Newly revised Regulation A, dubbed Regulation A+, began its life at the top of the grading curve, but has yet to prove its value in the marketplace as an offering technique, perhaps understandably given its very recent adoption. The revised regulation, which became effective on June 19, 2015, is designed to facilitate the development of a mini-IPO market for smaller U.S. and Canadian companies to offer their shares publicly without the full responsibilities of Securities Act registration. In order for Regulation A+ to succeed in this endeavor and prove its value to market participants, it must:
- offer, for at least some companies, an effective alternative to either a traditional IPO or offerings under Rules 506(b) or (c) or Rule 144A under the Securities Act; and
- stimulate investor interest (and foster investor confidence) in both primary and secondary markets.
The companies most likely to benefit from Regulation A+ are those not well served by either public or private markets. In general, these might be smaller companies with business models that are unlikely to attract enough institutional investment in private markets. Such companies might also be discouraged from entering the IPO process, because of the high transaction costs and compliance burdens associated with Securities Act registration and reporting under the Securities Exchange Act of 1934. Smaller companies with consumer-facing business models, especially those appealing to a particular affinity group or fan base, may also want the ability to reach out to retail investors who may be familiar with their brand. For these companies, Regulation A+ could provide the ability to offer their shares publicly, under a regulatory regime that is appropriately tailored to their size.
But the real value of Regulation A+ may prove to be for companies in certain niche markets – for example, where there is a high need for early stage capital – or for private companies in a wide range of industries doing transactions (like some stock-for-stock acquisitions) that cannot be easily done as private placements. Now is the time for practitioners to think creatively about the opportunities that Regulation A+ may offer.
Some Background on Regulation A+
Regulation A+ results from a JOBS Act–mandated overhaul of prior Regulation A, a little used exemption from Securities Act registration that required both SEC review of the offering document and state blue sky qualification. Old Regulation A offerings could not exceed $5 million, a virtually unworkable cap for this type of offering. Regulation A securities, however, could be publicly offered and resold without a holding period.
New Regulation A+ creates two tiers of offerings, with Tier 2 being potentially the more interesting and innovative. Under Tier 2, companies may “qualify” offerings of up to $50 million of their securities in any 12-month period made to an unlimited number of accredited and unaccredited investors. Companies may also qualify secondary sales by their affiliates in an amount up to 30 percent of the first Tier 2 offering and any follow-on offerings in the same 12-month period and up to $15 million per year in subsequent years. Unless the securities are also listed on a national stock exchange, the amount of Tier 2 securities that may be purchased by any single unaccredited investor in any year is limited to not more than (a) the greater of 10 percent of the investor’s annual income or net worth, in the case of an individual investor, or (b) the greater of 10 percent of the investor’s annual revenue or net assets, in the case of an entity.
The Tier 2 qualification process requires the submission and SEC review of a detailed offering statement that includes two years of audited financial statements. The company must wait for SEC review and qualification of the offering statement, but the offering is exempt from state blue sky review.
After a Tier 2 offering, the company becomes, in effect, a mini-reporting company, required to submit to the SEC annual and semiannual reports, as well as current reports of significant events. These reports, like the offering statement itself, can be viewed by the public on EDGAR. The requirements are analogous to, but less burdensome than, the basic periodic reporting requirements applicable to smaller reporting companies, except that reporting is done on a semiannual rather than quarterly basis. There are no rules governing the solicitation of proxies or requiring insider transaction reports. Tier 2 companies can exit from the reporting regime on essentially the same terms as public companies exit SEC reporting requirements. So long as the company continues to comply with Tier 2 reporting requirements, its shares can be traded in the over-the-counter market.
A Tier 2 company may list on an exchange if it registers its shares under the Exchange Act, in which case the company becomes subject to Exchange Act reporting requirements. A Tier 2 issuer that chooses this path, however, must give up some of the advantages of Regulation A+: it must use Form S-1 for its offering statement; its financial statements must be audited in accordance with standards set by the Public Company Accounting Oversight Board; and it becomes subject to the panoply of Exchange Act reporting and compliance requirements.
Tier 1 of Regulation A+ is more like the old Regulation A, with the important exception that companies may now offer up to $20 million of their securities in any 12-month period pursuant to Tier 1. Secondary sales by affiliates may constitute up to 30 percent of the first Tier 1 offering and any follow-on offerings in the same 12-month period and up to $6 million per year in subsequent years. Offerings may be made to an unlimited number of accredited and unaccredited investors, with no limitation on the amount that may be sold to unaccredited investors. The offering statement submitted to the SEC for review and qualification is similar to, but slightly less detailed than, the one required for a Tier 2 offering, and financial statements need not be audited. The offering is not exempt from blue sky qualification, which means that the company must potentially file for review in each state where offers are made. The North American Securities Administrators Association (NASAA) has developed a coordinated review process, which might make this less onerous than it seems.
Tier 1 companies do not have continuing reporting obligations, after the filing of a report on the completion of the offering. Like Tier 2 securities, Tier 1 securities are not “restricted securities” under Rule 144 under the Securities Act, meaning they can be freely sold by non-affiliates. Without the availability of current financial and other information, however, it may not be possible to trade Tier 1 securities in over-the-counter markets.
Both Tier 2 and Tier 1 offerings are limited to privately held companies organized and having their principal place of business in the United States or Canada. Companies can be barred from pursuing a Regulation A+ offering based on the presence of certain “bad actors” on their board of directors or as key executive officers, significant shareholders, promoters, or brokers in the offering. Companies that are registered as investment companies under the Investment Company Act of 1940, as amended, or that are required to be so registered, including business development companies, may not conduct offerings under Regulation A+. Regulation A+ is not available for blank check companies or special purpose acquisition companies, also known as SPACs. It cannot be used by companies that have a class of securities registered under the Exchange Act, but it can be used by voluntary filers and companies that have had their Exchange Act reporting obligations suspended by reason of having fewer than 300 holders. Regulation A+ can be used in connection with business combinations and can be used by subsidiaries of publicly traded companies.
Both Tier 2 and Tier 1 reflect the SEC’s effort to modernize the offering procedures for these exemptions. Both tiers permit issuers to submit draft offering statements to the SEC for confidential review before filing, require electronic filing pursuant to EDGAR, and permit electronic delivery of the offering circular to investors. Both tiers also permit the issuer to engage in “testing-of-the-waters” communications with investors before the qualification of an offering statement. A company may “tweet” communications designed to solicit interest in its offering, so long as the tweet includes an active hyperlink to all information required by Rule 255 under the Securities Act and, where possible, a statement emphasizing the importance of the required hyperlinked information.
Is Regulation A+ an Effective Alternative to Other Exemptions or a Registered IPO?
Why go through the process of Tier 1 or Tier 2 qualification if you can raise money from accredited investors under Rule 506(b) or (c) under the Securities Act? As long as investors are willing to provide financing on reasonable terms in private markets, Rule 506(b) or (c) will be the way to go. But despite a frothy market in private company shares and the billion-dollar valuations of certain tech company “unicorns,” many smaller companies have difficulty finding financing on acceptable terms in private markets. Regulation A+ requires more work on the preparation of the offering and more compliance effort afterwards, at least for Tier 2, but may expose companies to a different market. Regulation A+ allows companies to offer freely tradable stock to their investors. Regulation A+ also allows them to approach individual retail investors (both accredited and unaccredited), who are often not included in private markets. Tier 2 gives companies and investors many of the benefits of a publicly traded stock, with less cost and less regulatory burden.
Tier 2 offerings are perhaps more aptly compared to public offerings registered under the Securities Act. Again, the companies that are likely to be most successful in a registered initial public offering and in public trading markets thereafter are not likely to choose Regulation A+. First, there is the limitation on the amount of the offering; relatively few registered IPOs in current markets seek $50 million or less. Second, there is the inability to list securities on a national securities exchange without Exchange Act registration. While it is possible to combine a Tier 2 offering with an Exchange Act registration, as explained above, this is probably an attractive alternative mainly for companies planning to conduct a registered public offering in the near future. This option would require the issuer to forego many of the benefits of a Tier 2 offering as compared to a registered offering: the more limited initial disclosures, the more limited financial statement requirements, and the more limited reporting and compliance burdens after the completion of an offering. Tier 2 offerings without Exchange Act registration will most likely appeal to companies for whom these benefits outweigh the advantages and possibly higher stock prices associated with a stock exchange listing. These are generally smaller companies that in recent history have not been served well by public markets.
Tier 1 offerings may ultimately be compared to crowdfunding transactions, enabling very small companies to raise up to $20 million publicly from retail and other investors, without incurring the ongoing reporting obligations of Tier 2. Tier 1 has the significant advantage of allowing companies to raise more than the maximum amount of $1 million permitted under new Regulation Crowdfunding, which will become effective on May 16, 2016. The ability to raise more than $1 million also makes Tier 1 more attractive than Rule 504 under Regulation D of the Securities Act, which currently permits issuers to raise up to $1 million in any 12-month period publicly from both accredited and unaccredited investors, so long as the offering is made in accordance with state securities laws requiring the registration of securities and the filing and delivery of a substantive disclosure document. Even if Rule 504 is amended to permit a capital raise of up to $5 million, as the SEC has recently proposed, Tier 1 will still be necessary for a capital raise of more than $5 million. The greater dollar amounts that can be raised, as well as greater geographic flexibility, will make Tier 1 more attractive to some issuers in comparison to state-based crowdfunding exemptions.
Will Regulation A+ Find Its Niche?
It is of course impossible to tell at this stage how Regulation A+ will fare over the next few years, or whether it will fulfill its JOBS Act mission of creating, or helping to create, a vibrant market for the securities of smaller companies. More valuable than predictions, however, are suggestions for how Regulation A+ can be utilized. As indicated above, the most likely candidates for Regulation A+ offerings are smaller companies not well served by private markets at the time they need capital, perhaps because investments in their industry have fallen out of favor, their growth trajectory is unpredictable, or their need for funding surpasses what private investors are willing to provide without assurances of liquidity.
The advantages of Regulation A+ might be seen from the perspective of investors in smaller companies. One can imagine private investors pushing companies to engage in Regulation A+ offerings so that they could get liquidity for their existing investments or invest in the offering but have an ability to exit later on. Regulation A+ might be part of the exit strategy for private equity firms, possibly using the offering as a stepping stone to a later registered transaction where the private equity investor would make a full exit from the company. Public companies might use Regulation A+ as a step in selling off a subsidiary. The first step in such a transaction might be for the subsidiary or controlled company to do a primary offering under Tier 2 of Regulation A+. The Tier 2 primary offering could be accompanied by secondary sales by the controlling company. In subsequent Regulation A+ offerings, the former controlling company could sell off the remainder of its investment.
Regulation A+ may also be helpful from a technical standpoint for transactions that are difficult to accomplish through a private placement, but small enough so that a full-blown Securities Act registration would be overkill. Consider, for example, a private company purchasing another private company in exchange for shares of its stock. The offering of the shares could be accomplished as a private placement if there were only a small number of target company stockholders and each of them was willing to accept the stock with contractual restrictions on transfer. With a larger number of stockholders, or any significant number of unaccredited investors, it might be easier to accomplish the transaction by qualifying the securities of the acquiring company under Regulation A+. Regulation A+ could also be useful in the often complex environment of private company recapitalization transactions, if other exemptions (such as the exemption under Section 3(a)(9) under the Securities Act) were not available, as is sometimes the case. One possible problem in using Tier 2 of Regulation A+ in an acquisition or recapitalization transaction where there were unaccredited investors might be the limitation described above on the amount of Tier 2 securities that can be sold to any single unaccredited investor in a 12-month period.
Regulation A+ could be used in cross-border transactions involving Canadian issuers, but not other non-U.S. issuers, since Regulation A+ is currently limited to U.S. and Canadian companies. A company that was publicly traded in Canada but not registered under the Exchange Act in the United States might do a Regulation A+ offering to U.S. investors. These investors could then trade the shares on a Canadian exchange, combining the advantages of a Regulation A+ offering with an exchange-traded security. Canadian issuers might also find Regulation A+ useful for smaller southbound M&A transactions, allowing them to issue securities to the target company’s U.S. shareholders, without full-blown Securities Act registration.
These are only some of the possible applications of Regulation A+ in the future.