There is little doubt that innovation and entrepreneurship are the backbone of this nation. About 25 million small businesses employ more than 50 percent of the private workforce and generate more than half of the nation's gross domestic product.(1) The entrepreneurs driving the growth of our country suffered particularly in the aftermath of the 2008 financial crisis, as most traditional sources of capital dried up. Small business expansion and support was not the priority of the preceding U.S administrations, and the banking system failure did little to invigorate initiative and capital growth. As a result, not only was the American entrepreneurial drive hindered, but its ability to create jobs was also damaged, thus, job creation substantially declined. That situation may have changed when the legislator through the leadership of a few, realized that capital formation can only be efficiently created from the bottom up and that government cannot be the principal source of jobs creation. This resulted in the passage and ongoing implementation of the Jumpstart Our Business Startups Act (the “JOBS Act”)4, a bipartisan law signed by President Obama on April 5, 2012.
One of the most exciting provisions of the JOBS Act is “Title IV,” also known informally as “Reg A+.” Title IV was issued for public comment by the SEC on December 18, 2013 and will most likely be fully implemented by the end of 2014. We believe Reg. A+ has the potential to reignite American entrepreneurship and take it to a new dimension never achieved before.
"Reg. A" Background
Any discussion of Reg. A+ must begin with its progenitor, Regulation A. This earlier Reg. A was first adopted in 1936 and added to the Securities Act of 1933, as amended5 (“Reg. A” or Regulation A”), and provides for a simplified registration process tailored to smaller companies for the purposes of facilitating capital formation. Reg. A is sometimes referred to as a “Mini IPO”. Under Reg. A, private companies benefit of the following:
- They may raise up to $5 million in any rolling twelve-month period, through sales of their securities, without complying with the usual registration requirements of the Securities Act, including quarterly and annual reporting;
- Companies offering shares under Reg. A are not subject to a full audit and may instead, simply submit “reviewed” financial statements, which is usually substantially less expensive;
- In addition,Reg. A also enables pre-existing shareholders with an opportunity to resell a limited dollar amount of their unregistered securities; furthermore,
- Securities sold through Reg. A are freely tradable over any exchange that would host such trade or on any platform, one could argue that they are resalable on EBay if offered, moreover,
- Offering statements issued under Reg. A are reviewed by both the SEC and state securities regulators (under the states’ so-called “Blue Sky”7 laws).
It is important for emerging companies and entrepreneurs to know that the Blue Sky process could vary in its rigor, with some states being a simple formality to others being stricter. These are all vitally important characteristics of Reg. A. However, for the purposes of the present-day entrepreneur or emerging company, perhaps Reg A’s most important attribute—and one that is continued in Reg. A+--is the ability to generally solicit, advertise, and collect funding from ALL investors, accredited and non-accredited.
The Proposed Reg. A+ Under the JOBS Act
Reg. A+ amends the pre-existing Reg. A by establishing two “tiers” of offerings:
- Tier I comprises Reg. A under its traditional contours, as described above.
- Tier II, provides what is basically a “super-sized” version of Reg. A. Tier II offerings will enable companies to issue offerings of up to $50 million in any rolling 12-month period, up to $15 million of which may be resales by existing shareholders. Importantly, Tier II offerings will pre-empt state-by-state Blue Sky regulations, greatly streamlining and broadening the offering process. The only significant drawbacks of Tier II offerings are that companies issuing such offerings must submit to a full audit and must file annual financial statements.
|The table below summarizes some of the key differences, between Tier I and Tier II: Requirements||Tier I Reg. A||Tier II Reg. A +|
|Ongoing ReportingRequirements Post Offering||No ongoing reports required (New Form 1-Z exit report)||Various periodic and specialreports on Forms 1-K, 1-SA andSimilar to reports required pursuant to Title III crowdfunding.|
|Obligated to Comply with State ‘‘Blue Sky’’ Regulations||Yes, a State per State filing is required.||Preempts Blue Sky laws.|
There are further limitations to Title IV, under either tier. Companies utilizing Title IV must comply as follows:
- a. be organized under the laws of the U.S. or Canada;
- b. not be subject to ongoing reporting requirements under Section 13 or Section 15(d) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”);
- c. not be registered or required to be registered under the Investment Company Act of 1940, as amended (the “40 Act”);
- d. not be disqualified under the revised ‘‘bad actor” provisions of the proposed rules;
- e. not be a development stage company with no specific business plan or purposes or whose business plan is to engage in a merger or acquisition with an unidentified company or companies; (not a shell or blank check company) and
- f. not be an issuer of fractional undivided interests in oil or gas rights, or similar interest in other mineral rights.
Only equity securities, debt securities and convertible securities, including any guarantees of such securities, can be offered under the proposed Title IV rules.
Asset-backed securities, such as the collateralized debt obligations of the sub-prime crisis, will not be eligible to be offered under the proposed rules.
Securities Act Liability and New Communications Process.
Reg. A securities offerings would have Section 12(a)(2) liability in respect to offers or sales made through an offering circular or even oral communications that include any material misleading statements or material misstatement of facts. Thus, an offering pursuant to Reg. A is excluded from the operation of Section 11 of the Securities Act. Nonetheless, Reg. A offerings are, like any offerings, subject to the antifraud provisions under the federal securities laws.
The proposed rule would permit confidential submission of offering statements for first time offerings under Reg. A. The initial confidential submission and subsequent confidential amendments and SEC correspondence regarding the submissions would be required to be publicly filed as exhibits to the offering statement not less than 21 calendar days before qualification of the offering statement. Under the current rule, an offering statement that does not include a delaying notation will be qualified without SEC action on the 20th day after filing. Issuers can include delaying notations on the cover of the form, stating that the offering statement shall only be qualified by order of the Commission. The proposed rules would eliminate the delaying notation process. Timing of the public filing would not be tied to the commencement of a “road show.” In addition, the proposed rules will update Reg. A communication processes, including “Test the Waters”:
The offering statement would be “qualified” only by SEC order.
Rule 254(a) allows an issuer to publish or deliver to prospective purchasers a written document or to make television broadcasts or radio broadcast or, more relevantly, internet pre-offering pitches in order to determine whether there is interest in a contemplated securities offering. Issuer would be measuring the indications of interest from potential investors not only before the filing of an offering statement, but also after filing the offering statement, pursuant to "testing the waters," provision. All solicitation documents used after the public filing of the offering statement would need to be accompanied by a preliminary offering circular or contain a notice informing prospective purchasers about where the current preliminary offering circular can be obtained (including by providing a URL link to the offering circular online or offering statement on EDGAR).
• Confidential submission of draft offering statements and amendments would be permitted, provided the documents were publicly filed no later than 21 calendar days before qualification.
• The preliminary offering circular would have to be delivered at least 48 hours in advance of a sale. A final offering circular would have to be delivered within two (2) business days after the sale in cases the sale was made in reliance on the delivery of a preliminary offering circular. Such requirement is deemed satisfied if the final offering circular is available on EDGAR.
• Reg A issuers would be required to provide updates information after termination or completion of an offering. Reg A does not require that issuers file ongoing reports with the SEC, other than a Form 2-A to report sales or termination of sales made under Reg A. The proposed rule would require that Tier 1 issuers provide certain information about their Reg A offerings on a new form, Form 1-Z. Issuers of Tier 2 offerings would be subject to an ongoing reporting regime similar to crowdfunding provisions under Title III of the JOBS Act. Tier 2 issuers would be required to file annual reports on Form 1-K; semi-annual reports on Form 1-SA; current reports on Form 1-U; and special financial reports on Form 1-K and Form 1-SA.
• All filings would be required to be submitted to the SEC in electronic format via EDGAR. The proposed rule would revise the qualification process for Regulation A offerings and require that an offering statement could only be qualified by an SEC order.
Representatives and other FINRA members or their associated persons from participating in any manner unless they comply with the filing requirements of the rule.29 Rule 5110 also contain rules regarding underwriting compensation. Rule 5110(b) requires that certain documents and information be filed with and reviewed by FINRA, and these filing and review requirements apply to securities offered under Regulation Aii.
B. Integration Rule.
Rule 251 of Regulation A provides for certain integration safe harbors for both Tier 1 and Tier 2 offerings. Under the existing rules, Regulation A offerings will not be integrated with:
• Prior offers or sales of securities; or
- Subsequent offers and sales of securities that are:
- registered under the Securities Act, except as provided in Rule 254(d);
- made in reliance on Rule 701;
- made pursuant to an employee benefit plan;
- made in reliance on Regulation S; or
- made more than six months after completion of the Regulation A offering.
The proposed rules expand the list of specific safe harbor provisions for both Tier 1 and Tier 2 offerings to add subsequent offers or sales of securities made through crowdfunding offers (once the SEC has adopted implementing rules for crowdfunding). The proposed rule also would address abandoned offerings. When an issuer decides to register an offering after soliciting interest in a contemplated Regulation A offering, any offers made pursuant to Regulation A would not be subject to integration with the registered offering, unless the issuer engaged in solicitations of interest in reliance on Regulation A to persons other than QIBs and institutional accredited investors in test-the-waters communications. An issuer soliciting interest in either a Tier 1 or Tier 2 offering to persons other than QIBs and institutional accredited investors must An issuer soliciting interest in either a Tier 1 or Tier 2 offering to persons other than QIBs and institutional accredited investors must then wait 30 calendar days between the last solicitation of interest and the filing of the registration statement with the SEC.
An issuer or broker-dealer should be obligated to deliver a preliminary offering circular to prospective purchasers at least 48 hours in advance of sale when a preliminary offering circular is used to offer securities. Reliance on electronic delivery would require that investors consent to electronic delivery. FINRA Rule 5110 prohibits Registered Representatives and other FINRA members or their associated persons from participating in any manner unless they comply with the filing requirements of the rule.29 Rule 5110 also contain rules regarding underwriting compensation. Rule 5110(b) requires that certain documents and information be filed with and reviewed by FINRA, and these filing and review requirements apply to securities offered under Regulation A.
State “Blue Sky” Laws.
One of the biggest impediments on Regulation A has been the requirement to comply with state securities laws. Under the proposed rules, securities offered under a Tier I offering will remain subject to state registration and qualification requirements to the same extent as under current Regulation A. As per the proposed rules, application of such state securities laws will be preempted for Tier II offerings.
Title IV and the Reawakening of American Entrepreneurship.
Despite being bailed-out, many banks are still not lending to small businesses as much as they should or could. One of the reasons for this tight credit is that the Federal Reserve is actually paying banks interest for their money to be held in the banks’ reserves. As a result, bank reserves have increased from $2 Billion in 2008, to $1.8 Trillion in 2013.10
Money that otherwise could be used for job creation or made available for infusion into the market place to help small businesses and support growth is, instead, sitting idle. Under the proposed rules and the current provisions of Title IV and its two tiers of Reg A, entrepreneurs, startups and emerging companies may directly access a large pool of capital from its source—the People--thereby disintermediating the traditional sources of capital.
Because U.S. federal and state securities laws are astoundingly complicated, the U.S. has 52 sets of securities laws (federal + the 50 states + D.C). As a consequence, securities lawyers across the country become a necessary guide thought this complex landscape.
More importantly, the choice of offering type is a key component determining the success or failure of a capital raise and even the survival of a company. This is where securities attorneys and investment bankers become essential in assessing the most suited offering structure tailored for each specific issuer and its shareholders. Chances are that a well-capitalized group will successfully implement its business strategy and grow. Hence, it is important to understand that every offering should take into account various elements before being structured and undertaken. Those considerations may vary from industry to industry, followers, and marketability of the offering.
The major choices for private equity raises, and their relative pros and cons are provided below:
a) “Reg D”
Reg D is, by far, the most popular legal structure used by private entities to raise money. Simply, Reg D allows the issuer to raise an unlimited amount of money without an audit and without SEC or state review, provided that it only raises its money for “accredited,” i.e. wealthy investors. Now, following Title II of the JOBS Act, issuers using Reg D may generally solicit and advertise their offerings over any and all media, including the Internet, provided that, again, they only collect money from accredited investors. The burden to make sure such investors are indeed accreddted has been shifted to the Company and is no longer a mere form questionnaire subject to the signature of the investor. Additionally offerings made under Regulation D have no capital limitations meaning that there is no limit as to how much money an issuer can raise pursuant to Reg D. No audited financials are required under Reg D, even though most respectable banks or placement agents will require one, yet most Reg D offering median is about $1 million U.S dollars11.
b) “Reg A” and Reg A + and “The Democratization of Capitalism!”
For all of Reg D’s benefits, we believe that Reg A, especially its Tier II option, will ultimately be the more important structure. We contend that, providing entrepreneurs and smaller companies with the ability to directly access capital from those citizens who most believe in the company—regardless of social status or wealth—will not only allow companies to raise more money than they do now, but to raise better money, because it will be invested by people with personal, not merely cash-related, reasons to be invested, people for whom the company matters. While the audit requirement may increase the administrative burden on the offering companies, it will benefit the investing public by providing additional transparency and credibility. This additional transparency and credibility is critical because Reg A’s ultimate benefit over Reg D is its ability to include ALL investors—accredited and non-accredited, alike—in its investment universe. Even then, investors in Reg A shares will be able to freely trade those shares on secondary markets, thereby attaining a measure of liquidity and self-determination as to when they want to “cash-out” their positions. This option is not available to Reg D shareholders.
The spirit of Reg A is best illustrated in the story of Ben & Jerry’s ice cream company. In 1984, Ben & Jerry’s competitor, Häagen-Dazs, wanted to limit distribution of Ben & Jerry’s in Boston, prompting Ben & Jerry’s to file suit against Haagen-Dazs’ parent company, Pillsbury. In the business arena, Ben & Jerry’s “attacked” Haagen-Dazs by undertaking a successful Reg A campaign which they then parlayed into a direct public offering less than a year later.
c) Title III “Crowdfunding”
Ironically, the provision actually given the name “Crowdfunding,” Title III of the JOBS Act, may become the least utilized of the private capital structures. While intended to empower entrepreneurs and startups to mobilize financing from non-accredited investors, Title III may become bogged down in its own regulatory red tape. Offerings using Title III cannot be done independently and, rather, must be made through a broker-dealer or registered portal. Companies offering securities through Title III may not solicit or advertise their own offering but may merely point potential investors to their offering on the third party portal. Title III raises are limited to $1 million and any raise over $500,000 is subject to a costly audit. All Title III offerings are further subjected to ongoing requirements to provide their investors with regular financial reporting results.
In our estimation, the benefits of Title III do not outweigh their considerable detriments, especially when most of those benefits may be provided by Reg. D and Reg. A, with the latter also providing access to the full range of the investing population.
Entrepreneurs are for the first time allowed to freely solicit capital and present their projects to a vast pool of participants all on a more equal footing. For the first time in decades, the gap between the 1% and the 99%, when it comes to accessing capital and participating in equity and opportunities, is reduced. For the first time we seem to be at the cross roads of the social media age and capital formation, all of which made possible through a bipartisan piece of legislation that could well be the unattended master piece of the Obama Administration. Thorugh Reg. A as the true “crowdfunding”, we “the people” can shift the balance of powers and corporate America readjusting the un-equalitarian scale and boundaries to a system that voices individualism vs. corporatism, and as a reflection of true capitalism and libertarianism. the map.
Hence, through the internet and mass media and with our wallets we can better the wo0rld, or push an agenda favoring pertinent companies and innovators, advances in sciences not lobbied for by some obscure non for profits or venture capitalist, or private equity, together will reach for support when corporate America has turned innovation down t the detriment of faster profitability and promising pro format, and for the first time we may allow for voices of the people the 99% to interject and make a financial impact and difference like it was the case with PhoneBlock12 where social media campaigned allowed to put a new ecological cell phone on
Both the far right and the far left should find some comfort in the JOBS Act: freedom and the ability to support transactions through meritocratic ideals while assisting a true liberal free market place in which companies compete for the attention of the individual investor and consumer through the web. Indeed, on one hand it is a bill that support the views of The Occupy Wall Street group whom among other disbelieves Wall Street and corporate America, hence, now innovators and potential supporters can meet on the net without the bias input of big financial institutions while on the other hand its seems to adhere to the Tea Party movement who distrust government oversight and demand for a more liberal free self-regulated capitalism system, with in this case, substantially less government oversight, since it allows for investors to be approached directly by issuers without any absolute governmental interference.
We believe a new era of smaller-scale, but powerfully vital, entrepreneurship is dawning. The financing is out there in the shape of tens of millions of Americans who have never before had the opportunity to partake in private equity at such stage in the game. It is up to you to make them dream with you and partake in what you are doing for them to help you make it happen. The dialogue is open and the internet and social media is its new platform for interaction.