By this point, JOBS Act Titles II and III, which present revolutionary changes to venture capital investment, shouldn’t be entirely foreign concepts. But just when you think the madness is over -- BAM -- you find out there’s a Title IV with equally disruptive implications for the finance industry.
What has been left untouched in this realm? What onerous regulations haven’t yet been instated?
IPOs. Yes, of course. “Baby IPOs.”
“This is Regulation A, affectionately known as Regulation A+, and this is what we’re calling ‘registered crowdfunding,’” said Georgia Quinn, associate at Seyfarth Shaw LLP, of Title IV at the Crowdfund Global Expo. “Now, again, these rules are still in the proposed stage, and just some highlights for those of you unfamiliar with securities law, we already had Regulation A. This was an exemption that was supposed to help small businesses raise up to $5 million and supposed to be what we call a 'Baby IPO.' So it’s a smaller scale of what we would see in a full blown F-1 IPO process.”
The problem, Quinn said, was that in the last five years, a mere 11 companies utilized this option. Much of this reluctance to use Regulation A was because existing regulations mandate that while companies didn’t need the full federal disclosure that would come with a standard IPO, they had to abide by the state rules in any state they planned to sell securities.
“As you can imagine, that is hugely expensive and time consuming,” Quinn said. “Several states have the ability to actually look at the quality of investment and make a qualitative decision as to whether or not they think your business is viable and whether or not they’re going to allow you to sell securities in their state. So that was just not a workable solution, and it’s still not workable.”
This requirement to follow states’ financial regimes was kept under updates to Title IV, though the SEC recently asked for comment on it, so it seems like that might change. What did change under JOBS Act updates was the addition of a Tier II under Regulation A. While Tier I is capped at $5 million and requires state compliance, Tier II is capped at $50 million, with preemption from state laws, but federal disclosure required.
The downside to Tier II is that audited financial results and ongoing disclosure are necessary, which isn’t the case for Tier I. Title III crowdfunding does require ongoing annual disclosure, but only stipulates audited financial statements for raises over $500,000. Quinn and co-presenter Samuel Guzik, founder of Guzik and Associates, agreed that this requirement is particularly baffling considering the monetary values at stake.
“I think that’s a good sticking point for people to think about,” Quinn said. “In crowdfunding, you can only raise up to $1 million, but you have to provide audited financials. With Regulation A, which has been on the books since 1936, you can raise up to $5 million with no audited financials needed.”
Again, the drawback there is the requirement to comply with state blue sky laws, but Guzik said given the SEC’s call for comments, there’s at least some hope that would change. If so, he said Tier I of Title IV would essentially be crowdfunding-plus: all the benefits with none of the drawbacks.
Some of those other drawbacks to Title III crowdfunding that are absent in Title IV include the low investment limit, and the portal requirement. In Title IV, portals are optional, so companies can use one but also work with broker-dealers, and are able to advertise their offerings anywhere, as opposed to the advertising confinement to portals in Title III. Additionally, and of particular importance according to Guzik and Quinn, is the "testing the waters" provision.
“What you don’t have in crowdfunding but you have here and in other areas is something called testing the waters, which means you can go out and start soliciting people to test the interest for your offering before you really have to start spending money with disclosure and all that stuff, and that’s a huge advantage in this process,” Guzik said.
Issuers can conduct a general solicitation, and if they don’t get the traction needed for a viable financing, can retract their Title IV offering without consequence. However, they cannot close on a deal without SEC approval of their registration.
Additionally, Regulation A securities, which can only include equity or equity debt, are immediately freely tradable, with no one-year holding period.
Drawbacks on the Title IV side include a cap on the number of investors, with 500 unaccredited investors allowed, and a total of 2,000. Title III has no such limit. And, again, the time and money associated with federal registration and ongoing financial audits is burdensome.
Still, Guzik said Title IV might be the better option depending on what companies are looking for.
“Frankly, if you’re going to put the time and energy into the disclosure documents, the review is the least of your issues, I think,” he said. “If you have a company that’s worth funding, you’re better off raising more money and going through the process.”