Understanding Recent Changes to Regulation A17 May, 2017
As an offering exemption to the Securities Act, (as opposed to a private placement exemption), Regulation A effectively facilitates a cost-efficient means for smaller companies to raise capital in small amounts. Long before the JOBS Act was signed into law by President Obama in 2012, there were a number of initiatives designed to amend Regulation A. Historically, the principal issue with Regulation A had been the low dollar threshold of $5 million offering proceeds in a twelve-month period. With the passing of the JOBS Act, the dollar threshold for Regulation A+ was increased to $50 million and a number of other important changes were made.
In an attempt to understand more fully the intricacies and implications of Regulation A+, and how small companies can use it, we sat down with Anna Pinedo, currently a partner and co-leader of Mayer Brown’s global capital markets group, to get her insights into what it might mean for small businesses who are seeking to raise capital.
Q: How did Regulation A become Regulation A+?
A: There was a requirement in Title IV of the JOBS Act that the SEC undertake rulemaking to adopt a small offering exemption consistent with the framework of Regulation A, but with a higher offering threshold and certain enhanced investor protection provisions. Title IV also required that the Government Accountability Office (GAO) undertake a study relating to the impediments to broader reliance on then existing Regulation A. The study revealed that, on a comparative basis, issuers that were trying to raise capital had Regulation D, specifically Rule 506, available to them, which permits companies to raise an unlimited amount of capital in a private offering made to accredited investors. The study showed that this was a considerably more attractive option to issuers compared with the limitations associated with Regulation A and its $5 million threshold. The GAO study also noted that blue sky requirements were a significant impediment to broader use of Regulation A.
The SEC adopted final rules that became effective during June 2015. The final rules amended and modernized the existing Regulation A to become Reg A+ and created two tiers of offerings. Tier 1 provides for offerings up to $20 million, and Tier 2 is for offerings of up to $50 million.
Q: Who is eligible to use Regulation A+ and who isn’t?
A: Eligible issuers are defined as those that are organized and have their principal place of business in the United States or Canada and are not SEC reporting companies, investment companies or blank check companies. Regulation A+ can be used by Real Estate Investment Trusts (REITs) as well as Canadian issuers that already have a class of securities listed and traded on a securities exchange in Canada. A public company is also eligible to use Regulation A+ to raise capital through a subsidiary, as long as that subsidiary is not a separately reporting company. Also eligible would be a company that was once a reporting company, but subsequently has deregistered.
Ineligible issuers would include certain bad actors and issuers that have relied on Regulation A in the past, issuers that have not filed ongoing reports in a timely fashion and issuers that have had their Exchange Act registration revoked within five years before the filing of the offering statement.
Q: What securities are eligible?
A: Securities that are eligible to be offered under Regulation A+ are limited to equity securities (including warrants), debt securities and debt securities that are convertible into or exchangeable into equity interests, including any guarantees of such securities.
Q: What are the limits on the offerings?
A: Under Tier 1 an issuer can offer and sell up to $20 million in a twelve-month period, of which up to $6 million can constitute secondary sales.
Under Tier 2 an issuer can offer and sell up to $50 million in a twelve-month period, of which up to $15 million may constitute secondary sales.
Keep in mind, however, that in the issuer’s initial Regulation A+ offering and any Regulation A+-exempt offering in the twelve months following that offering, the selling security holder component cannot exceed 30% of the aggregate offering. After the first year following an issuer’s initial qualification of a Regulation A+ offering statement, the limit on secondary sales falls away for non-affiliates.
Q: What about limitations on investors?
A: Under Tier 2 of Regulation A+, a non-accredited natural person is limited to purchase no more than 10% of the investor’s annual income or net worth, whichever is greater, for natural persons, and 10% of the greater of annual revenue or net assets at fiscal year-end for non-natural persons. This investment limit only applies to non-accredited investors, not institutions, and will not apply if the securities are to be listed on a national securities exchange, such as the NASDAQ, at the consummation of the offering. The investment limit does not apply to Tier 2 Regulation A+ offerings.
Q: What does it mean to “test the waters”?
A: This is one of the great advantages of a Regulation A+ transaction. “Test the waters” means an issuer can use marketing materials with appropriate disclaimers and attempt to solicit interest to see if there is investor appetite for an offering prior to confidentially submitting its offering statement.
Ultimately, materials that are used after an offering statement is publicly filed will have to be filed with the SEC. Therefore, when preparing “test the waters” materials it’s important to ensure that those materials are fair and balanced in their presentation of the company, the investment opportunity, the risk, etc.
Q: How does a company decide between pursuing a Tier 1 and Tier 2 offering? Is it based solely on the amount of money they want to raise?
A: Offering participants often wonder if they should opt for a Tier 2 offering even if they don’t intend to raise more than $20 million. During that decision process issuers should consider the difference in the financial statement disclosure requirements between the two. This may not be as significant a concern for issuers that have been in business for a relatively short period of time as it is for companies that have been in business for more than two years and may never have conducted an audit. Another factor to consider is the ongoing reporting requirements that will be applicable to an issuer that undertakes a Tier 2 offering. Does that make sense for the issuer? The issuer’s aspirations should also be considered. Is the offering a prelude to an IPO, or is it an alternative to an IPO?
And finally, an Issuer should evaluate where it intends to offer the securities. Is it only in a few states? Is it principally through the Internet? There are still a significant number of states that have a merit review approach and that apply a number of standards that are not so easy to comply with, so before making the Tier 1/Tier 2 decision, an issuer should consult closely with council. Understand where the securities will be sold and as well as the offering requirements and standards that will be imposed in merit review states.
Q: Can Regulation A+ be a stepping stone to an IPO?
A: A Regulation A+ offering could be a good choice for a company that doesn’t feel quite ready to do an IPO. In this way, they’re able to remain private, but at the same time develop a market following. The “test the waters” process, as well as the public filing of the offering circular, serves to make information about the issuer broadly available. An issuer might view a Tier 2 offering as an opportunity to build internal systems for reporting and to assemble a team accustomed to periodic reporting in advance of an IPO. Aside from cost, this affords the benefit of qualifying the company as an emerging growth company when it comes time to do its IPO. Finally, by conducting a Tier 2 offering the issuer may attract the attention of potential acquirers, or may raise its profile within the financial community.
Q: How popular do you expect Reg A+ to be?
A: It’s hard to say. The changes to Regulation A+ were designed to offer a cost-efficient means for smaller companies to raise capital in larger amounts. However, there is some doubt that these new rules will boost the use of Regulation A+ as much as anticipated. Particularly with regard to larger offerings using Tier 2, the enhanced reporting requirements—and the scrutiny they entail—may be too much of a negative, even with the ability to raise up to $50 million and to offer unrestricted securities. Companies may simply continue to rely on Rule 506 private placements (which have no dollar limit), even if the securities are “restricted.” Or, conversely, they may decide to just go all the way with a bona fide IPO.
To learn more about how Regulation A+ can help small businesses raise capital, download our free white paper, "Understanding Regulation A+ Changes."