longer investment limitations on purchasers, and all securities issued under Regulation A+ are non-restricted and transferable. Tier 1 offerings must still comply with blue sky laws, but financial disclosures are less rigorous.
In comparison, Tier 2 offerings are limited to an aggregate offering of $50 million over a 12-month period. The offerings are subject to periodic reporting requirements that are effectively scaled-down versions of the annual, quarterly, and ongoing reporting requirements that Exchange Act reporting companies are subject to. However, Regulation A+ exempts all Tier 2 offerings from blue sky requirements, which are instead preempted by federal securities law.
In addition to removing barriers and increasing capital limits, Regulation A+ has also broadened the base of investors. Originally, only accredited investors who made over $200,000 a year or had a net worth of $1 million could buy securities that were not subject to SEC registration under Regulation D. According to the SEC, only 7% of American individual investors could invest as an accredited investor as presently defined. Under Regulation A+, there is no cap on the total investment from each unqualified investor under Tier 1 and a cap of 10% of annual income or net worth under Tier II. A definitive ruling on crowdfunding is still pending under Title III of the JOBS Act.
The preemption laws and expansion of the investor base under Regulation A+ has received considerable push-back from state regulators and the North American Securities Administrators Association. According to the Secretary of the Commonwealth of Massachusetts, “[preemption] is a step that puts small retail investors unacceptably at risk.” Under the original Regulation A, companies were required to file the offering and pay fees in each state in which they were selling. Although the additional level of scrutiny was considered a safeguard by many states, the cost and the burden of filing under the blue sky laws were often too much for the limited capital raises.
The updated Regulation A+ provides a greater annual dollar limit without the “costly entanglement in the web of state blue sky regulation” for larger sums of capital. Companies are still required to provide audited financial statements and ongoing periodic reporting that will provide the transparency necessary to maintain investor confidence, while investors can diversify their portfolios and provide liquidity without an IPO offering. In effect, Regulation A+ acts as an intermediate step in the IPO process and a means to obtain growth capital for small companies.
The issuance of debt and especially equity raises a number of questions, including those related to valuation and fairness from a financial point of view. At Mercer Capital we have over three decades of experience in assisting management teams and boards of directors in evaluating such questions. Please call if your firm is considering a raise, under Regulation A+ or otherwise, that may require financial advisory services.
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