Regulation A and the Reawakening of U.S Entrepreneurship!
by
Sunny Joseph Barkats on Apr. 11, 2014
Business Corporate Business Business Securities
Summary: There is little doubt that innovation and entrepreneurship are the backbone of this nation.
Reg.
A and the Reawakening of American Entrepreneurship!
Introduction:
There is little doubt
that innovation and entrepreneurship are the backbone of this nation. About 25
million small businesses employ more than 50 percent of the private workforce
and generate more than half of the nation's gross domestic product. [1]
The entrepreneurs driving the growth of our country suffered particularly in
the aftermath of the 2008[2]
financial crisis, as most traditional sources of capital dried-up. Small business
expansion and support was not the priority of preceding U.S administrations,
and the banking system failure did little to invigorate initiative and capital
growth. As a result, not only was the American entrepreneurial drive hindered, but
its ability to create jobs was also damaged, thus, job creation substantially declined.
That situation may have changed when the legislator through the leadership of a
few[3]
realized that government failed to revive the economy as rapidly as hoped and capital
formation can only be efficiently created from the bottom up and that government
cannot be the principal source of jobs creation. This resulted in the passage
and ongoing implementation of the Jumpstart Our Business Startups Act (the “JOBS
Act”)[4],
a bipartisan law signed by President Obama on April 5, 2012.
I. Reg. A Background
Any discussion of Reg.
A+ must begin with its progenitor, Regulation A. This earlier Reg. A was first adopted
in 1936 and added to the Securities Act of 1933, as amended[5]
(“Reg. A” or Regulation A”), and provides for a simplified registration process
tailored to smaller companies for the purposes of facilitating capital
formation. Reg. A is sometimes referred to as a “Mini IPO”[6].
Under Reg. A, which will now run parallel to Reg. A+, private companies benefit of the following: (i) they may raise up to $5 million in any
rolling twelve-month period, through sales of their securities, without complying
with the usual registration requirements of the Securities Act, including
quarterly and annual reporting; (ii) companies offering shares under Reg. A are
not subject to a full audit and may instead, simply submit “reviewed” financial
statements, which is usually substantially less expensive; in addition, (iii) Reg.
A also enables pre-existing shareholders with an opportunity to resell a
limited dollar amount of their unregistered securities; furthermore, (iv),
securities sold through Reg. A are freely tradable over any exchange that would
host such trade or on any platform, one could argue that they are resalable on
EBay if offered, moreover, (v) offering statements issued under Reg. A are
reviewed by both the SEC and state securities regulators (under the states’
so-called “Blue Sky”[7]
laws).
II. Proposed Reg. A+ Under the JOBS Act
Reg. A+[9]
amends the pre-existing Reg. A by establishing two “tiers” of offerings:
·
Tier I comprises Reg. A under its
traditional contours, as described above.
· Tier II, provides what is basically a “super-sized” version of Reg. A. Tier II offerings will enable companies to issue offerings of up to $50 million in any rolling 12-month period, up to $15 million of which may be resales by existing shareholders. Importantly, Tier II offerings will pre-empt state-by-state Blue Sky regulations, greatly streamlining and broadening the offering process. The only significant drawbacks of Tier II offerings are that companies issuing such offerings must submit to a full audit and must file annual financial statements.
A. Eligibility.
There are further
limitations to Title IV, under either tier. Companies utilizing Title IV must
comply as follows:
a.
be organized under the laws of the U.S.
or Canada;
b.
not be subject to ongoing reporting
requirements under Section 13 or Section 15(d) of the Securities Exchange Act
of 1934, as amended (the “Exchange Act”);
c.
not be registered or required to be registered
under the Investment Company Act of 1940, as amended (the “40 Act”);
d.
not be disqualified under the revised ‘‘bad
actor” provisions of the proposed rules;
e.
not be a development stage company with
no specific business plan or purposes or whose business plan is to engage in a
merger or acquisition with an unidentified company or companies; (not a shell
or blank check company) and
f.
not be an issuer of fractional undivided
interests in oil or gas rights, or similar interest in other mineral rights.
Only equity securities,
debt securities and convertible securities, including any guarantees of such
securities, can be offered under the proposed Title IV rules. Asset-backed
securities, such as the collateralized debt obligations of the sub-prime
crisis, will not be eligible to be offered under the proposed rules.
B. Securities Act Liability and New Communications
Process.
Reg. A securities offerings would have Section 12(a)(2) liability in respect to offers or sales made through an offering circular or even oral communications that include any material misleading statements or material misstatement of facts. Thus, an offering pursuant to Reg. A is excluded from the operation of Section 11 of the Securities Act.
· The offering statement would be “qualified” only by SEC order.
· Confidential submission of draft offering statements and amendments would be permitted, provided the documents were publicly filed no later than 21 calendar days before qualification.
·
Reg A issuers would be required to
provide updates information after termination or completion of an offering. Reg
A does not require that issuers file ongoing reports with the SEC, other than a
Form 2-A to report sales or termination of sales made under Reg A. The proposed
rule would require that Tier 1 issuers provide certain information about their
Reg A offerings on a new form, Form 1-Z. Issuers of Tier 2 offerings would be
subject to an ongoing reporting regime similar to crowdfunding provisions under
Title III of the JOBS Act. Tier 2 issuers would be required to file annual
reports on Form 1-K; semi-annual reports on Form 1-SA; current reports on Form
1-U; and special financial reports on Form 1-K and Form 1-SA.
·
All filings would be required to be
submitted to the SEC in electronic format via EDGAR. The proposed rule would revise the
qualification process for Regulation A offerings and require that an offering statement
could only be qualified by an SEC order.
·
An issuer or broker-dealer should be
obligated to deliver a preliminary offering circular to prospective purchasers
at least 48 hours in advance of sale when a preliminary offering circular is
used to offer securities. Reliance on electronic delivery would require that
investors consent to electronic delivery. FINRA Rule 5110 prohibits Registered
Representatives and other FINRA members or their associated persons from
participating in any manner unless they comply with the filing requirements of
the rule.29 Rule 5110 also contain rules regarding underwriting compensation.
Rule 5110(b) requires that certain documents and information be filed with and
reviewed by FINRA, and these filing and review requirements apply to securities
offered under Regulation A[ii].
B. Integration
Rule.
Rule 251 of Regulation A provides for certain
integration safe harbors for both Tier 1 and Tier 2 offerings. Under the
existing rules, Regulation A offerings will not be integrated with:
·
Prior offers or sales of securities; or
·
Subsequent offers and sales of
securities that are:
·
registered under the Securities Act,
except as provided in Rule 254(d);
·
made in reliance on Rule 701;
·
made pursuant to an employee benefit plan;
·
made in reliance on Regulation S; or
· made more than six months after completion of the Regulation A offering.
The proposed rules expand the list of specific safe harbor provisions for both Tier 1 and Tier 2 offerings to add subsequent offers or sales of securities made through crowdfunding offers (once the SEC has adopted implementing rules for crowdfunding).
One of the biggest impediments on Regulation A has been the requirement to comply with state securities laws. Under the proposed rules, securities offered under a Tier I offering will remain subject to state registration and qualification requirements to the same extent as under current Regulation A. As per the proposed rules, application of such state securities laws will be preempted for Tier II offerings.
III. Title IV and the Reawakening of American Entrepreneurship.
Despite being
bailed-out, many banks are still not lending to small businesses as much as
they should or could. One of the reasons for this tight credit is that the
Federal Reserve is actually paying banks interest for their money to be held in
the banks’ reserves. As a result, bank reserves have increased from $2 Billion
in 2008, to $1.8 Trillion in 2013.[10]
Money that otherwise could
be used for job creation or made available for infusion into the market place
to help small businesses and support growth is, instead, sitting idle. Under
the proposed rules and the current provisions of Title IV and its two tiers of
Reg A, entrepreneurs, startups and emerging companies may directly access a large pool of capital from its source—the
People--thereby disintermediating the traditional sources of capital.
A.
Reg. A Vs. Red D 506.
Because U.S. federal
and state securities laws are astoundingly complicated, the U.S. has 52 sets of
securities laws (federal + the 50 states + D.C). As a consequence, securities lawyers
across the country become a necessary guide thought this complex landscape.
More importantly, the choice of offering type is a key component determining the success or failure of a capital raise and even the survival of a company. This is where securities attorneys and investment bankers become essential in assessing the most suited offering structure tailored for each specific issuer and its shareholders. Chances are that a well-capitalized group will successfully implement its business strategy and grow. Hence, it is important to understand that every offering should take into account various elements before being structured and undertaken. Those considerations may vary from industry to industry, followers, and marketability of the offering.
The major choices for
private equity raises, and their relative pros and cons are provided below:
a) “Reg D”
b)
“Reg A” and Reg A + and “The Democratization of Capitalism!”
We contend that, providing entrepreneurs and
smaller companies with the ability to directly access capital from those
citizens who most believe in the company—regardless of social status or
wealth—will not only allow companies to raise more money than they do now, but
to raise better money, because it will be invested by people with personal, not
merely cash-related, reasons to be invested, people for whom the company
matters. While the audit requirement may increase the administrative burden on
the offering companies, it will benefit the investing public by providing
additional transparency and credibility. This additional transparency and
credibility is critical because Reg A’s ultimate benefit over Reg D is its
ability to include ALL investors—accredited and non-accredited, alike—in its
investment universe. Even then, investors in Reg A shares will be able to
freely trade those shares on secondary markets, thereby attaining a measure of
liquidity and self-determination as to when they want to “cash-out” their
positions. This option is not available to Reg D shareholders.
The spirit of Reg A is best illustrated in the story of Ben & Jerry’s ice cream company. In 1984, Ben & Jerry’s competitor, Häagen-Dazs, wanted to limit distribution of Ben & Jerry’s in Boston, prompting Ben & Jerry’s to file suit against Haagen-Dazs’ parent company, Pillsbury. In the business arena, Ben & Jerry’s “attacked” Haagen-Dazs by undertaking a successful Reg A campaign which they then parlayed into a direct public offering less than a year later.
c)
Title III “Crowdfunding”
Ironically, the
provision actually given the name “Crowdfunding,” Title III of the JOBS Act,
may become the least utilized of the private capital structures. While intended
to empower entrepreneurs and startups to mobilize financing from non-accredited
investors, Title III may become bogged down in its own regulatory red tape.
Offerings using Title III cannot be done independently and, rather, must be
made through a broker-dealer or registered portal. Companies offering
securities through Title III may not solicit or advertise their own offering
but may merely point potential investors to their offering on the third party
portal. Title III raises are limited to $1 million and any raise over $500,000
is subject to a costly audit. All Title III offerings are further subjected to
ongoing requirements to provide their investors with regular financial
reporting results.
In our estimation, the
benefits of Title III do not outweigh their considerable detriments, especially
when most of those benefits may be provided by Reg. D and Reg. A, with the
latter also providing access to the full range of the investing population.
Conclusion:
Entrepreneurs are for
the first time allowed to freely solicit capital and present their projects to
a vast pool of participants all on a more equal footing. For the first time in
decades, the gap between the 1% and the 99%, when it comes to accessing capital
and participating in equity and opportunities, is reduced. For the first time we
seem to be at the cross roads of the social media age and capital formation,
all of which made possible through a bipartisan piece of legislation that could
well be the unattended master piece of the Obama Administration.
Hence, through the internet and mass media and with our wallets we can better the wo0rld, or push an agenda favoring pertinent companies and innovators, advances in sciences not lobbied for by some obscure non for profits or venture capitalist, or private equity, together will reach for support when corporate America has turned innovation down t the detriment of faster profitability and promising pro format, and for the first time we may allow for voices of the people the 99% to interject and make a financial impact and difference like it was the case with PhoneBlock[12] where social media campaigned allowed to put a new ecological cell phone on the map.
We believe a new era of smaller-scale, but powerfully vital, entrepreneurship is dawning. The financing is out there in the shape of tens of millions of Americans who have never before had the opportunity to partake in private equity at such stage in the game. It is up to you to make them dream with you and partake in what you are doing for them to help you make it happen. The dialogue is open and the internet and social media is its new platform for interaction.
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