September 22, 2022

Part 2: Raising Capital with Regulation A

Welcome back to part 2 of our discussion on how to use Regulation A to raise capital. If you haven’t already, make sure you’ve read part 1 before diving into this conclusion. If you’re up to date, then let’s continue our discussion. In our previous post, we explored Regulation A – what it is, how it works, and whether it’s a good option for your deal. We touched on other regulations, as well as the pros and cons of Reg A deals. In this part, we’ll broaden the discussion by exploring how to build your team, test the waters, create an offering statement, and more.

Building Your Team

When making a Regulation A offering, the right team is critical. Who do you need, though? Below, we’ve outlined the most important members, as well as their roles within the deal, and important things to know.

1. Securities Attorney – The most important team member is your securities attorney. You need a consummate, experienced professional who knows these waters very well. This is not an area where “close” will work, so those without official experience in this capacity should not be considered.  

2. Broker-Dealer – You’ll also need a broker-dealer. That’s particularly true for deals in any of the following seven states:

  • Arizona
  • Florida
  • New Jersey
  • New York
  • North Dakota
  • Texas
  • Washington

Each of these states requires that you have a broker-dealer, or you cannot move ahead with your deal. If you attempt to move forward without one because you feel that federal rules supersede state rules, you will have a long, drawn-out battle on your hands. Ultimately, it’s safest simply to have a broker-dealer as part of your team no matter what states you’re working in.

3. Auditor – The financial reports that go into your offering must be audited. Therefore, you’ll need an experienced auditor as part of your team. These professionals are not cheap, but you must have one on your team from the very beginning. Even if your company is brand new and has never done any business, you must still go through the audit process.

4. Transferred Transfer Agents – A transfer agent is an important team member because they manage the investor accounts and keep track of who bought what shares, as well as who sold what shares. They help you stay organized and ensure that your records are as accurate as possible.

5. Compliance Service – Every team needs a compliance service. Yours will handle all your regulatory filings and blue-sky filings. Note that blue-sky filings are very different within Regulation A. Within Regulation D, they’re simple. You take money from an investor within a specific state. You then have 15 days to do a notice filing on the state. Within a Reg A deal, many states want notice before you take any money from investors. They want you to predict future movements and sales. As you can imagine, it’s very difficult to comply with those requirements.

6. Offering Platform – Technically, an offering platform is optional. There are Reg A platforms available if you prefer. They’re just websites that present your deal to investors. Investors can use the website to peruse information about your deal, team, and other specifics, and then make an informed decision.

7. Securities Escrow – Finally, you will need a bank with a securities escrow account.  You can expect to pay around $4,000 - $5,000 in fees, but this is where your investment money will go when investors begin contributing. Your money will also stay in that account until you raise the minimum offering amount and you’re allowed to access the funds.

Testing the Waters

In comparison to other regulations, Reg A gives you a lot of latitude to test the waters. That’s important because you must go into this process with a good understanding of the risks and rewards. However, there are things you need to know about this process.

Immediate Communication

Reg A allows you to gauge potential investor interest and make course corrections when and where necessary through preliminary “testing the waters” communications. Note that you must also disclaim a few pieces of information when approaching investors. First, you need to tell them that you are not taking any money currently, only gauging interest. Second, you need to tell them you’re not making an offer to buy. Finally, there is no commitment or obligation on the investor’s part currently.

The Offering Statement

Any testing of the waters you do must include a link so that potential investors can explore your offering statement once it’s filed with the SEC. With each potential investor, you must either send them the link, include a copy with your communications, or tell them who to talk to for further information or to get a copy of your offering statement.

SEC Scrutiny

It’s important to understand that any testing the waters communications, specifically written ones like emails and Facebook posts, will be scrutinized by the SEC. They will be filed along with your offering statement, so they will also be made public. This is important because you must keep your communications truthful. Any lies or half-truths within your testing the waters materials can come back to bite you. You will be held accountable for them.

Your Offering Statement

Now that we’ve covered important information about your testing the waters communication, we can move on to the offering statement itself. You might be more familiar with this as Form 1-A, but either way, it’s what you file to make Reg A offerings. Below, we’ll cover some of the most essential components of your offering statement.

Your Basic Information

Your offering statement should include basic information about the issuer, the offering, how much money was raised, what tier under the regulation you’re using, and more. Think of this as your foundation – the building blocks for the rest of the offering statement.

Offering Circular

You’ll also need to include your offering circular. If you’ve done a Reg D deal before, you’re familiar with private placement memorandums. If you’ve been involved in other types of investments, you know what a prospectus is. Your offering circular is the same thing – a data-filled document that includes the following information:

  • Important offering details
  • A list of risk factors so that investors cannot say they weren’t warned
  • Your business plan
  • The expected use of your proceeds
  • Bios for all the officers

Audited Financials

Another critical part of your offering statement is a copy of your audited financials. This includes the balance sheet and income statement, as well as the auditor’s notes about the company’s performance. These documents will also include notes/warnings about company underperformance and what will happen if that’s the case.

Exhibits

The offering statement will include many exhibits. These are things like your LLC formation documents, as well as your company bylaws, and others that spell out how the relationship between managers and investors is handled. Other exhibits include:

  • Contracts with third-party providers
  • Broker-dealers’ contracts
  • Testing the waters materials
  • Auditor certifications
  • Legal and tax opinions

Gathering all this information can be time-consuming and challenging, but you must do so.

Filing

Once you’ve gathered all the information and put everything together, it’s time to file your offering statement. This process involves several critical steps. First, you must file your offering statement electronically with the Electronic Data Gathering Analysis and Retrieval System (EDGAR). Note that there are no paper filings, nor can you fax your offering statement to the SEC. It all goes through EDGAR.

Once filed with EDGAR, the SEC accepts your offering statement and makes it publicly available through the system. Because of the potential for public scrutiny, your documents must be formatted correctly.

Dealing with SEC Comments

You might assume that once you file your offering statement, your work is done, and you can start focusing on the deal. That’s not the case, though. The SEC will have questions, comments, and adjustments for your statement. Within 27 days, you will get a comment letter from the SEC. Some of the most common questions and comments include the following:

  • Clarify operational information or financial details.
  • Explain different aspects of the business plan, particularly if you’re doing something novel.
  • Expand on your risk factors. This is particularly common if the SEC feels other things should be disclosed to your investors.
  • Remove subjective, hyperbolic, or sales language from the offering statement. This is most common when the offering statement includes subjective language, like better, safer, etc.
  • Remove speculative language, such as promises of high returns or the expectation of fast results.

The letter you receive from the SEC will include all their comments, questions, and adjustments. They will be numbered. Depending on the situation, these line items will need to be responded to, or they will need to be answered and your offering statement will need to be revised. Your attorney should handle this, with input from you and your management team. Once the offering statement is updated, you must resubmit through EDGAR. Within 27 days, you will receive another comment letter and you will go through this process again. Eventually, you and the SEC will hash everything out and you will no longer receive comment letters.

Requesting Qualification

Once the SEC runs out of comments and questions, you can petition them to qualify your offering. When that happens, you can immediately begin raising money through new marketing, as well as contacting those you talked with during your testing the waters phase. Note that this is not “registering” an offering. It’s still an exempt, non-registered offering, even though the SEC has been involved.

It's also important to understand that qualification does not equate to approval from the SEC. You will, in fact, never receive approval in any form from the SEC. Comments, questions, and adjustments communicate disapproval, which is easy enough to see, but you will never receive anything that says you’re officially approved. You will even be required to put a cover sheet over your Form 1-A that states the SEC has NOT given its approval for this offering.

Finally, qualification is not the end of the process. Yes, you can start raising money and pitching investors, but you must deal with ongoing reporting, as well.

Ongoing Reporting

While your offering is open, you will submit reports periodically to the SEC. There are three that you need to know about.

Annual Report (1-K)

One of the reports you need to understand is your annual report, the 1-K. Don’t confuse this with the K-1, which is what you will give investors to show them what their portion of the tax burden of your offering is, at least if it's taxed as a partnership. The 1-K is a securities filing with your annual report. You must update the details of your offering circular, you're going to talk about how the business is doing, disclose any related party transactions, and update the financials with more recent info.

Semi-Annual Report (1-SA):

There's also a semiannual report required in between the annual report (every six months). In this report, you must discuss the business’s financial condition. The report will also update the financials, although, in the 1-SA, they do not have to be audited.

Occasional Updates (1-U)

Occasionally, you're going to file what's called a 1-U. This announces the company's significant happenings or material happenings. If there's a change in the business plan, a change in control, or officers, you must disclose that on the 1-U.

Wrapping Up

By this point, you should have a better grasp on how to structure your team, as well as the most important steps in the process. You should feel prepared to file your Reg A offering and communicate with investors. In creating a strong foundation for your business, you will be well positioned to reach your capital raising goals.


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