Earlier this year, we wrote an analysis of the Securities and Exchange Commission’s (“SEC”) proposals to increase limits on certain exempt financings while “harmonizing” the maze of exemptions that have confused investors and issuers for decades. Fortunately, the SEC approved these proposals last month.
Though she opposed the changes, SEC Commissioner Caroline Crenshaw observed that due to these new rules, “issuers will be able to conduct larger and more frequent private offerings with fewer restrictions.”
The changes to Regulation A+ (“Reg A+”) and Regulation Crowdfunding (“Reg CF”) are among the most significant for small and medium-sized issuers seeking to raise capital.
Regulation A provides an exemption from registration for public offerings of securities under two offering tiers:
- Tier 1 provides exemptions for securities offerings of up to $20 million in a 12-month period, but does not preempt state filing requirements and is therefore not used quite as extensively as Tier 2;
- Tier 2 provides exemptions for securities offerings of up to $75 million (previously $50 million) in a 12-month period.
Basic requirements apply to both tiers, including company eligibility requirements, bad actor disqualification, and mandatory disclosures, among other requirements. Due in large part to its higher limits and greater permitted reach, more issuers elect to raise capital under Tier 2 than Tier 1. However, Tier 2 does limit the size of investments by non-accredited investors and requires audited financial statements, and ongoing report filings.
The amendments make several significant changes to Reg A+, such as:
- Increase maximum offering amount for Tier 2 from $50 million to $75 million;
- Raise the maximum offering amount for Tier 2 secondary sales from $15 million to $22.5 million; and
- Simplify requirements for Reg A offerings and provide more consistency between Reg A and registered offerings.
The amendments also make many significant changes to Reg CF, such as:
- Increase the offering limit from $1.07 million to $5 million;
- Change investment limits for investors by:
- Eliminating accredited investor investment limits
- Changing the formula for calculating non-accredited investor investment limits by using the greater of annual income and net worth; and
- Provide an 18-month extension to the temporary relief that provides exemptions from certain Reg CF financial statement review requirements for companies that offer up to $250,000 of securities within a 12-month period.
For both Reg A+ and Reg CF, the amendments also allow for the use of certain special purpose vehicles (“SPVs”) to facilitate investments in Reg A and Reg CF issuers. This important change allows companies to maintain a cleaner and simpler capitalization table by permitting them to aggregate Reg CF and Reg A+ investors into one consolidated group, which is more appealing to institutional investors, who the company may wish to target in future offerings. Previously, Reg CF investors were required to hold securities in their own names, resulting in the unwieldy administrative burden of making cap tables with thousands of investors. The new amendments permit the use of certain SPVs to function as a conduit for investors to invest in Reg CF and Reg A+ issuers while enabling the companies to maintain cleaner cap tables that they can manage more efficiently.
Many mature issuers previously determined that Reg CF and Reg A+ capital raises were not worth the effort due to the fundraising limits, complexities, and compliance requirements mandated under the previous rules. Critics often point out that the $50 million Reg A+ funding limit is seldom reached. The SEC’s new amendments appear to be changing that perspective, however. Reg A+ is garnering greater interest among more established, middle-market issuers with capital needs that are in line with the $75 million funding limit. Similarly, the Reg CF increase from $1.07 million to $5 million appears to entice more mature startups and small businesses. By simplifying the requirements and substantially increasing fundraising limits, the SEC has made Reg A+ and Reg CF more meaningful and attractive for issuers and investors alike.
According to Chairman John Clayton, “the complexity of the current framework is confusing…particularly for those smaller companies whose limited resources spent on navigating our overly complex rules are diverted from direct investments in the companies’ growth. These proposals are intended to create a more rational framework that better allows entrepreneurs to access capital while preserving and enhancing important investor protections.”
At a time when capital markets are tightening and companies are struggling to fund operations and growth, the SEC’s proposed rule changes could be a boon to private issuers from startups to middle market companies. Below is a summary of the proposed changes:
(1) Raise offering and investment limits:
a. Reg A, Tier 2: raise fundraising limit from $50 million to $75 million (and increase secondary offerings from $15 million to $22.5 million).
b. Reg CF: raise fundraising limit from $1.07 million to $5 million; eliminate investment limits for accredited investors and change calculation rules to allow non-accredited investors to invest based on the greater of their annual income or net worth.
c. Rule 504, Regulation D: increase the maximum offering amount from $5 million to $10 million.
(2) Ease restrictions on Testing the Waters and Demo Day Communications:
a. Allow Reg CF issuers to use generic solicitation materials to “test the waters” before deciding which exemption to rely on for its offering. This enables issuers to better align the claimed exemption with the character of the transaction and the profile of its most interested investors.
b. Allow Reg CF issuers to “test the waters” before filing an offering document with the SEC in a manner similar to current Reg A rules.
c. Exempt certain “Demo Day” event communications from general solicitation prohibitions.
(3) Change Eligibility Requirements for Reg A and Reg CF: proposed rules would amend eligibility requirements for Reg A and Reg CF issuers. It would also allow the use of special purpose vehicles to facilitate Regulation CF offerings. However, the proposed rules would limit the types of securities that may be offered in a Regulation CF offering.
(4) Streamline and Harmonize the Patchwork of Exemption Rules and Requirements: streamline and integrate the framework of exemptions to make it easier for companies to raise capital in reliance on different exemptions either simultaneously or at different times in their lifecycle. The SEC’s proposals would enable the SEC and issuers to determine the applicable exemption by looking at the particular facts and circumstances of the offering, and focusing on whether the issuer can establish that each offering either complies with the registration requirements of the Securities Act, or whether an exemption from registration is available for the particular offering. The Commission also proposed four non-exclusive safe harbors from integration.
