Fundraising is critical for businesses at all stages of growth and development. Without access to capital, it's impossible to bring bright new ideas to life. Unfortunately, however, shady business dealings, scam artists, and predatory practices have hurt the private investment industry. Today, it's nearly impossible to fundraise without wading through a massive amount of red tape from the SEC.
The good news is that there are ways around many of the obstacles to business owners and potential investors. One of those is Regulation A.
Regulation A has seen a lot of buzz in recent months. However, it is often unclear how it dovetails with other rules and regulations, such as Regulation D Rule 506 B, Regulation D Rule 506 C, Regulation CF, and others. In this guide, we will take a deep dive into Regulation A and establish a few things: what it is, how it ties in with the others we've just mentioned, and the pros and cons involved. It's all part of ensuring you can make an informed decision when it comes to raising funds.
The Evolution of SEC-Related Protections for Investors
Regulation A is an exemption from having to register securities with the SEC. It is a way of creating what we call "unregistered offerings. In reference to regulation A, you may also hear it called a "mini IPO." The government instituted a change to the regulation through the Jumpstart Our Business Startups (Jobs) Act, so you may even hear people call it Regulation A Plus or Tier 1 or Tier 2. Of course, all of these refer to the same thing. But, for simplicity, we'll call it Reg A.
Regulation A has its roots in the past, all the way back to the Great Depression. After the market crashed in 1929, Congress decided to remove the right to sell securities and then licensed those rights back. The goal was to protect investors from shady business dealings that marked the 1920s and led directly to the Great Depression.
These changes were eventually codified in what we know today as the Securities Act of 1933, which says that all securities sold in the United States must be registered with the SEC and applicable state securities regulators. Registration is time-consuming, expensive, and drawn-out, but it's mandatory, even for smaller deals.
To help combat that cost and complexity, the SEC introduced exemptions. Essentially, unless you're making a public offering, there are workarounds for the regulation process. Regulation D is the oldest securities registration exemption with the newer Rule 506 B and Rule 506c, which traditionally covered roughly 99% of offerings.
Under 506 B, business owners and investors are able to raise an unlimited amount of money. However, there's no public solicitation allowed. In other words, the people that you raise money from must have already been in your personal or professional network.Logging into Facebook and Instagram to find strangers to invest in your deal is not allowed. This is certainly a downside, and it's only one of them.
Another downside is that you're limited in terms of how many unaccredited investors you can have. To oversimplify, accredited investors are very wealthy people or people that have incomes of $200,000 (or $300,000 with a spouse or spousal equivalent)a year or a net worth of $1,000,000 or more (not including their home). This can exclude many individuals, even technical millionaires, whose home accounts for most of their wealth. Roughly 5% to 10% of the US population is accredited. In a 506 B offering, you can only have 35 unaccredited sophisticated investors brought into an investment every 90 days. This investor suitability requirement can severely limit your investor pool.
506 C is another popular registration exemption option. Like 506 B, this provision allows for an unlimited amount of fundraising. It also allows general solicitation(i.e., advertising), which 506 B does not. In other words, you can seek investors out through Facebook and other social media outlets – strangers are welcome.
However, there's a catch here. Where 506 B allows you to bring in some sophisticated, unaccredited investors, 506 C strictly prohibits it. So, you are completely locked into that small percentage of Americans who are considered "accredited."
Regulation CF, or regulation crowdfunding if you prefer, is a new exemption. It allows you to raise money online and publicly solicit investors. Unlike under Regulation D offerings, Regulation CF will enable you to involve anyone, accredited or unaccredited.
However, there are limits on how much people are allowed to invest. The percentage is based on their net worth or income, but anyone can invest even a nominal amount. Another caveat here is that your overall offering amount is limited to just $5 million (which marks a stark increase over the original limit, which was only $1.07 million).
Another limitation is that all Regulation CF offerings must be placed through a FINRA registered crowdfunding portal. The crowdfunding portal is responsible for compliance with the investment requirements and may charge a minimum monthly fee or commissions between 4% to 10% of capital raised.
Exploring Regulation A
Now that we've covered other rules and regulations, as well as their pros and cons, it's time to introduce Regulation A. You'll find that it takes care of many of the negatives that marred the other fundraising options, but there are still a few caveats, including the fact that it doesn't offer an unlimited amount of fundraising. Let's walk through what you should know.
Let's start with the fundraising limit for Regulation A. A quick Google search may reveal that the limit is $50 million. Unfortunately, however, that information is outdated. The current limit is $75 million.
In addition to the $75 million maximum raise limit, Regulation A allows you to publicly advertise for investors. There's no requirement that you already have a relationship with your investors, which opens up the door to all kinds of marketing options, including the following:
- Social media sites like Facebook and Instagram
- TV and radio spots
- Newspaper and other print materials
Finally, anyone can invest. There is no rule regarding accredited or unaccredited investors. In that regard, it's similar to Regulation CF but with a much higher fundraising limit. However, that does bring us to a hurdle, and it's something we've discussed in relation to other options: unaccredited investors can invest up to a certain percentage of their net worth or income. Investors are prohibited from putting more than 10% of the greater amount of their annual income or net worth into any one investment opportunity.
While some might chafe at yet one more rule, the truth is that it's very reasonable. It's there for a good reason: it offers a lot of protection. Imagine taking 10% of your total net worth and setting it all on fire (if the deal goes bad). That's a significant loss, but at just 10%, it's a survivable loss. If unaccredited investors could put a more substantial percentage into a deal, it's possible that they would be wiped out if something went wrong.
The Downsides of Regulation A
We've covered a lot of benefits relating to Regulation A. However, there are a couple of downsides that you should understand.
This is a higher-cost option. If you're only looking to raise $5 to $10 million, this is probably not the right choice for you. It's designed for those with much higher fundraising needs, and the cost is commensurate with that the additional process and regulatory requirements.
Another downside here is the timeline involved. It takes longer to get your offering to the point where you can invite investors in and accept their money. You should plan on a realistic timeframe of 3-6 three to six months.Some qualification processes may take even longer – up to a year in some instances. That means if you need money quickly, this is not the option for you. Instead, consider Reg D or Reg CF.
Who Is a Good Fit for Regulation A?
Now that we've covered Regulation A, how it compares to others, and some of the downsides, it's time to define who's the best fit for it. Who is Reg A appropriate for?
Drawing on what we've covered, we can narrow our focus a bit. Regulation A is a good fit for those who:
- Need to raise a significant amount of capital.
- Are not in a rush to raise that capital.
However, because this option is open to all near by, it means that you need to have a modicum of marketing savvy to use it to its best advantage. You need to generate attention and get eyeballs on your offer. Thanks to the fact that anyone can invest in Regulation A deals, it opens up the door to exercise your creativity and build your following. And, today, that largely means being on top of your social media game.
For this to be of value, you'll need to understand today's social media platforms, including WhatsApp, Facebook, Twitter, YouTube, TikTok, LinkedIn, Snapchat, Instagram, and all the rest. These platforms are ideal for generating a following and building interest in your deals, but you need to have those followers before doing anything.
Does that mean it's only open to the Kim Kardashians of the world? Do you have to be an "influencer" already to make use of Regulation A? Not at all.
You can be almost anyone. You need to have a decent following to leverage. You don't have to have a social media empire that spans all the platforms we just touched on, but you do need to have a substantial presence on one or more of them. Put another way; you need to be someone who can get attention through marketing, which usually requires both marketing skills and an existing audience.
However, if this is your first securities offering, you might be better off starting with another strategy as Reg A is not for the faint of heart. As mentioned, it is both time-consuming and expensive. You'll incur many expenses, from paying technology providers to using a securities escrow account and incurring fees there. You'll also be shelling out a lot for your marketing efforts. Therefore, it's wise to estimate $75,000+ for your Reg A offering, from start to finish.
Speaking to the time factor and what we outlined previously, it's also essential to understand the amount of work involved here. Reg A offerings tend to attract a significant number of investors, which is a good thing. However, having more investors means doing more paperwork. It means producing more K1 reports, spending more time with tax matters, fielding more questions.
Ultimately, it comes down to the audience that you're targeting. With a Reg A offering, you're targeting the general public, which means smaller investments, lower net worth individuals, and less knowledgeable investors overall. You'll need to provide the proper guidance and offer more information than you would with a different audience, such as angel investors who already know the lay of the land.
One key thing to remember here is that there's a world of difference in how you'll need to treat someone who's putting up $5,000 as a significant portion of their life savings and someone with $200,000 to throw around without affecting their financial status. The investor who's putting up a significantly larger percentage of their net worth will have a higher degree of knowledge and require more information and answers to their questions.
Raising capital is rarely simple and seldom straightforward. Unfortunately, jumping through the SEC's hoops is not easy, either. Thankfully, there are multiple rules and regulations that allow you to make offerings and raise funds to suit your needs.
Regulation A is one of the most popular right now for many reasons, including the fact that you can market your offering to anyone at all. That opens the door to those with marketing savvy and social media know-how, allowing you to get deals in front of unaccredited investors. However, Reg A is costly and time-consuming, with lots of legwork involved, so it's not for everyone.
If you're looking for an experienced legal team to assist with your next offering, Crowdfunding Lawyers is here to help. Click here to schedule a free consultation and we will follow up with you promptly.