Lobbying Affiliate: MML&K Government Solutions

SEC’s Reg A+ opens the door to a new world of investors for small business

Attorneys

September 24, 2015
Susan Baniak
Business Lexington

With the March release of the Securities and Exchange Commission’s new rules for businesses looking to raise capital, smaller companies can now begin to delve into the enticing potential of equity crowdfunding.

For businesses that can navigate the new regulations, the door is open to court investment not only from deep-pocketed accredited investors but also everyone else looking to get in on the ground floor of the next big thing, including clients, business associates and other citizens of more average means.

In keeping with the JOBS Act passed by Congress in 2012, the newly released Regulation A+ updates and expands the existing Regulation A, a little-used SEC exemption for smaller issuers of securities. The updated version makes the exemption more interesting for businesses by increasing the previous $5 million limit on the amount of capital that companies can raise.

The new regulations are divided into two tiers of offerings that now allow companies to raise up to $20 million for Tier 1 or up to $50 million for Tier 2 in a single year.

Beyond just increasing the limits, however, Regulation A+ also provides avenues for businesses to solicit non-accredited investors in unlimited amounts for the first time and to explore the possibilities for capital formation with potential investors before committing fully to a formal offering. But while the SEC’s regulatory changes introduce a wealth of new possibilities for local businesses, the process isn’t cheap or easy.

“Time will tell whether Reg A+ is as big of a game-changer as many predict,” said Thomas Flanigan, a member at McBrayer, McGinnis, Leslie & Kirkland PLLC. “It does open up investment from an entirely new group of investors on an expanded level, but it also comes with a greater expense, if done properly.”

Both tiers of Regulation A+ are subject to rules of issuer eligibility, disclosure and other terms, but Tier 2 introduces additional requirements for audited financial statements and annual, semiannual and current events reports, along with a limitation that allows non-accredited investors to spend no more than 10 percent of either their annual income or net worth, whichever is greater. Also, while Tier 1 offerings are still subject to state securities law registration as before, the Tier 2 option streamlines the process by allowing companies to bypass state registration requirements.

Essentially, Tier 2 allows companies to pursue a “mini-IPO” that is less complicated and intense than a traditional IPO, but the estimated expense for complying with the many regulatory aspects can run between $50,000 and $100,000, according to Flanigan, still placing the opportunity out of reach for many small businesses.

But for companies that can bear the cost and effort required for the added regulatory hoops, Regulation A+ offers some attractive perks. Companies that want to gauge the interest of potential investors can do so by using social media apps such as Twitter to solicit non-binding interest without the communication being deemed as a prospectus. Initial filings of offering statements can also be made confidentially, Flanigan said, giving companies more time and leeway to pull together the details after filing and make adjustments for up to three weeks prior to the offering being qualified by the SEC. The confidentiality also allows companies to move forward with an offering without revealing their intentions to competitors too early in the process.

“These are certainly business-friendly moves, and they provide the business with the opportunity to see whether a Reg A+ offering will be worth the time and expense,” Flanigan added.

While Regulation A+ can be seen as unlocking the door to private equity for small businesses, according to Flanigan, more SEC regulations aimed at easier capital formation are likely to follow.

Such regulatory changes also are likely to be a boon for local economies as well. Locally focused companies can now engage their clients, neighbors and other community members as not only a valuable customer base but also a potential source of investment capital. The opportunity to garner financial support from a broad audience of vested community members could ultimately spur new jobs and growth in local economies that depend heavily on small businesses as economic drivers.

Still, other methods of handling offerings, such as the SEC’s Regulation D, are still in place and likely to be easier, cheaper and faster than Regulation A+ for those looking to take a more traditional route, Flanigan pointed out.

“What will ultimately demarcate traditional funding vehicles from these Reg A+ off erings is whether companies believe that opening the investment door to all investors will make a difference to that particular company,” he said.

In addition, smaller business owners who use Regulation A+ could also be taken aback, Flanigan said, if they suddenly find themselves beholden to perhaps hundreds of inexperienced small investors with little patience for the fluctuation and risk that typically come with business investment.

It is, as Flanigan calls it, a “true democratization of capital raising” — and democracy can be a messy business.

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