Raising equity capital is a struggle. That’s true whether you’re a real estate company, a medical company, a car wash, or operating some other type of business. The good news is that it’s possible to do it more easily than many assume and with complete legality. We’re talking about Regulation A.
Regulation A has gotten a lot of buzz. It’s new and has only become usable within the last six years or so. It’s also been updated in recent years to make it even more business-friendly. In this post, we’ll explore the ins and outs of Regulation A, whether it’s right for you and, if it is, how you do a regulation offering and what to expect along the way.
First, a Disclaimer
Before diving too far into the discussion, it’s important to understand that this information is not meant to be legal advice. It is offered solely for your information and enrichment. Please speak with a qualified professional advisor, attorney, or CPA before attempting any fundraising or investing in private securities.
What Is Regulation A?
In a nutshell, Regulation A is an exemption from having to register securities with the SEC. It allows businesses to make unregistered or private offerings. It’s also called a mini-IPO and Reg A, as well as Regulation A+, thanks in large part to the improvements made five or six years ago.
Reg A had its start in the Great Depression. Selling securities was largely responsible for the largest economic crash the world has ever experienced. Congress reacted by making it illegal to sell any security. They then licensed the right to sell securities back to businesses in the hopes of protecting investors from shady business practices that were common at the time.
The result was the Securities Act of 1933, which says all securities offered within the United States must be registered with the SEC and applicable state security regulators. Of course, registration is not simple or streamlined. It requires jumping through multiple hoops and paying fee after fee.
For smaller deals under $100 million, registration is simply too costly and time-consuming. Thankfully, businesses can apply for an exemption. Qualifying for an exemption means that if you don’t make a public offering, you do not need to worry about running afoul of the SEC.
The SEC created regulations that outline offerings that are not deemed “public” and that are exempt from the requirement to register. Regulation A is one of those, but there are others. These include the following:
Regulation D: This is the oldest regulation of all and is one of the most frequently used.
Regulation D, Rule 506 B: This is the single most used rule and covers 99% of offerings. Under Rule 506 B, businesses are allowed to raise unlimited amounts of capital. However, there’s no public solicitation allowed. In other words, the people from whom you raise money must have already been part of your personal or business network. There can be no outreach.
The other downside to this rule is that you’re limited when it comes to how many unaccredited investors you’re allowed to have as part of the deal. For those unsure what that means, only around 5% or 10% of the US population is made up of accredited investors. That means this rule automatically limits your reach and blocks 90% to 95% of the population. The rule mandates you can only have 35 unaccredited investors brought in every 90 days.
Regulation D, Rule 506 C: Rule 506 C is another popular option. This one allows you to solicit the public, meaning that you can market a deal through social media and other methods. You are not limited to just those already in your personal or professional network. However, you cannot market your deal to unaccredited investors at all.
Regulation CF: Regulation CF is all about crowdfunding and is relatively new. It allows you to raise money online through public solicitation, and anyone can invest, whether they’re accredited or unaccredited. However, there are limits on the amount they can invest based on their net worth or income. Your overall offering amount is also limited to just $5 million. And, while that marks a fivefold increase from previous years, it’s still a relatively small amount, making Regulation CF of limited use for many businesses.
All About Regulation A
With a better understanding of the alternative regulations available, let’s turn our attention to Regulation A. In many ways, it trumps the other options. For instance, while it’s not unlimited, you can raise up to $75 million instead of just $5 million. You can also solicit investors publicly, including through social media and traditional advertising methods, like billboards and TV ads. And finally, anyone can invest regardless of their accreditation status. With that being said, both unaccredited investors and investors on credit are limited to investing no more than 10% of their net worth.
The Downsides of Regulation A
While Regulation A offers many upsides, investors need to be aware of some downsides. Only a few exist, but they can make a difference in your experience.
1. Longer Timeline – Regulation A offerings have a longer timeline than other regulations. Getting your offering to the point where you can bring in investors and accept their money takes longer. You must plan for at least three months, but it could extend as far as six months. In some cases, it may take longer – up to a year in rare instances. For those who need to raise capital fast, Reg D and Reg CF will be better options.
2. It’s Expensive – While Regulation A offerings are not as expensive at registering with the SEC, they aren’t cheap. The offering must be created and then submitted to the SEC. There is often quite a lot of back and forth, usually involving attorneys. The offering document is also much more extensive than what’s used with other regulations, which adds to the complexity, financial costs, and attorney involvement.
Who Is a Good Fit for Regulation A Offerings?
With a better understanding of the various pros and cons, it’s time to determine who’s a good fit for this regulation. The three general types of people best suited for this regulation include the following:
1. Significant Capital Needs – If you need to raise a considerable amount of capital, Regulation A might be the better option.
2. Good at Marketing – If you have the knack for marketing, particularly through newer media like Facebook, Twitter, and the like, Regulation A could be a great fit.
3. You Have a Large Following – If you already have a large following on social media, YouTube, or other online platforms, this could be a good fit since Regulation A allows you to market to accredited and unaccredited investors alike, and your audience probably consists of mostly unaccredited individuals.
Hurdles to Using Regulation A
Regulation A can help businesses raise the equity capital they need, but the process is not for the faint of heart. If you have never done a securities offering before, Regulation A may not be the best place to start. Below, we’ll explore some of the hurdles:
1. Expense – As mentioned before, Regulation A is an expensive process, although it is still more affordable than registering with the SEC. The costs include an experienced attorney, an auditor, technology providers, a securities escrow account with considerable fees, and marketing costs, to name just a few. Expect to put in between $75,000 and $100,000 to finish.
2. Time Commitment – We’ve touched on this one before, as well, but it bears repeating. You can expect to spend a minimum of three months before the deal is ready. Many deals take longer than that. It’s important to be prepared for this, as well as what that time commitment will mean for the business. Where will you draw funds from in the meantime? Do you need to structure expenses in a specific way until the offering goes live?
3. Volume of Investors – Regulation A offerings tend to attract more investors than standard Regulation D offerings. Superficially, that sounds like good news. However, having more investors means more paperwork. It means having to produce more K1 reports at tax time and fielding more investor questions. All that takes its toll on the business and the team behind the offering.
4. Net Worth – It’s worth noting that while Regulation A offerings tend to attract more investors than other regulations, they are not necessarily of the same caliber. Regulation A offerings usually attract investors with a lower net worth. This is because you’re targeting the public rather than being hyper-focused on accredited investors with a high net worth.
5. Care and Feeding of Investors – Yes, Regulation A offerings can help you reach many more people than other regulations. However, that may not be as great as it sounds on paper. You’ll be reaching mostly unaccredited, low net worth investors, which means that they’re going to need more “care and feeding.”
That is, these are investors with less experience and investing savvy. They will have more questions, and you will need to take more time to explain things to them. They are also putting up a significantly greater percentage of their net worth, which means they will have a stronger interest in the operation of the offering.
The Nitty Gritty Details
Finally, we must cover some of the details surrounding Regulation A offerings. Understanding these details will help you make more informed decisions before venturing into this territory, as well as enjoy a smoother process if you decide that Regulation A is the right path.
1. Maximum Amount – As mentioned, the maximum amount of capital you can raise with a Regulation A offering is $75 million. Note that this only applies to US and Canadian issuers. If your entity is formed in the US or Canada and your principal place of business is in the US or Canada, you are local to this area, and this rule applies.
2. No SPACs – SPACs, or special purpose acquisition companies, have become quite popular lately. However, they’re barred from participating in Regulation A offerings. That’s because SPACs aren’t companies in the traditional sense. They’re shell businesses that don’t have a business plan and no way to generate money. Usually, they exist to buy out other companies, but they have not made that information public yet. The message they send out is, “Just trust us. Give us your money.” That’s not allowed under Regulation A.
3. No Investment Companies – In addition to banning SPACs, Reg A is not available for investment companies or business development companies. In other words, businesses that deal primarily in securities or buying other securities can’t participate. That means no funds are allowed in Reg A.
4. Oil & Gas – Finally, there can be no undivided fractional interest in oil and gas under Reg A.
This concludes part one of our dive into Regulation A offerings. We’ve covered a lot of ground in a relatively short time. By this point, you should have a better idea of what Regulation A is, how it compares with other regulations available, and the various pros and cons. You should also have a feel for whether this is the right path for your own needs, as well as some of the nitty-gritty rules that apply.
Make sure to check back for our second installment. We’ll continue our discussion about Regulation A, including how to build out your team, test the waters, create an offering statement, deal with qualification and reporting, and more.