When the JOBS Act was passed into law in 2012, small businesses in United States were given the opportunity to finally be able to tap into the crowd – everyday people – to raise capital even if the company was a startup, early stage or otherwise not going to be able to attract private equity or venture capital money. After 80 years, the heart of the American economy, small businesses, could finally raise capital from anyone, not just wealthy or well-connected individuals or institutions, and still remain a private company.
Over the past few years, two provisions of the JOBS Act have allowed small businesses (and some large businesses!) to raise billions of dollars from investors that for decades would not have been allowed to invest. Regulation A (also called Reg A or Reg A+) and Regulation Crowdfunding, or Reg CF as many call it, changed the landscape for small businesses that needed money to grow. While most people decide which of these provisions to use based on the amount of money they are trying to raise (Reg A allows an offering of up to $75M in one year while Reg CF is limited to $5M per year) there are many factors to be considered by a company seeking capital that go far beyond the simple question of “How much do I need to raise?”
As a securities attorney who has handled many of both types of offerings, and as a crowdfunding consultant who has helped direct the marketing and other non-legal facets of both Reg A and Reg CF offerings, I have some insights that most do not have. In this new series of articles, I’ll share many of the things companies need to consider when they choose which regulatory exemption from SEC registration to use in order to raise capital from the crowd.
I’m going to break this down into several articles that I will post over the next few weeks to save you from having to read the War and Peace version of how to democratize capital raising all at one time!
Also, note that Reg A involves two tiers: not-so-coincidentally named Tier I and Tier II. because Tier I has limited use for most companies raising capital and is rarely used compared to Tier II.
This week: The Basics.
Who can raise capital?
For both Reg A and Reg CF, only a company (usually a corporation or an LLC) can raise capital. Individuals cannot raise funds with either Reg A or Reg CF.
Regulation A is only available only to companies organized in and with their principal place of business in the United States or Canada.
Regulation CF requires the company raising funds to be organized under the laws of a state or territory of the United States or the District of Columbia. There is no “principal place of business requirement” for Reg CF which opens the door to foreign companies using the law with some restructuring.
Who can invest in a Reg A or Reg CF offering?
Anyone, regardless of their level of income or net worth, may invest in a Reg A or Reg CF offering. This includes anyone in other countries, as long as it is legal in their jurisdiction to invest and assuming there is no ban in the United States on that person or anyone from their country investing.
Are their limits on how much someone can invest in a Reg A or Reg CF offering?
There are no limits on the amount any person or entity may invest in either type of offering, if the investor is “accredited.” An accredited investor is defined in 17 CFR § 230.501(a) and there are many criteria that allow one to meet the definition, but the most common two categories are (a) any natural person whose individual net worth, or joint net worth with that person's spouse or spousal equivalent, exceeds $1,000,000 (not including the person's primary residence not included as an asset and indebtedness that is secured by the person's primary residence, up to the estimated fair market value of the primary residence at the time of the sale of securities, not included as a liability or (b) any natural person who had an individual income in excess of $200,000 in each of the two most recent years or joint income with that person's spouse or spousal equivalent in excess of $300,000 in each of those years and has a reasonable expectation of reaching the same income level in the current year.
For an investor who is not accredited, they may still invest in a Reg A or Reg CF offering. In both cases, the amount one may invest is limited. In the case of Reg CF, it is further limited by the amount that person has invested in other Reg CF offerings in the past 12 months.
I’d explain the formulas behind the limitations here, but it would only confuse you and make you ask yourself why these two provisions of the JOBS Act that basically allow companies to do the same thing to not have the same formula to determine how much money a non-accredited investors is allowed to invest. The good news is that this calculation is done behind the scenes through software that makes it fairly easy for an investor to determine how much they are legally allowed to invest. The other good news is that Congress didn’t put the burden on companies using Reg A or Reg CF to check the math or verify the numbers an investor uses. Unless the company is aware the investor is not “accredited” the company is allowed by law to rely on the investor’s representations.
How much capital can a company raise?
In any one year period, a company may raise up to $5M with Reg CF.
In any one year period, a company using Reg A may raise up to $75M with Tier II of Regulation A, and up to $20M with Tier I. This is commonly misconstrued to mean any company raising between $1-$20M must use Tier I, which is not true. A company may raise from $1-$20M with Tier I, and from $1-$75M with Tier II.
I’m not going to get into the details of Reg A Tier I versus Reg A Tier II in this article for one simple reason: the use of Reg A Tier I is very limited for most companies. The reason for this in a nutshell comes down to one major factor: Reg A Tier II allows a company to raise capital anywhere in the U.S. without having to comply with every state’s Blue Sky laws while Tier I is the opposite and requires the issuer to comply with those laws in every state where investors will be solicited. Compliance with state by state Blue Sky laws is extremely expensive and could easily double or triple the cost of getting a Reg A Tier I offering live. Imagine having to have your offering circulars to raise capital undergo review by each state’s securities regulators, instead of just the SEC. Imagine the legal bills of trying to come up with filings in each state that are the same, and every time one of 50 state regulators or the SEC tells you to change one random paragraph, then having to go to all the other states again to make sure that they are happy with the change one regulator 2,000 miles away required. Imagine watching your bank account get drained as you pay even more attorneys’ fees.
Suffice to say, Reg A Tier I is an often excellent choice to raise capital if you plan to only target residents on one state (an example would be a local restaurant who wants to open more locations in the same city), it is not a great choice for a company trying to reach investors across the fruited plain.
How much does it cost to raise capital?
For a company that is already formed, typically it costs approximately $15,000-$25,000 in out of pocket expenses to get a Reg CF offering live. The costs after the offering is live typically involve mostly marketing expenses, which can vary dramatically from case to case.
For a company that is already formed, typically it costs approximately $50,000-$75,000 in out of pocket expenses to get a Reg A offering live. Just like Reg CF, the costs once the offering is live typically involve marketing expenses which can vary dramatically.
These numbers are general guidelines, and the cost could be far lower, or much higher, depending on all of the circumstances.
What legal documents do I have to prepare?
In order to start raising capital with a Reg CF offering, a company must file a document called Form C with the SEC which contains certain required legal disclosures, risks factors, company information, information about the securities you are selling, financial statements and more. Note that some funding portals – who are a sort of mini-broker-dealer – will offer to draft and file the Form C for you to save money. Before taking this extremely risky chance, consider the risks of allowing non-lawyers to draft legal documents for you that investors will be relying upon. Your company, and perhaps the principals and directors of your company, will be on the hook for whatever is contained in that Form C filing. There are potential criminal penalties for those whose names are signed to these documents if they are not prepared correctly. Securities laws are complicated and paying a seasoned securities lawyer with Reg CF experience to draft and file this important document for you is something most prudent companies do.
In order to start raising capital with a Reg A offering, a company must file a document called Form 1-A with the SEC. Typically, this is a far more extensive document than Reg CF’s Form C, even though it contains much of the same basic disclosure requirements. In reality, Form 1-A is basically a shorter form of a prospectus used by companies that hold an IPO. Form 1-A undergoes a review process with the SEC and must be “qualified” before you can go live and start raising capital.
What financial and accounting requirements must I meet to file my proposed offering with the SEC?
This can get complicated, so I’ll give you the basics which apply in most situations.
Reg A is simple. With Tier II, all offerings must include up to two years of financial statements audited by an independent CPA. If your company is less than two years old, you must have audited financial statements from inception to the present.
Reg CF is a bit more complex, and what financial statements must be included in your SEC filing depends on how much you plan to raise, and whether this is your company’s first Reg CF offering or not and whether the date of the offering is more or less than 120 days after the end of your company’s prior fiscal year.
The basic rules are:
If you are planning to raise less than $124,000, you may disclose internally created financial statements for the past two fiscal years certified as accurate by your management.
If you are planning to raise between $124,000 and $618,000, you must disclose independent CPA reviewed financial statements for the past two fiscal years.
If you two are planning to raise between $618,000 and $1,235,000 and this is the first time your company has used Reg CF, you must disclose independent CPA reviewed financial statements for the past two fiscal years. If you have previously used Reg CF, you must disclose independent CPA audited financial statements for the past two fiscal years.
If you two are planning to more than $1,235,000, you must disclose independent CPA audited financial statements for the past two fiscal years.
Also, for Reg CF, if your company has audited financial statements available for the relevant time period, you must disclose those.
After you start raising capital, are there any ongoing filings to make with the SEC?
For both Reg A and Reg CF, there are ongoing reporting requirements. While none of these are as expensive or burdensome as those required of fully registered public companies, they are very important to remain compliant with federal securities laws. The main reports to be filed are discussed below, although other reports may be required.
Reg CF only has one major ongoing SEC reporting requirement. An issuer that sold securities in a Regulation CF offering is required to provide an annual report on Form C-AR no later than 120 days after the end of its fiscal year and must post the report the company’s website. The annual report requires similar financial information to what is required in the Form C offering statement that is initially filed to start a Reg CF offering, but the financial statements do not need to be audited or reviewed by an independent CPA. This filing requirement ends when one of five events occurs:
(1) the issuer is required to file reports under Exchange Act Sections 13(a) or 15(d);
(2) the issuer has filed at least one annual report and has fewer than 300 holders of record;
(3) the issuer has filed at least three annual reports and has total assets that do not exceed $10 million;
(4) the issuer or another party purchases or repurchases all of the securities issued pursuant to Regulation Crowdfunding, including any payment in full of debt securities or any complete redemption of redeemable securities; or
(5) the issuer liquidates or dissolves in accordance with state law.
At that point, the issuer may file notice on Form C-TR reporting that it will no longer provide annual reports.
For Reg A, Tier II, there are more reports to file to remain compliant. Similar to Reg CF’s annual report on Form C-AR, Reg A issuers file an annual report on Form 1-K within 120 calendar days of the issuer’s fiscal year end. Form 1-K requires two years of audited financial statements. It also requires an update of information from the issuer to information previously filed. It also requires disclosures relating to the issuer’s business operations for the prior three fiscal years (or, if in existence for less than three years, since inception) as well as related party transactions, beneficial ownership of the issuer’s securities, executive officers and directors, including certain executive compensation information, management’s discussion and analysis of the issuer’s liquidity, capital resources, and results of operations.
And requires an update of information from the issuer requires issuers to update information previously filed and to provide disclosures relating to the issuer’s business operations for the prior three fiscal years (or, if in existence for less than three years, since inception) as well as related party transactions, beneficial ownership of the issuer’s securities, executive officers and directors, including certain executive compensation information, management’s discussion and analysis of the issuer’s liquidity, capital resources, and results of operations.
Additionally, Reg A Tier II requires a semiannual report to be filed on Form 1-SA within 90 calendar days after the end of the first six months of the issuer’s fiscal year. Form 1-SA requires issuers to provide disclosure primarily relating to the issuer’s interim financial statements and management’s discussion and analysis of the issuer’s liquidity, capital resources, and results of operations.
Reg A also requires an issuer to file a “current report” on Form 1-U within four business days of the occurrence of one (or more) of the following events: fundamental changes; bankruptcy or receivership; material modification to the rights of securityholders; changes in the issuer’s certifying accountant; non-reliance on previous financial statements or a related audit report or completed interim review; changes in control of the issuer; departure of the principal executive officer, principal financial officer, or principal accounting officer; and unregistered sales of 10% or more of outstanding equity securities.
How fast can I get an offering live?
This is a hard question to answer because there are so many variables. One variable – how long it takes your company to get its financial statements done - almost always takes longer than expected and without those statements, you cannot file with the SEC under Reg CF or Reg A.
Some companies do not have their books in order, or their books are not to GAAP (Generally Accepted Accounting Principles) so there can be delays getting the basic financial statement requirement complete which holds up the entire process.
But realistically, I tell my law firm clients that it is about a 3 month process to get a Reg CF offering live from the time I am hired, and a 4-6 month process to get a Reg A offering live. That being said, there are times I have been able to get an offering live on a shorter timeline, and times it took longer than those estimates.
Coming next week: Part 2 of the 6 part series: How Does a Company Receive The Capital It Raises? Also, this article is not and should not be considered legal advice. Yes, I am a securities lawyer but no, you did not hire me to provide you with legal advice. In all cases, consult with your own lawyer as every legal situation is unique and do not rely on my educational and informative article as legal advice.
