Until now, the Reg A path, which is nearly as old as the SEC itself, has been sparingly used. Congress voted to lift the cap as part of the Jumpstart Our Business Startups (JOBS) Act, which was signed into law in April 2012, largely to encourage more small and mid-sized companies to consider that option.
However, it’s another more subtle change the SEC has made to the rules – one that the agency was not specifically required to adopt – that some experts believe will make the Reg A option now much more appealing to companies in need of capital. In keeping with the initial regulations proposed about a year ago, the commissioners finalized new rules that exempt Reg A offerers from registering with state financial regulators in every state in which they’re prospective shareholders reside.
“I have never felt that the $5 million cap was that significant, because if you look at Reg D, you see that the average raise is less than $3 million,” DJ Paul, who last fall was appointed by SEC Chair Mary Jo White to join the agency’s advisory board on small and emerging companies, said in an interview. He was referencing a similar option in the SEC rulebook – known as Regulation D – which pertains to small offerings to a select group of private investors, as opposed to a public offering. “The real friction point has been this state approval requirement,” Paul said.
Under that requirement, a company that wanted to offer shares to investors in a dozen states would be subject to 13 reviews of separate securities laws – one in each state and one by the SEC. State regulators have warned that those additional reviews help to thwart fraud and protect investors. However, entrepreneurs and legal experts have said there’s little evidence that the multiple-hoops process does anything except deter businesses from using Reg A.
“This regulatory process can be lengthy, cumbersome and expensive, factors that many believe have contributed to the infrequent use of Regulation A,” several attorneys from Richmond-based law firm McGuireWoods wrote in a white paper last year about the proposed rule changes. While there are typically hundreds or thousands of Reg D offerings a year, there are often only a dozen or so Reg A deals, Paul explained. Some years have passed without a single one.
Under the new rules, small businesses will now only have to go through the simplified SEC review.
“That change had to happen, or else Reg A was going to continue to be a dead-letter, never-used alternative,” said Paul, who also co-chairs an advocacy nonprofit called Crowdfund Intermediary Regulatory Advocates based in New York.
In an attempt to ease concerns about potential scams, the SEC also established two Reg A tiers. For those raising between $20 million and $50 million through a public offering, there will be additional review requirements. That’s a slight change from the proposed rules, which split the tiers at the $5 million mark. Commissioners have also agreed to require Reg A offerers to file their paperwork to the SEC for public review several weeks before they start selling to investors, giving state regulators a chance to comb through those documents if they wish to look for red flags.
Ahead of the vote, SEC Chair White said Wednesday that she believes the changes “strike an appropriate balance for the roles of federal and state law” and will make Regulation A offerings “an effective, workable path to raising capital that also provides strong investor protections.”
The finalization of the rules was the latest step in what has become an exceptionally long process to breathe life into the JOBS Act. Now on the cusp of its third birthday, only about half of the provisions in the statute – which, by providing better access to capital to new and growing businesses, was touted as a potentially powerful gust of wind in the economy’s sails – have been put in place by the SEC.
Among the most highly anticipated changes mandated by Congress but not yet implemented by the SEC are rules allowing companies to raise small amounts of money from mom-and-pop investors via what are known as online crowdfunding portals. Initially, the SEC was to give that process the green light by the end of 2013; however, the agency has been slow to move on the rule-making process. The SEC put forth proposed rules in October 2013, but it isn’t clear when they will be finalized.
While the crowdfunding rules, which are outlined in Title III of the JOBS Act, have drawn most of the JOBS Act’s spotlight, Paul explained that the Reg A changes (contained in Title IV of the legislation) will likely have a much more significant impact for certain companies.
“With Reg A, we’re talking about businesses that are going to be much further along in their life cycle than the ones that would benefit from Title III,” Paul said, noting that the online crowdfunding rules will limit entrepreneurs to raising no more than $1 million from non-accredited investors. “Obviously, a company raising $1 million is in a very different place than a company raising $40 million, or even $10 million.”
“It’s all part of a continuum,” Paul added. “While crowdfunding will be important for getting capital to genuine start-ups – ones that have three people working for them – this will help those that have 300 people working for them and are still looking to grow.”