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The plus side of Reg A

Posted in IPO On-Ramp, JOBS Act News, Regulation A+

To date, the Jumpstart Our Business Startups Act (the JOBS Act) is best known for legalizing securities crowdfunding (better called ‘crowd investing’), lifting the ban on the mass marketing of private offerings, and fostering an IPO on-ramp for so-called emerging growth companies, like Twitter.  But there’s more to the JOBS Act than these better publicized sections. On December 18, the SEC proposed rules under yet another section of the Act (Title IV) that would permit companies that register a “mini-IPO” with the SEC to raise up to $50 million from the general public in a 12-month period.  In the coming months, expect to hear more about this exemption (called Regulation A+) that may prove useful to companies looking to raise capital across a broad range of sectors, industries, and geographic regions.

Adding the plus to Reg A:  The existing Reg A permits the sale of up to $5 million of securities to both accredited (high net-worth or income individuals) and unaccredited investors so long as the issuer files a mini-registration with the SEC (one that the SEC then approves) and complies with relevant state law registration requirements in each state where funds are solicited.  Unfortunately, as the following graph demonstrates, the Reg A exemption has been rarely utilized.

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* Note that the number of qualified Reg A offerings has decreased from 57 in 1998 to 1 in 2011.

According to a July 2012 GAO report, existing Reg A has remained unpopular compared to other exemptions due to the high costs of complying with both federal and state registration requirements, as well as the $5 million limit on fundraising.

Under the SEC’s proposed rules to implement the new Reg A+, state registrations would not be required, and a small company would be able to raise up to $50 million from the public, deal in unrestricted securities (which are immediately re-sellable), engage in ‘testing the waters’ to gauge investor interest, and promote the offering to the broad marketplace.  The increase in the investment cap and the preemption of state laws will likely generate interest in this exemption, and could in some cases render it a viable competitor to the existing Reg D private offering exemption.

Bridging private and public markets: Given the proposed parameters of the Reg A+ exemption, there are expectations that it will provide a bridge for small companies that are seeking to grow but are not yet mature enough to proceed to the IPO on-ramp.  Additionally, companies in sectors, industries, or geographic regions that have struggled to gain access to traditional sources of capital might turn to this tool in order to seek funding from a larger pool of investors.  Real estate, life sciences and biotech, brick-and-mortar businesses such as restaurants, and perhaps even some technology companies outside of leading venture capital hubs may be drawn to the benefits of a Reg A+ offering.  It is also likely that traditional early-stage venture capital or private equity investors will welcome Reg A+ as a new exit option.

Finally, there are certain aspects of Reg A+ that could render it a viable model for companies looking to use Internet-based investment platforms to facilitate broader crowd-investing. For example, Washington, D.C.-based Fundrise utilized the existing Reg A exemption to raise $325,000 from crowd investors in D.C. and Virginia through its Web-based platform. The Web-raise could be considered one of the first equity crowd-investments in the country, but it did not need to wait on SEC implementation of the JOBS Act crowd-investing provisions since existing Reg A was already available. Now, with an increase in funding caps and the possibility of state law preemption, Reg A+ could draw even greater Web-platform interest.

Addressing the level of small company IPOs: The Reg A+ mini-IPO might also provide a capital solution for small companies that are not yet able to meet the costs or size requirements of today’s IPO market.  Depending on the SEC’s final rules, it is conceivable that a company would be able to file with the SEC under the Reg A+ exemption and then ultimately decide to list on a national exchange as a publicly reporting company.  In this way, small companies might have at their disposal a more cost-effective method of going fully public.

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As with all new securities law exemptions, however, there are open questions regarding the role of state regulators and the inclusion of adequate investor safeguards – though the registration requirements of Reg A+ call for significant disclosure.  There are also questions of how to make this exemption a viable, cost-effective tool for companies by ensuring regulatory harmony with other relevant securities rules, including those related to reporting company shareholder thresholds, which require public reporting once a company has more than 500 unaccredited investors.

In any event, stay tuned as a national discussion develops on adding the “plus” to Reg A.

[1] Sources: Bloomberg, Milken Institute

[2] Sources: Proposed Rule Amendments for Small and Additional Issues Exemptions Under Section 3(b) of the Securities Act: Page 211, Milken Institute

Daniel Gorfine is the director of financial markets policy and legal counsel in the Washington office of the Milken Institute. He focuses on entrepreneurship, capital access, and financial market issues.

This post was originally featured on the Milken Institute’s blog, Currency of Ideas, available at: http://currencyofideas.tumblr.com/.