For private companies seeking capital, recently finalized SEC regulations provide an alternative to an initial public offering (IPO). Pursuant to the Jumpstart Our Business Startups (JOBS) Act of 2012, the amendments to Regulation A, commonly now being referred to as "Regulation A+," are effective as of June 19, 2015. This regulation allows startups to raise up to $50 million in a "mini-IPO." These offerings provide many benefits of a full-fledged IPO, with relaxed registration and reporting requirements.
Public Offering vs. Private Placement
In the past, private companies had two ways of tapping the capital markets: an IPO or a private placement. An IPO allows a company to offer its securities to the general public, provides significant liquidity for shareholders, facilitates future capital-raising, and can enhance the value of the company's equity. It also subjects a company to rigorous SEC registration and public reporting requirements, and to other responsibilities and liabilities.
In contrast, private placements involve little or no ongoing reporting, and they avoid the heightened scrutiny, expense and accountability associated with going public. But they also limit the amount of capital that can be raised, require investors to meet certain financial standards, and impose other restrictions that can make it more difficult to attract investors.
In its previous incarnation, Regulation A was rarely used. In addition to having a low offering limit of $5 million, it required issuers to register securities under the Blue Sky laws of every state in which they were offered or sold. For these reasons, most private companies relied on Rule 506 of Regulation D to raise capital in an unregistered offering.
Rule 506(b) allows a company to sell an unlimited amount of securities, provided it 1) doesn't use general solicitation or advertising, 2) limits purchasers to accredited investors, plus up to 35 nonaccredited, "sophisticated" investors, and 3) provides nonaccredited investors with detailed disclosures. Accredited investors include individuals who meet income and net worth requirements and certain entities.
For companies that wish to offer securities to the general public, Rule 506(c) waives the general solicitation ban, provided the company takes "reasonable steps" to ensure that all purchasers are accredited. This requires screening and documentation measures beyond the self-certification typically used in Rule 506(b) offerings.
Purchasers in a Rule 506 offering receive "restricted securities," which can't be resold until certain conditions are met.
A Middle Ground
For many private companies, the final rules offer an appealing middle ground between going public and staying private. They provide two tiers of offerings:
- Tier 1: Up to $20 million over a rolling 12-month period, including no more than $6 million in offers by affiliated shareholders.
- Tier 2: Up to $50 million over a rolling 12-month period, including no more than $15 million in offers by affiliated shareholders.
Unlike Regulation D, Regulation A+ allows companies to sell unrestricted securities to anyone. They can sell shares to family, friends, employees and the general public, regardless of whether they're accredited or sophisticated, using most forms of general solicitation or advertising.
There's an investment limit, however, equal to 10% of an investor's net worth or net income, whichever is greater. Investors may self-certify their net worth or income, however, so there's no need to verify it. Companies may gauge initial interest in the offering before incurring the expense of preparing an offering circular.
The Price Of This Flexibility?
There are several requirements that investors must adhere to:
- Registration and reporting obligations are beyond those required for private placements, but less stringent than those associated with IPOs.
- Issuers must file detailed offering statements with the SEC, subject to the same level of scrutiny as an IPO registration statement, including two years of audited financial statements for Tier 2 offerings. (Reviewed statements are sufficient for Tier 1.)
- There are no ongoing reporting requirements for Tier 1 offerings, but Tier 2 issuers must file annual, semiannual and current reports, which are abbreviated versions of Forms 10-K, 10-Q and 8-K.
Although the requirements for Tier 2 offerings are more rigorous, Tier 1 offerings have a significant disadvantage: They're subject to state Blue Sky laws, while Tier 2 offerings are exempt. For this reason, it's unlikely that many companies will use Tier 1 offerings.
An Attractive Option
If your company isn't ready for an IPO, a mini-IPO under Regulation A+ may be an attractive option. It provides broad access to the capital markets, without the limitations of a private placement.