The entrepreneurial community has been abuzz recently over the potential of the new Regulation A+. Finalized by the SEC pursuant to the JOBS Act and effective since June 2015, this update to the existing Regulation A exemption allows companies to seek out liquidity by offering equity to an unprecedented base of investors – the unaccredited. ((SEC Adopts Final rules on Regulation A+, Morgan, Lewis & Bockius LLP (Apr. 2015), http://www.morganlewis.com/~/media/files/publication/morgan%20lewis%20title/white%20paper/securitiessecadoptsfinalrulesregulationaapril2015.ashx?la=en)). Regulation A had previously allowed eligible nonreporting companies to sell up to $5 million in securities exempt from the more expensive and time-consuming registration requirements of section 5 of the Securities Act. ((SEC Proposes Rules to Facilitate Small Business Financing, Morgan, Lewis & Bockius LLP (Jan. 2015), http://www.morganlewis.com/~/media/files/publication/morgan%20lewis%20title/white%20paper/whitepaper_secproposedrulestofacilitatesmallbusinessfinancing_jan14.ashx.)) However, the old exception gained little traction with the fundraising community due to its limitations. ((Id.)) While Regulation A limited access to unaccredited investors, included a low cap on total offering amounts, and withheld preemption for state security laws, the new Regulation A+ rolls back many of these impediments facing companies seeking to fundraise through equity without going public. ((Marty Dunn, et al., Regulation A+: Final Rules Offer Important Capital Raising Alternatives, Morrison & Foerster LLP (Mar. 26, 2015), http://www.mofo.com/~/media/Files/ClientAlert/2015/03/150326RegulationA.pdf)) For example, offerings made in the second tier of Regulation A+ no longer limit sales to unaccredited investors, allow for up to $50M in total offerings, and permit federal preemption of state security laws. ((Id.))
Although some tout Regulation A+ as “one of the biggest changes in the financial service industry”, it remains to be seen whether the new exemption will live up to its lofty expectations. ((Tanya Prive, Regulation A+: Now Everyone Can Invest In Your Startup, Forbes (Jun. 19, 2015, 3:49 PM), http://www.forbes.com/sites/tanyaprive/2015/06/19/regulation-a-now-everyone-can-invest-in-your-startup/.)) The recent Regulation A+ approval of Groundfloor, a real estate crowdfunding platform, is a case study in how companies still face significant hurdles in trying to fundraise under this exemption. An early test case for a Tier 1 offering, Groundfloor paid over $450K in legal fees, $30K for financial auditing, and $6K to comply with state securities laws. ((Amy Wan, An Analysis of the First Approved Real Estate Crowdfunding Regulation A+ Filing, Crowdfund Insider (Sept. 11, 2015, 11:06 AM), http://www.crowdfundinsider.com/2015/09/74256-an-analysis-of-the-first-approved-real-estate-crowdfunding-regulation-a-filing/.)) In addition, it took the company over 5 months from the date of their first filing, and an estimated 20 months from the date of their first financial audit to receive final approval from the SEC. ((Id.)) Despite the significant financial and time investments, Groundfloor only raised a modest $500K in their first round. ((Id.)). While future rounds will likely prove less expensive, the $50K net raise still illustrates just how prohibitively burdensome the Regulation A+ process can be, especially for companies who are not already flush with cash. Putting aside the financial cost and time investment, companies seeking to go the Regulation A+ route need to consider the significant and potentially sensitive disclosures required for the offering process. As seen with the Groundfloor raise, filing required the company to disclose their financial statements as well as information about their convertible note/seed round. ((Id.))
The true costs imposed by the Regulation A+ process may not fully materialize even upon the completion of an offering. One of the revolutionary aspects of Regulation A+ is that it does not limit the number of unaccredited investors who can enter a company’s cap table. ((Marty Dunn, et al., supra note 4.)) While some have argued that equity crowdfunding from accredited investors does not foreclose future venture capital and institutional investment rounds in practice, it remains to be seen whether the same holds true with unaccredited investors. ((Tanya Prive, Three Myths About Equity Crowdfunding Debunked, Forbes (Oct. 27, 2014, 11:18 AM), http://www.forbes.com/sites/tanyaprive/2014/10/27/three-myths-about-equity-crowdfunding-debunked/.)) The novelty of the Regulation A+ process makes it difficult to predict how taking on a large number of unaccredited investors will change the calculus for later investors when companies graduate from individuals to institutions for subsequent raises. ((See Dave Berkus, Beware the “Dirty Cap Table,” Berkonomics (Mar. 8, 2012), http://berkonomics.com/?p=1201))
For better or for worse, entrepreneurs are driven by an exuberant optimism in their own product and abilities. While it is no surprise that many are tempted by Regulation A+’s incredible potential, the wise might temper expectations until additional data is released. At the very least, savvy entrepreneurs should assess with clear eyes whether they have the funds, counsel, and risk appetite to take on such a significant and unproven endeavor.
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