On June 19, 2015, amended Regulation A recently adopted by the SEC will become effective. The new Regulation A, mandated by the JOBS Act and often dubbed as Regulation A+, is a significant improvement over the old Regulation A, which was rarely used as a capital raising vehicle. The old Regulation A permits unregistered offerings of up to $5 million of securities in any 12-month period, including no more than $1.5 million of securities offered by security holders of the company. Permissible thresholds of Regulation A+ are much higher. It provides for two tiers of offerings: “Tier 1, for offerings of securities of up to $20 million in a 12-month period, with not more than $6 million in offers by selling security-holders that are affiliates of the issuer; and Tier 2, for offerings of securities of up to $50 million in a 12-month period, with not more than $15 million in offers by selling security-holders that are affiliates of the issuer.”
However, will Regulation A+ become a more popular choice for smaller companies than Regulation D in raising capital? Is Regulation A+ a workable compromise between the company’s need to have access to capital and the SEC’s goal of investor protection?
Rule 506 of Regulation D is one of the most widely used capital raising exemptions under the US securities laws. The main reason of its popularity is its flexibility. Although Rule 506 does not provide an opportunity for selling security holders to participate in the offering as Regulation A+ does, Rule 506 does not have any caps on the dollar amount that can be raised. In addition, any company: public or private, US or foreign can raise capital under Rule 506. However, only a US or Canadian issuer that is not (i) a reporting company under the Securities Exchange Act of 1934 immediately prior to the offering, (ii) an investment company, or (iii) a blank check company is considered an “eligible issuer” under Regulation A+. Note that “bad actor” disqualification applies to both Rule 506 and Regulation A+ offerings. Also, a company that had its registration revoked under Section 12(j) of the Exchange Act within five years before the filing of the offering statement or that has been delinquent in filing required reports under Regulation A+ during the two years before the filing of the offering statement (or for such shorter period that the issuer was required to file such reports) is not eligible to do an offering under such Regulation.
In some instances, Regulation A+ appears to be more accommodating than Rule 506. For example, Rule 506 allows an unlimited number of accredited investors as purchasers (with Rule 506(b) also permitting up to 35 non-accredited investors), and Tier 1 of Regulation A+ does not have any limitation on the number or type of investors. Tier 2 also does not have any limitations on the number of investors, but imposes a per-investor cap for non-accredited investors (unless the securities are listed on a national exchange) of the aggregate purchase price to be paid by the purchaser for the securities to be no more than 10% of the greater of annual income or net worth for individual investors or revenue or net assets most recently completed fiscal year for entities. In addition, Regulation A+ allows issuers to “test-the-waters” by trying to determine whether there is any interest in a contemplated securities offering (assuming such practice is allowed under applicable blue sky laws for Tier 1 offerings), while the traditional Rule 506(b) does not allow for general solicitation and advertising (Rule 506(c) permits general solicitation and advertisement).
The biggest downside of Regulation A+ structure is that blue sky registration requirements are not preempted for Tier 1 offerings, which significantly limits the use of Tier 1 for offerings in multiple states. Such preemption exists for Rule 506 offerings as well as Tier 2 of Regulation A+ offerings. But the welcomed flexibility of doing nationwide offerings under Tier 2 comes with a heavy price tag of ongoing reporting. After a Tier 2 offering, an issuer must file with the SEC annual reports on Form 1-K, semi-annual reports on Form 1-SA and current reports on Form 1-U (within 4 business days of the event). The SEC also noted that companies may “voluntarily” file quarterly financial statements on Form 1-U, but the practical effect of desired compliance with Rules 15c2-11 and Rule 144 to maintain placement of quotes by market makers and resales of securities, will lead to “voluntary” quarterly reporting becoming essentially mandatory.
Rule 506 offerings are usually accompanied by private placement memoranda, or PPMs, (even when offerings are solely to accredited investors) to protect issuers from Rule 10b-5 liability under the Exchange Act. There is no prescribed format for such PPMs and they are not reviewed by the SEC. In connection with Regulation A+ offerings, an issuer must file Form 1-A (a “mini” registration statement) through EDGAR with the SEC (first-time issuers are eligible to initially do a non-public submission of a draft of Form 1-A). Such Forms 1-A are subject to the SEC review and comment process, which increases the cost of the transaction and extends the time from the beginning of the transaction and the closing.
The good news is that Regulation A+ provides a new way for smaller companies to raise capital and get some liquidity in their securities. However, if a company is confident that it can raise money through the traditional Rule 506 private placement, it may still want to avoid the SEC review process, the hassle of blue sky compliance under Tier 1 or ongoing reporting obligations of Tier 2 introduced by Regulation A+.