SEC Adopts Reg A+ to Ease Capital Development
Raising equity capital is always a challenge for emerging growth companies in the United States. The SEC recently adopted a new rule for raising capital by private companies – Reg A+ – that holds promise of stimulating capital formation.
Kickstarter and other crowd funding sources that arrange donations or pre-sales of products to fundraise become too limited for promising innovative businesses; their financial yield often tops out at several hundred thousand dollars. Since the break-down of the NASDAQ in the Dot Com Bust at the turn of the century, going public has become a fantasy for all but a very few young companies. In 2014, 115 companies had IPO's in the United States – 115.
Between Kickstarter and a wished-for IPO, emerging growth companies often raise capital from wealthy angel investors (maybe after sweat equity, tapping credit cards, and friends and family investments). Then professional venture capital investors provide growth capital to the most promising businesses – often on terms that entrepreneurs find distressingly controlling. And angel-funded companies often do not succeed in raising venture capital funding; they disappear, however promising their prospects, while they are not yet cash flow positive. No venture funding. Very quickly, no business.
At the end of March 2015, the SEC potentially revolutionized capital formation in the United States by adopting what is commonly known as Reg A+. Reg A+ permits essentially retail sale of securities to individual investors who are not wealthy by the SEC's definition of "accredited investors" and who have nothing to do with institutional investment funds. Under Reg A+, companies raising capital can advertise on the internet and otherwise. And, most significantly, U.S. and Canadian operating companies can raise up to $20M under what is known as Reg A+ Tier 1, and can raise up to $50M under what is known as Reg A+ Tier 2. Reg A+ also provides opportunities for existing early investors in young companies to sell at least a portion of their stock without waiting for the most likely liquidity event for the business: a sale to a larger company.
There are of course significant technical details, compliance, and costs. But when one is talking about numbers like $20M and $50M for growth companies, those are amounts of capital that can sustain some costs.
Who can take advantage of Reg A+ and how?
In my view, Reg A+ is not for funding the founding of companies, at least outside of Northern California. Reg A+ offers significant opportunities for expansion capital for young businesses. A cloud-based informatics company that has been operating for 10 years has taken about $1M of angel capital. The company has several million dollars in revenue, stunning gross margins, and blue chip customers. What it needs is capital to fund sales and marketing to deliver customers rapidly that already are in its pipeline. The company has been approached by larger companies to acquire it, but the founders don't want to sell cheap. It is an excellent candidate for Reg A+.
Consider companies such as Airbnb, Uber, and newer businesses in the sharing economy. Ordinary citizens working in their systems, and believing in their innovations, can now invest their dollars where they are investing their time.
The issue for many companies raising capital is who will organize the small investors so that the offering process can be efficient. Charles Schwab? Other existing brokers? Entirely new web-based businesses? One can anticipate that Reg A+ will lead to innovations in the organizations raising capital for companies for a fee, as well as fueling innovation by operating companies.
If you have any questions regarding the content of this article, please contact Frank D. Ballantine at fballantine@clarkhill.com | (312) 985-5937 or another member of Clark Hill's Corporate Law Practice Group.