Since its enactment, most of the discussion of the Jumpstart Our Business Startups Act (JOBS Act) has centered on crowdfunding and the IPO onramp provisions of the Act. However, the legislation’s expansion of Regulation A actually promises to have the greatest impact on small and mid-sized business capital formation.
Capital markets access
In theory, Wall Street has always been available to American businesses of any size seeking to raise capital. But in practice, for a host of reasons related to expenses and regulatory burdens that have grown exponentially in the past two decades around initial public offerings, only the largest companies have had access to Wall Street.
“Main Street” businesses looking for capital have been limited to privately issuing debt or equity securities with individuals and private fund investors, under significant restrictions on the securities’ resale.
Making matters more complicated, to buy these securities, investors must be limited in number or meet significant net worth or earnings thresholds to be classified as “accredited investors.” The Dodd-Frank legislation effectively increased the net worth requirements for accredited status, and indications suggest that the private placement market has shrunk by at least 30 percent as a result of that change to the law.
Alternatively, there has long existed an exemption from the traditional IPO process, known as Regulation A, which permits a company to issue up to $5 million of securities per year in offerings that are free from the resale and investor restrictions associated with privately placed securities. However, because of the annual dollar amount limitations, a robust market in Regulation A securities has never developed.
Old regulation, new opportunity
The JOBS Act expands Regulation A’s annual dollar limit tenfold – from $5 million to $50 million. Here’s why this expansion will be a game changer for small business capital formation:
• Public solicitation: Offerings are issued and sold publicly, and companies are permitted in many instances to solicit interest in their offerings before filing with the Securities and Exchange Commission (SEC). Therefore, small businesses will now be able to connect with potential investors more easily.
• Freely tradable: Trading Regulation A securities is not restricted, much like traditional, publicly held securities (such as stocks and bonds). This flexibility, when combined with the increased size of Regulation A offerings, should attract more investors to small business offerings. In addition, the growth in size of these offerings should encourage the development of disciplined, sophisticated markets for real liquidity at the “Main Street” level.
Main Street Impact
What this means to small businesses across the country is that they will be able to access needed capital without having to conduct an IPO or complying with the significant restrictions on resale. In addition, because the accredited investor requirements do not apply to investors in a Regulation A offering, there will be a larger pool of potential investors, many of whom will now be less hesitant to invest in smaller offerings.
Regulation A likely could become the dominant avenue for small and medium-size businesses to form capital. Moreover, as those businesses grow, funded by the capital from their Regulation A offerings, they will find appealing the IPO onramp. The onramp provides a means to increase the amount of capital they can raise without the necessity of a traditional IPO and the costly regulatory compliance burden to which publicly held companies are subject.
With what is expected to be an exponential increase in the use of Regulation A to form capital, there is every reason to believe the financial markets will develop a robust secondary market for these securities.
Still a ways to go
For the benefits of expanded Regulation A to be realized and put into practic, the JOBS Act requires the SEC to develop revisions of the rules governing the use of Regulation A. This will likely occur within a year’s time, if not sooner. We believe Regulation A is in the process of becoming a very viable vehicle for small, mid-sized and emerging companies to form capital, which will benefit the investor community at large.
Rob Kaplan and Tom Voekler are partners at Kaplan, Voeker, Cunningham & Frank, PLC, a multi-city law firm focused on capital formation and compliance for emerging businesses. They can be reached at RKaplan@kv-legal.com and TVoekler@kv-legal.com.
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