As the CARES Act stimulus funds run dry and most emerging growth companies were left out in the cold, the SEC’s proposed amendments may provide much needed relief for businesses in need of capital. Interestingly, the SEC’s vote preceded the economic meltdown wrought by COVID-19 and resultant lockdowns that have curtailed economic activity, but they are timely to say the least.
The SEC’s proposed amendments aim to improve and streamline the confusing patchwork of exemptions that have confused and limited companies seeking to raise capital from private investors. The proposed amendments seek to enable companies to raise more capital more efficiently while improving investor protections.
All securities offerings require SEC registration unless they qualify for an exemption. Whether raising a seed round or growth capital in pursuit of an IPO, most emerging growth companies rely on exemptions to raise capital as it is excessively burdensome and expensive to conduct registered offerings. Companies seeking to raise capital must qualify for one of 10 exemptions or safe harbors, each of which has unique and often contradictory requirements. The SEC’s proposed rules would reduce friction points among the available exemptions to make it easier for issuers and investors to navigate the exempt offering process.
According to Chairman Jay 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 on 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; and
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 proposed 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.