What the New Regulation A Really Means to Your Company

www.TheSecuritiesAttorneys.com
What the New
Regulation A Really
Means to Your
Company

Disclaimer

This is not legal or
investment advice

Seek competent advice
from qualified attorneys
and investment bankers

This is a only a summary –
study the rules in depth

Your situation may vary

The more you know about
finance and business, the
more you can profit

The new Regulation A (so-called
“Regulation A+”) was recently
announced by the SEC in Release
No. 33-9741.

The new Regulation A exemption
creates two tiers of Regulation A
offerings:

Tier 1, offerings of up to $20 million
in a 12-month period, including up
to $6 million for the account of
selling security-holders.

Tier 2, offerings of up to $50 million
in a 12-month period, including up
to $15 million for the account of
selling security-holders.

For offerings up to $20 million, the
company could elect whether to
proceed under Tier 1 or 2 but
audited financial statements are
needed for Tier 2. Tier 2 offerings
are exempt from state “Blue Sky”
regulations.

These rules will take effect 60 days
after publication in the Federal
Register.

We now look at factors important to
to you as company management.
This is based on our experiences
with small, fast growing companies
looking for financing.

We believe the following factors are
material to a company's decision to
use the new Rule:

Audited
Financial
Statements

First question you ask is how long
will it take to get the money?
If you can get funds faster than your
competition, you win. The speed of
funding largely dictates how fast
you can grow.

Second question, what will it cost in
out of pocket cash before we get
the money?

If you have not been getting audited
as part of your historical
operations, it will take time to get
the audit done.

Accountants in my experience are
almost always late. They can run
into unforeseen issues you have in
the books or they can just be slow.

Once an accountant is engaged, you
are stuck with them.
An accountant can drag out the work
and if you replace them, it will cost
you more time and money.

With Reg A+, if you want to raise a
small amount of money, you can
offer stock without an audit and
hope that investors who do not
know your company will trust you.
Or you can wait and pay to get the
audit.

You do not need a full PCAOB
audit. You may have an
accountant who is familiar
with your work and can do a
relatively fast audit.

I would suggest you compare the
cost of a non-PCAOB audit with a
PCAOB audit to see if you might
prefer the PCAOB audit which
could be useful later on.

State Filing
under “Blue Sky” laws

State filing was one of the reasons
old Reg A was not used. If you
wanted to do an offering in many
states, your Blue Sky fees were
huge.

Even in one state,
the state regulator could
hold you up for
what seemed like forever

You would almost inevitably be
subject to merit review rules which
imposed severe, if not impossible,
limitations on new, speculative
companies.

Many years ago I had one state
regulator tell me off the record that
his state would never approve a
Reg A offering. Presumably they
intended to delay approval until
the issuer gave up.

Under Tier 1, you can have
one state designated
as the lead state
for coordinated state review.

However, you may still be stifled
by stringent merit review in a merit
review state. Merit review can be
difficult for a small startup that is
incurring red ink because it is
spending money to grow.

Under Tier 2, you are exempt from
state filing review. However, you
have to face the delay and expense
of getting an audit.

Advertising

If you have exhausted friends and
family, advertising is vital.

You have to either get an
underwriter who will do a small
deal, and there are very few of
those, or have an effective
promotional campaign.

These campaigns cost money up
front and are much more likely to
succeed if the company is in a
hot industry.

If the issuer is limited to a
tombstone ad, sales will be
hampered.
While Tier 2 seems to have few
limits on the presentation itself, in
Tier 1, almost all states limit
advertising to a tombstone ad.

The test the waters feature may be
useful in seeing if an offering is
viable without committing to the
whole cost.

However, a huge marketing effort is
often needed to place stock in a
new and unknown company with a
limited history and this is the type
of company we might think of as a
crowdfunding company.

A limited amount spent on testing
the waters may not be enough to
show sufficient response to create
confidence in the issue's
marketability.

Approximately 12.4 million U.S.
households are accredited
investors, based on either the
income or net worth. Most have
not invested in the types of deals
contemplated under the new
Regulation A.

Speed of Processing

The SEC was kind enough to provide a
very enlightening discussion of the
existing ways to raise up to $50
million.

The SEC reported that the average
offering under the old Reg A took 300
days to qualify with the SEC.

We doubt that many companies would
use any avenue to raise money if they
knew it would take 300 days just to
start selling, after the delay involved
in preparing the filing.

If it takes three months to prepare the
filing, and three months to place the deal,
480 days could have elapsed between the
decision to make the offering and having
the money in the bank. For a fast growing
company, this is impractical.

The SEC statistics revealed that Reg D,
Rule 506 was much more popular than
the old Reg A.

If it takes 300 days to qualify, as it did
under old Regulation A,
you would have been much
better off filing a full S-1.

In calendar years 2012 to 2014,
only 26 Regulation A offerings
were qualified by the SEC.

Compare this to 11,228 Regulation D
offerings in 2014 that would have been
potentially eligible to be conducted under
amended Regulation A.
Of those, 10,671 offerings relied on
Rule 506, only 376 on Rule 504, and
only 181 on Rule 505.

Consider the time to completion for a Reg
D, Rule 506 offering. Using the same
three months to prepare the offering and
the same three months to sell, gives us
less than half the time of an old Reg A
offering, assuming only accredited
investors subscribe so there is no state
Blue Sky review.

If the time to qualify with the SEC does not
accelerate, you will see more companies
opting for private placements, including
Rule 506(c) which allows advertising to
accredited investors. After a successful
506 offering, the company can then go
public at its leisure.

Resales by Affiliates

One of the sensible provisions of some
state securities laws is to limit fast resales
of insiders by various rules, including
escrow of insider stock. This forces the
insiders to develop the company in order
to see capital gains.

Reg A+ allows 30% of the stock
sold to be sales by existing holders
even if the issuer has no net income
from continuing operations.

As we know, many successful startup
companies, companies that have been
acquired at huge prices, have never
had net income.

Allowing insiders to sell is very beneficial
if the insiders have been making a large
financial sacrifice to build their company,
as is quite common. For example, the
founders may be of an age where they
want to send their children to college.

Selling stock allows the key executives to
get back into decent financial condition.
However, investors may be less
enthusiastic about an offering if they see
large sales by insiders in the offering.

Secondary Market

Secondary trading is important to those
who want to sell their investment, be they
investors or insiders.

The Reg A company can trade on
OTCMarkets Pink Sheets, giving the
company limited visibility and costing
$4,200 per year with a $500 setup fee.

To move up on OTCMarkets to OTCQB
status, the company would have to pay to
OTCMarkets $2,500 application fee and
$10,000 per year.

These are not very attractive options.
Pink Sheet stocks are shunned by
serious investors and costs are
important to small companies.

The SEC believes that “Tier 1 offerings
will be conducted by issuers that are
unlikely to seek the creation of a
secondary trading market in their
securities.”

The new Reg A may be used by
companies that do not want a secondary
market, but are seeking simply to take
in money in lieu of classic venture
capital investment.

These companies may have failed
to get venture capital, or they may not
be willing to accept the terms offered
by venture capitalists.

Reg A+ amends Exchange Act Rule 15c2-
11(a) so that an issuer’s ongoing reports
filed under Tier 2 will give the specified
information about an issuer and its
security that a market maker must review
before publishing a quotation.

There are advantages in forgoing venture
capital money and instead seeking private
investors. Venture capitalists may drive a
harder bargain than private investors. The
company insiders will not have to give up
a large degree of control. The company
can advertise widely in a Tier 2 deal.

However, all investors look to have an exit
strategy which could be an immediate
secondary market, registration rights, or
some other method.

Rule 144

It would be impossible to overestimate the
importance to small, growing companies
of Rule 144, which allows the resale by
investors of securities purchased outside
of a public offering. Having such an exit
strategy encourages investors to write
checks.

Under the new rule, Tier 2 ongoing annual
and semiannual reports do not satisfy the
current information requirements of
Rule 144 for the entire year.

The SEC did not believe that the frequency
of the required Tier 2 ongoing reporting
merits a broad determination that such
reports will constitute “adequate public
information” or “reasonably current
information” on a year-round basis. Only
quarterly reporting can do this.

Semiannual reporting is required under the
final rules for Tier 2 offerings. Thus
companies will only have “adequate
current public information” for the
portions of the year during which the
financial statements of such issuers
continue to satisfy the respective rules.

The company may voluntarily submit
on Form 1-U quarterly financial
statements or other information
necessary to satisfy Rule 144.

Issuers wishing to register Regulation A
securities under the Exchange Act
can file a Form 8-A with the qualification of
a Form 1-A. Only issuers that follow
Part I of Form S-1 in the offering circular
can use Form 8-A.

Application to a
Developing Company

Some believe the new Rule is a great
boon to companies needing
crowdfunding. We assume that a
company like this has a hot new
technology, one that might grow
rapidly with proper funding.

Typically such companies are making
losses to get developed. The founders are
often taking limited salaries and have
invested most of their own capital. The
company is seeking outside investors
because it has exhausted friends and
family.

The company may or may not have angel
money. It may not have successfully
gotten venture capital or it may find that
VC terms are too rich or the founders may
not want to give up control.

Often the company does not have large
cash reserves for up front costs.
Being publicly traded will help the
company attract money as it will allow
investors to have an exit strategy.

Let us look at how the new Reg A
might impact such a company. In
terms of time, if the offering is
processed rapidly, the new rule may
help. In terms of time and money the
company has a key decision to make
in getting an audit or not.

Personally, I believe that an audit will
increase the marketability of the deal
because an audit will increase investor
confidence. Further, a company without
an audit can only trade in the Pink Sheets.
Pink Sheet stocks are shunned by many
investors.

However, the company must be careful
in its selection of an auditor as time
and money can be lost here.

As always with small companies, a huge
marketing effort is needed to overcome
the fact that the company is unknown and
overcome the prejudice against small
companies. The new Rule may be of some
help here if the company is Tier 2, another
reason to go for an audit.

Summary

Small issuers have to look to the time
and expense of getting an audit and
weigh that against the costs and limits
of state rules in Tier 1.

The issues presented are time, up front
expense, restrictions on advertising, and
merit review. As an audit will create
more trust, it may be desirable for
marketing reasons. The audit will move
the company into Tier 2 which may allow
the company more options for advertising.

In Tier 2, the company will also
escape state merit review. The
company should also look to how it
wants to approach having a secondary
market for its securities.

Overall, any rule which increases the
options of small, growing companies
is a good rule. Much will depend on
how it is implemented and the speed
of processing filings.


Questions –
email me at
John.Lux@
Securities-
Law.info

(240) 200-4529

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