Raising capital with regulation A+
Although Regulation A+ is still in its infancy, the market is starting to take note. Over 100 companies seeking to raise an aggregate of over $2 billion publicly filed offering documents under Regulation A+ in the approximately 12-month period following its adoption. Designed to streamline and democratize private company capital raising, Regulation A+ has already stirred-up significant interest by enabling companies to cast a broad net and raise capital from an unlimited number of non-accredited investors. If your company is seeking a more flexible approach to accessing capital from the public market than a full-blown IPO, a Regulation A+ offering may make enormous sense. This new framework allows companies to market offerings with very few limitations to traditional investors, existing or potential consumers, and other affinity group members to drive both broad ownership and customer loyalty.
Regulation A+ Explained
“Regulation A+” informally refers to the revamped version of Regulation A adopted by the U.S. Securities and Exchange Commission (SEC) in June 2015. It is a set of rules designed to ease the regulatory burden on smaller U.S. and Canadian private companies by allowing them to conduct “mini-IPOs” in which they may offer and sell up to $50 million in securities to the public without going through the costly and time-consuming SEC registration process. Instead, companies file a simplified offering document with the SEC for “qualification,” a process that has, thus far, been significantly faster than the traditional SEC registration review and comment process. Once the offering document is qualified by the SEC, a company may sell its securities to the general public (both accredited and non-accredited investors) and the securities sold will be freely tradable by all non-affiliate purchasers. There are two tiers of offerings under Regulation A+, and depending on the size of the offering or a company’s voluntary compliance with tier-specific requirements, a company may have certain ongoing reporting obligations that continue following the closing of its offering.
Advantages of Regulation A+
Regulation A+ offerings have several advantages over traditional forms of financing. If well-executed and marketed, a Regulation A+ offering can be a great way to build a company’s brand. Rather than selling primarily to traditional institutional investors, a Regulation A+ offering allows a company to reach a much broader investor base and reward customers and brand advocates with the opportunity to invest in a favorite company. Not only can this reinforce brand loyalty, but it may increase the likelihood they recommend the company’s products to others. By raising smaller individual amounts of money from a broader pool of investors, existing owners can retain more control of the company than is typical in IPOs or other more traditional forms of financing. Venture capital firms and other institutional investors often take large ownership positions and demand board seats, or insist on other mechanisms for exercising control over a company. For entrepreneurs who have worked hard to build their companies from the ground up, the opportunity to avoid ceding control to investors is a significant advantage of a Regulation A+ offering.
The number of filings under Regulation A+ has been significantly higher than the number of filings under the old Regulation A. As mentioned above, over 100 companies seeking to raise an aggregate of over $2 billion publicly filed offering documents under Regulation A+ in the approximately 12-month period following its adoption. Of these, roughly 50 companies seeking over $840 million had their offerings successfully qualified by the SEC while others still had filings under SEC review at the end of the approximately 12-month period post-adoption. By way of contrast, in the entirety of 2011, only one company had an offering qualified under the old Regulation A, which limited sales to only $5 million over a 12-month period and required companies to comply with the onerous requirements of the various state securities laws (under Regulation A+, Tier 2 offerings are exempt from state securities law requirements).
Currently, Regulation A+ seems to be gaining traction in certain industries. An SEC official reported in February 2016 that approximately half of the filings under Regulation A+ had been made by companies in the business services, real estate and credit industries. The balance reportedly was comprised of companies from a wide variety of different sectors. Despite this variety, most companies were pre-revenue and roughly 70% had less than $1 million in assets. Roughly 80% of the offerings were equity offerings and most were self-underwritten. Of those that were not self-underwritten, roughly 90% were conducted on a “best-efforts” basis. These statistics reflect that many early adopters may have sought to leverage Regulation A+ to “crowd-finance” offerings without meaningful participation from the most prolific new issue buyers – professional, institutional investors. To date, yield products designed to appeal to income investors (often retail) have found the strongest reception, while successful fund raises for growth capital have been rare (see Elio Motors below). Our expectation is that the types of companies utilizing Regulation A+ will continue to diversify. Given its enhanced marketing flexibility, reduced costs and greater efficiency versus a registered offering, we expect Regulation A+ to become an increasing common alternative for all companies raising less than $50 million.
Elio Motors, an A+ Company
While a variety of companies with diverse profiles have taken advantage of Regulation A+, there are characteristics that make certain companies more likely to have a successful Regulation A+ offering. For example, perhaps your company has already raised some capital but is continuing to look for a further capital injection to get it over the hump? Does your company sell a physical product that is relatively easy for people to understand? Does your company have a large, loyal and engaged customer base? Is your company starting to generate revenue? If the answer is “yes” to all or most of these questions, your company may be well-positioned to raise capital using Regulation A+.
By way of example, Elio Motors illustrates the potential success of Regulation A+. Elio Motors is developing an ultra-high-mileage, three-wheeled vehicle designed to get 84 miles per gallon. With a price tag of approximately $7,000 and an interesting, futuristic design, the vehicle seems to have resonated with the public. The company was able to capitalize on this interest, raising nearly $17 million from over 6,500 investors in its “mini-IPO,” which closed in February 2016. Elio Motors is currently trading on the OTCQX marketplace and over 62,000 vehicles had been reserved for purchase as of November 2016.
Regulation A+ Versus Traditional Private and Public Offerings
Compared to traditional Regulation D private placements, Regulation A+ offerings are not limited either exclusively to accredited investors or up to 35 non-accredited investors, if the company provides comprehensive financial and other informational disclosures. Regulation A+ offerings are, however, likely to take substantially more time to complete than traditional private placements due to the need for SEC review of the offering document in the qualification process. Also, unlike traditional private placements, companies looking to raise more than $20 million dollars in a Regulation A+ offering (or who voluntarily adopt the more expansive “Tier 2” standards) will be subject to certain ongoing reporting requirements following the completion of their offering. Compared to a traditional IPO, Regulation A+ offerings are typically “qualified” by the SEC in less time than it takes for a traditional IPO registration statement to be declared “effective”. In addition, the costs associated with a Regulation A+ offering are likely to be substantially lower than those associated with a traditional IPO, although companies utilizing Regulation A+ should still expect to incur significant legal and accounting fees. For example, companies utilizing Regulation A+ will need to engage counsel to prepare offering documents and conduct due diligence, and companies looking to raise more than $20 million under Regulation A+ will be required to work with their accountants to prepare audited financial statements. Another consideration that will impact cost, timing, and disclosure requirements (both initial and ongoing) will be the selection, if any, of listing venue for the shares post-offering. For issuers that choose to list on a national exchange, initial disclosure in the Form 1-A will more closely resemble that of a registered offering and ongoing disclosure must comply with exchange standards. Alternative trading venues, including markets operated by OTC Markets Group, require less disclosure. Although costly and time-consuming in its own right, companies employing Regulation A+ in advance of a future uplisting to a national securities exchange will find themselves further along the learning curve when that time comes.
Risks and Challenges
Despite the many advantages of Regulation A+ offerings, companies considering Regulation A+ should be aware of certain pitfalls. While there has been a substantial uptick in filings and qualifications since Regulation A+ was adopted, the market is continuing to sort-out how the new Regulation A+ fits into the broader landscape of exemptions from SEC registration. As a result, with some notable exceptions (e.g., WR Hambrecht + Co), investment banks have been slow to embrace Regulation A+ and nearly 80% of Regulation A+ offerings through February 2016 were self-underwritten. For those employing a self-underwriting model, it is important not to get lost in the crowd, and taking charge by investing in a strong marketing/promotional campaign is likely to help a company stand out from the crowd, capture the market’s attention and increase the potential for a successful offering. For larger offerings, i.e. $20-50 million, it may be most productive to leverage multiple distribution channels to attract traditional institutional investors as well as a crowd-sourced (largely retail) investor community.
In addition, while securities purchased by non-affiliates in Regulation A+ offerings are freely tradable, the secondary market for Regulation A+ securities is still developing. As of November 2016, no securities issued in a Regulation A+ securities offering had been listed on a national securities exchange. However, the OTC Markets Group, which operates the preeminent over-the-counter quotation system for broker-dealers, has taken an interest in Regulation A+, including the potential to expand its scope. As discussed above, Elio Motors is currently trading on the OTCQX marketplace. Further, the OTC Markets Group has appeared before the SEC to discuss certain legal/mechanical impediments relating to, among other things, the ability of broker-dealers to publicly quote Regulation A+ securities. The OTC Markets Group has also petitioned the SEC to expand the availability of Regulation A+ to smaller public companies, which could dramatically impact public company capital raises. While companies considering a Regulation A+ raise should think about these challenges, given that many investors in Regulation A+ offerings are devoted customers investing for the long-haul, these liquidity concerns may be less important than they are in alternative financings.
While the ability of Regulation A+ to fully disrupt and democratize private company capital raising will depend on greater acceptance and participation from the investment banking community, Regulation A+ has already attracted significant attention and can benefit the right type of company that is ready to commit itself to strongly marketing its offering. Thanks to some important improvements to the old legal framework, Regulation A+ represents a new and improved pathway for private U.S. and Canadian companies to raise much-needed capital from a broad base of investors and to build their brand in the process.
Victor Boyajian, Dentons
Ira Kotel, Dentons
Asim Grabowski-Shaikh, Dentons
Justin Sciabbarrasi, Dentons
Whitney White, WR Hambrecht + Co
Robert Malin, WR Hambrecht + Co