CrowdExpert | David Pricco | Nov 2015

Equity Crowdfunding With Reg A+ is Now In Effect

While Title III Equity Crowdfunding will open up the opportunity for many early stage startups to raise up to one million dollars using online crowdfunding platforms, Regulation A+ which went into effect June 19th 2015 allows medium sized companies to raise up to $50 million online.

Reg A+, as a quick refresher, is a new set of SEC rules which allow private companies a streamlined process to raise money from investors. Title IV of the JOBS Act reformed the old Regulation A exemption by splitting it into two tiers: Tier 1 allows companies to raise up to $20 million in any 12-month period with minimal ongoing SEC reporting requirements, but with the offering subject to “blue sky” state securities laws, requiring the issuer to register and comply with different regulations in each state they offer securities in. Whereas Tier 2 allows companies to raise up to $50 million and is exempt from blue sky regulation, but does add ongoing SEC reporting requirements. Both tiers of Reg A+ permit testing-of-the-waters, confidential filing of the offering statement, general solicitation, sales to unaccredited investors, and can also be potentially exempt from the shareholder limitations under the Exchange Act.

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So now that Reg A+ has been in effect over the summer and half the fall, what trends are we seeing in its use? What kinds of companies are taking advantage of the new regulations? How are funding platforms facilitating Reg A+ offerings? And how, if at all, is the Main Street, unaccredited investor taking advantage of Reg A+?

Too Early to the Party?

Unfortunately, even with the benefit of several months we have not yet seen an outpouring of Reg A+ offerings. The biggest reason is that it takes 4-8 months to get complex regulatory filings, such as those required by Reg A+, through the SEC (not to mention state filings if proceeding under Tier I). Even those Reg A+ offerings that have gone past the testing-the-waters phase are suspected to have begun the filing process back under the old Reg A regime in order to get the filings approved by the SEC in time to take advantage of Reg A+ as soon as it came into effect.

In a keynote address  on Oct 28th 2015 SEC Chairman Chair Mary Jo White gave us the following update:

As for Regulation A+, which just became effective in June, it is obviously too early to draw conclusions. Companies are beginning to take advantage of the new rules in greater numbers than was the case under the prior version of the exemption, with approximately 34 companies publicly filing offering statements and 16 companies filing non-public draft offering statements. The staff has qualified three offerings so far, and it remains to be seen how investors will react to such offerings.
– SEC Chairman Chair Mary Jo White

So that’s it, only 3 offerings qualified so far. We’re just getting started.

We spoke to one of our favorite experts in the Investment Crowdfunding space, Sara Hanks, CEO at CrowdCheck, a provider of due diligence services for crowdfunding platforms, for her perspective:

“It takes time to put together an SEC filing. Even though the Form 1-A is simple compared to a full SEC registration, it’s still a grown-up SEC filing with all the SEC rules. Additionally, securities lawyers are some of the most conservative creatures on the planet. I hear that a lot of them are dissuading their clients from using Reg A until they see what the market looks like.”
– Sara Hanks, CEO @ CrowdCheck

June 19th was about 4 months ago, so given the 4-8 month estimate of filing time, we should be seeing the rest of the first round of Reg A+ offerings open for investment coming online between now and February 2016. If those work out, then there will likely be a second wave mid-next-year.

Consumer products and consumer-facing companies are expected to be big users of Reg A+ once the process is more established. Evangelist customers of popular products interested in investing in the company to help fuel its growth. The most famous use of the old Regulation A rules was actually by Ben & Jerry’s ice cream. With the slogan “Get a scoop of the action,” Ben & Jerry’s raised $750,000 from 1,800 ice-cream-loving Vermonters in 1984, allowing them to build a new plant and expand, and setting the stage for a $5.8 million initial offering the following year.

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Sara Hanks points out how retail companies specifically will have a more difficult time with Reg A+, as the filings require an audit, which for retail companies means a physical audit of their inventory.

“For example, I know of two companies that cannot file with the SEC because they’ve only just engaged their accountants for their audit. Both are retail companies with actual sales. Which means inventory. An auditor has to physically examine the inventory both at the beginning of the audit period and the end. Obviously, accountants can’t go back in time and count stuff from a time before they were engaged, so both these companies are going to have to wait for a bit before they can get clean audit opinions.”
– Sara Hanks, CEO @ CrowdCheck

This doesn’t mean we won’t see more consumer companies using Reg A+ the way Ben & Jerry’s did, just that it will take them longer to prepare their offerings for SEC compliance.

We’ve also seen companies in the real estate industry express interest in utilizing Reg A+ as an additional source of capital for development beyond bank loans or large private equity investors; retail investors seeking to diversify their portfolio may also be interested real estate securities tied to specific properties, rather than investing in REITs or aggregated mortgage-backed securities.

Fundrise, EarlyShares, and GroundFloor are real estate investment crowdfunding platforms to keep an eye on, as they have expressed interest in utilizing Reg A+ to make offerings available to unaccredited investors.

Reg A+ Is Expensive

Reg A+ is not for startups looking for seed crowdfunding for their new idea.

“Regulation A+ is not likely to be suitable for an early stage company. Rather, it will most likely be useful for companies that have raised capital already, but now want to raise a significant amount of additional capital (up to $50 MM).  They have the financial resources to hire the lawyers and accountants necessary to engage in the process of a Regulation A+ offering, but not the resources to engage in an IPO.”
– Alexander J. Davie, Securities Attorney

According to CrowdFund.co: “In all, the costs are likely going to range somewhere between $40,000 and $100,000 for the front-end and 1% to 10%+ for the back-end.”

• Attorney filing fees. Filing your Form 1-A with the SEC: $25,000 to $80,000
• Accounting & audit costs. Both Tier 1 and Tier 2 of Regulation A+ require two years of audited financials. The second tier simply requires a bit more in terms of ongoing reporting, which adds to the complexity and cost. Tier 2–while a bit more onerous on the reporting side–pre-empts the state Blue Sky laws : $12,000 to $30,000
• Broker-dealer and other promotional costs.: 5-10%+ depending on investor relationships

These fees should come in time down as providers get accustomed to the new workflow and more attorneys, accounts, and broker-dealers start providing Reg A+ compliance services.

The moniker of “mini-IPO” makes sense for Reg A+ offerings. In addition to the initial registration process, submission of ongoing audited financials to the SEC is required. Though not as strenuous as the PCAOB requirements that public companies adhere to, it is still a significant cost and effort for startups.

For context keep in mind that a real full IPO costs the company raising money on average $2.6 million dollars in registration, legal and financial service fees, and raises an average of $100 million dollars. So there is huge potential here for Reg A+ to allow medium sized companies to raise money that were not yet ready for a standard IPO.

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Success Stories So Far

Given the long lead-time necessary for a company conducting a Reg A+ offering to get its regulatory filings through the SEC and state securities regulators, true success stories in the form of completed offerings with money in the bank are far and few between. However, several companies have had very successful “testing-the-waters” periods, where investors expressed non-binding interest in participating in a potential Reg A+ offering by the company.

For example, ElioMotors, a startup that aims to develop an ultra-high mileage, low-cost, three-wheeled vehicle with the same comfort and safety as traditional automobiles, hosted a testing-the-waters campaign on StartEngine, an equity crowdfunding platform using Reg A+ and open to unaccredited investors. (Check out our CrowdExpert interview with CrowdFundX, the marketing agency behind Elio’s groundbreaking campaign.)

In 19 days Elio was able to to secure stated interest from 5000 investors to the tune of $16 million, with the company considering a Tier II offering of $25 million. Though it remains to be seen to what degree people who say they would like to invest actually write a check when the offering goes live.

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