Regulation A+: What Entrepreneurs Need to Know
The road to a successful funding round isn’t easy, and the road to a successful Regulation A+ has its own unique challenges. If an entrepreneur’s goal is to raise $5M or less, the business may be better served by Regulation Crowdfunding, but if the goal is to raise more than that, then founders should explore Regulation A+ as an option.
What is Regulation A+?
On April 5, 2012, President Barack Obama signed the Jumpstart Our Business Startups Act (or JOBS Act), with the goal to create more opportunities for both entrepreneurs and investors. What this act did was set in motion laws that would allow everyday investors to purchase shares in startups.
Traditionally, the only individuals who could easily invest in startups, whether buying debt in a restaurant or equity in the next mobile app, were accredited investors. Accredited investors are those who:
- Have made over $200,000 in annual salary for the past two years
- Or have made over $300,000 in joint annual salary (for spouses) over the past two years
- Or have over $1M in net worth, excluding their primary residence
In August 2020, the SEC expanded the definition of accredited investors to add new eligibility criteria, which include holders of certain professional licenses as well as limited liability companies and “family offices” with at least $5M in assets or assets under management respectively. However, the definition of “accredited investors” is still quite limited and only applies to a small subset of the population.
But with Regulation A+, companies can raise money from the entire public: both accredited and non-accredited investors can participate. It is no longer fundraising from the wealthy, but from the crowd: friends, family, users, community members, and more can all participate in a raise.
The first law from the JOBS Act, Title IV, otherwise known as Regulation A+ or Reg A, went into effect on June 19, 2015. Fun fact: the first ever Regulation A+ offering, Elio Motors, was hosted on StartEngine’s platform. Elio Motors went on to raise $17M through StartEngine.
The Mini IPO
Regulation A+ has a reputation for being the “Mini IPO.” There are key differences from a true ‘Initial Public Offering’, but by using Regulation A+, companies can raise up to $75M in a given year from the public. The offering has to be qualified by the SEC, but the qualification process and ongoing reporting are less intensive and less costly than an IPO, hence the nickname “mini.”
Regulation A+ is most similar to an IPO in that investors can sell their shares the day after buying them if they want to (though this doesn’t mean they can—companies have to choose to quote their shares on a trading platform to let their investors access potential liquidity). There is no lock-up period after purchase.
Indeed, companies that raise capital with Reg A can be listed on national stock exchanges if they choose to and provide enhanced disclosure, though many businesses choose not to as the costs of being listed on a national exchange can add significant expenses to the whole endeavor, as well as an increased administrative burden. Companies also have the option of listing on OTC markets, which are less burdensome in that regard, or on an ATS like StartEngine Secondary.
This liquidity is important because it means that investors aren’t locked into the investment until the traditional exit points: the company going public or being acquired (events that generally take anywhere between 5-10 years to happen, if at all). The shorter timeline brings a smaller degree of risk for the investor, so in turn they won’t demand as high of a return on their investment. This is what is known as a liquidity premium.
As a caveat, Reg A securities are still largely illiquid as there are few places to trade them. StartEngine Secondary is one of the first such marketplaces in the US that enables companies that have raised capital via Regulation A+ and Regulation Crowdfunding to give their investors access to potential liquidity.
With that liquidity premium in mind, entrepreneurs can structure capital raises more favorable to the business: they are no longer driven to the accelerated growth and high returns required by venture capitalists.
A note about Tier 1 and Tier 2
With Regulation A+, companies have two paths to explore. Tier 1 Regulation A offerings, in which companies can raise up to $20M and Tier 2, with which companies can raise up to $75M. In general, we advise companies to use Tier 2 as Tier 1 offerings are not exempt from blue sky laws. However, companies should discuss all paths and associated requirements with their own counsel to determine the best path for their business.
This means that for Tier 1 offerings, companies must qualify or register the offering with any state they plan to sell securities in, and every state is different. In other words, there are 54 laws (50 states and 4 territories) companies would have to follow, not to mention the federal laws. In short, this takes a while and is expensive.
Tier 2, on the other hand, preempts state blue sky laws, and so companies do not have to individually qualify or register their offering with every state. For the purpose of this blog post, Regulation A+ and Reg A both refer specifically to Tier 2 offerings.
The SEC’s Regulatory Changes: March 15th, 2021
On March 15th, 2021, new regulatory changes from the SEC increased the maximum companies can raise in a calendar year from $50M to $75M. Similarly, the maximum amount companies can raise via Regulation Crowdfunding was increased from $1.07M to $5M.
These changes also include other updates, such as permitting certain “demo day” communications that will not be considered solicitation, harmonizing how these different exemptions can work together, and simplifying certain requirements for Reg A+ offerings.
These Regulatory changes are important to note because moving forward companies that historically raised a few million dollars via Regulation A+ would now opt to raise that funding via Regulation Crowdfunding (it’s cheaper and faster to launch), and the new $75M annual limit of Regulation A+ may attract more mature companies that previously found the $50M limit to be too low.
Who can conduct a Regulation A+ offering?
In order to conduct an offering, companies must be U.S. or Canadian (whereas only U.S. companies can utilize Regulation Crowdfunding). Companies must also pass “bad actor” checks, preventing scams from raising capital from the public for example, or individuals who have been charged with securities fraud.
Regulation A+ also has a significant cost and requires substantial work to prepare the offering document (more on those below), so Regulation A+ isn’t a good fit for companies that are not willing to invest time and resources into preparing their offering.
Why do a Reg A?
The first answer to this question, and the most important, is that it grows community. Businesses that raise capital via Regulation A are attracting fans, customers, clients, and followers, and encouraging them to buy into their mission and not just come along for the ride, but be rewarded for their support and loyalty with a piece of the financial pie. This in turn breeds greater loyalty and turns these new investors into ambassadors, who are more likely to refer new business and be vocal participants in the community.
The second part comes down to the fact that Regulation A can be an efficient means of raising capital. If companies want to raise $5M or less, they should consider Regulation Crowdfunding, but for those looking to raise more, a Regulation A+ offering can be a faster process than going through the motions of pitching venture capitalists and drumming up interest on the ground.
Plus, the founding team can maintain control of the company. Shareholders own smaller pieces of the pie and won’t be controlling voting rights, nor are there now new members on the board that the founding team didn’t explicitly go out looking for. Businesses are able to use the raise as a means of generating press coverage in the same way you would a product launch.
How much does it cost?
The cost varies, but the short answer is it costs a good deal more than Regulation Crowdfunding. Companies can expect to pay anywhere between $50,000-$100,000 before their offering is qualified and they can begin raising capital. Then they can expect to dedicate more funding to a marketing budget to attract more investors to their campaign.
What is “testing the waters?”
Before companies begin accepting investment through the offering, companies can “test the waters.” This means that investors can indicate their interest in an offering and how much they would like to invest before the company can actually accept that investment. The intent for “testing the waters” is for companies to gauge market interest in their offering before going through the costs and time associated with being qualified.
The main benefits of “testing the waters” are that it allows investors to provide their payment information in advance, making it easier for those reservation holders to complete an investment when the offering does go live. This can help companies create a lot of momentum in the first few days of the raise and generate buzz.
However, it’s worth noting that companies can’t count on all of the numbers from a “testing the waters” page to convert into investment. There is some drop off because once the offering is qualified and the company can accept investment, the investors who submitted reservations in a test the waters are then required to reconfirm their investment.
If companies are unsure of whether to go through the process of doing a Regulation A+ campaign, another route to consider is doing a Regulation Crowdfunding offering first and gauge the market’s appetite by raising $5M. If that raise is successful, the company now has capital to go through the up-front costs of getting qualified for a Regulation A+ offering as well as a roadmap for how to successfully raise capital from the public.
How long does it take to be qualified?
Similar to cost, timing is not a hard science and will vary from company to company. However, companies should anticipate that it will take approximately:
- 30 days to compile the necessary documents
- 30 days to complete and submit disclosure to the SEC
- 90-120 days to get to qualification, although this can vary widely
Per a report from the SEC, it takes an average of 110 days to be qualified. For context, an IPO takes around 90-180 days, so this is still a good deal faster.
How does a company get qualified?
Companies must file a Form 1-A in order to launch a Regulation A offering. This form includes everything from a description of the business and its executive officers, financial statements, an offering circular, risk factors, use of proceeds, the securities being offered, and more. It’s a lot. Businesses will need legal counsel, independent auditors and accountants, underwriters, and a lot of coffee. One hundred bags of coffee beans.
Once the form is submitted to the SEC, companies can expect rounds of comments from regulators asking questions about specific details of the Form 1-A. Those comments must be addressed before the Form 1-A is finalized and ready to go.
Where can companies launch a Reg A?
Companies can raise capital using a Regulation A+ on their own, but it’s recommended that they work with a broker-dealer or a funding portal (disclosure: StartEngine is both) that can provide help and expertise, as well as handle the plumbing of the raise itself. These portals and broker-dealers also bring their own investor pools along, so it can be a good way to get additional exposure for the offering and generate more investment.
What happens after the raise?
If the raise fails, any committed funds are returned to investors. If the Regulation A+ is successful, companies have three ongoing reporting requirements:
- Annual reports, in which companies must disclose information about business operations and transactions and provide analysis, along with two years of audited financials
- Semi-annual reports, in which companies must provide unaudited financial statements as well as management discussion and analysis
- Event reports, in which companies must file in the event of a material change to the rights of shareholders or to the nature of the business itself
If the business has fewer than 300 shareholders of record, they may file to withdraw from these reporting requirements after the first annual report. On the flip side, if the company meets certain asset and number-of-shareholders tests and has a public float of more than $75M (held by non-affiliates) or annual revenue greater than $50M annually, the company will enter a two-year transition period to begin complying with the reporting requirements of fully public companies.
30 companies have raised $159M+ on StartEngine via Regulation A+. Want to learn whether Regulation A+ is right for your business? Visit the StartEngine website to learn more.
A company which intends to apply to list its securities on the marketplace will be subject to certain requirements which it may or may not be able to satisfy in a timely manner. Even if a company is qualified to list its securities on the market, there is no guarantee that a demand for these securities will exist. Even if a company does meet the requirements for listing its securities, we do not know the extent to which investor interest will lead to the development and maintenance of a liquid trading market. You should assume that you may not be able to liquidate your investment for some time or be able to pledge these shares as collateral.
Editor’s note: this article was originally published on January 30th, 2019 and was updated on April 9, 2021 to reflect new information as well as the SEC’s regulatory changes to Regulation A+, which include increasing the maximum amount companies can raise in a calendar year from $50M to $75M.