The raising of private funds from venture capital sources or individual investors have traditionally been undertaken by means of federal exemptions that have allowed offerings primarily to “accredited investors.” However, those offerings frequently limit who can invest, market re-sales and secondary market trading and provide no liquidity for investors.
The Securities and Exchange Commission (SEC) has announced new rules that are intended to make it easier to raise investor funds. After formulating and evaluating different approaches over the last two years, the SEC’s newly amended “Regulation A” (Reg. A) became effective June 19, 2015. Prior Reg. A offers were limited to $5 million, hardly enough to warrant the expense and trouble of an offering and therefore as a practical matter rarely used. Reg. A is now amended to allow so-called Tier 1 offerings up to $20 million, and among other facilitative factors excludes the need for audited financial statements, a real boon especially to first time issuers. Tier 2 offerings allow issuers to raise up to $50 million, a startling break-through for companies that are likely beyond early-stage development but still need fairly substantial amounts of investor capital to continue growth. Tier 2 offerings will, however, require audited financial statements and after the offering, regular filings of annual, semi-annual and current reports (describing material events) with the SEC. But such reports are less complicated than required if a full registration statement were being filed.
Aside from not requiring audited financial statements, Tier 1 offerings have no limitations on the net worth, net income or investment experience of investors. Tier 1 investors need not be accredited and there are no individual investment limitations. Restrictions on who could invest and how much they could invest has caused many companies that wished to attract private venture funds to have to forego seeking outside capital from individual investors. Now, in a Tier 1 offering there is no limit on the number of shares an investor may buy or the dollar amount that he/she can invest.
Unlike Tier 1 offerings, Tier 2 companies that wish to raise more than $20 million must limit investor’s purchases to no more than: (a) 10% of the greater of annual income or net worth (for natural persons) or (b) 10% of the greater of annual revenue or net assets at the end of the prior fiscal year (for non-natural persons). These Tier 2 investor qualifications will not apply if a potential investor is an “accredited investor” meaning one who has at least $1 million net worth (exclusive of primary residence) or at least $200,000 in annual income ($300,000 including spouse’s income). Such limits will also not apply if the company will be listing its securities on a national securities exchange (e.g., NASDAQ).
Tier 2 offerings will be exempt from having to register and qualify under state laws, a great benefit. Tier 1 offerings, on the other hand, will still, as in the past, require state review and qualification. However, the organization of state regulators has proposed rules to facilitate such offerings so that perhaps only one state review may be needed to satisfy all of the other states’ requirements.
Aside from regular operating companies, even those without revenues and in development stage, the SEC will allow real estate investment trusts (REITs), “shell companies” and even issuers of penny stocks to use Reg. A. So called “blank check” companies (those who have no specific business but plan to engage in the merger or acquisition with an as of yet selected or unidentified company) will not be allowed to use Reg. A.
Unlike private Rule 506 offerings, securities issued in Reg. A Tier 1 or 2 offerings will be unrestricted and freely transferable. Because persons buying securities in a Reg. A offering will have no transfer restrictions, should the offering attract at least several hundred investors an active market may develop for the trading of such securities in the over the counter market. Unlike new Reg. A offering, securities sold pursuant to the Rule 506 exemption are “restricted securities,” meaning they must be held for usually at least a year before the investor can resell. That has been a severe limitation on raising funds for a number of investors who desire liquidity and a market where their stocks are publicly traded.
Since Reg. D Rule 506 private offerings have been pretty much limited to accredited investors, because Reg. A Tier 1 investors need not be accredited and have no individual investment limitations or financial sophistication, net worth or net income levels that can often complicate private Reg. D offerings, Tier 1 or Tier 2 offerings may be preferable.
However, unlike Rule 506 private offerings, Reg. A offerings (whether Tier 1 or 2) will still require SEC review, and as stated above, Tier 1 offerings will also require state qualification. But for the right issuer, Reg. A may now be a very viable financing tool.
There are few limits on use of general advertising and solicitation for Reg. A offerings. Almost all other federal securities exemptions prohibit or limit general solicitation and advertising except in the case under Rule 506(c) but all the purchasers in a 506(c) must be “accredited investors.” A company intending to make a Tier 1 or 2 offering may “test the waters,” that is solicit interest, with documents intended to evaluate interest in a proposed offering.
The Reg. A process which, like most “public offerings” may still be relatively expensive because of the need for SEC review, printing, engaging lawyers, accountants and brokerage firms (to help sell/distribute the securities and hopefully participate in an after-market). Furthermore, as indicated above, once a Tier 2 Reg. A offering is completed, there will be SEC continuous reporting requirements. All “public” offerings, including Reg. A offerings, also require FINRA filings and review should a FINRA broker-member participate in the offering.
Notwithstanding all the new advantages to use of Tier 1 and Tier 2 offerings, because Tier 1 requires both state and federal, and Tier 2 federal, prior review, closing and ability to accept investor funds can be delayed for several months. On the other hand, a Reg. D Rule 506(c) offering to only accredited investors can be closed within a few weeks.
For more information about this matter please contact Kemp Klein.
