“I know I have to include financial statements when I file an Offering Statement under Regulation A. When should these statements be dated and what periods should they cover?”
“What ongoing reports do I have to file with the SEC after my Regulation A offering is qualified, and when do I have to file them?”
We hope to answer these questions below.
Types of Financial Statements in the Offering Statement
A Regulation A Offering Statement can require four kinds of financial statement:
A balance sheet as of the end of a fiscal year
An interim balance sheet
A statement of income, cash flows, and changes in stockholders’ equity
Interim statements of income, cash flows, and changes in stockholders’ equity
Requirements for Financial Statements
In general, the financial statements must be audited in a Tier 2 offering, but not in a Tier 1 offering. However, interim financial statements – balance sheets and statements of income and cash flows – never have to be audited, even in Tier 2.
Audits in Regulation A may be performed using U.S. Generally Accepted Audited Standards or the standards of the Public Company Accounting Oversight Board. The accounting firm that prepares the audit does not have to be registered with the PCAOB.
When Should the Financial Statements in the Offering Statement Be Dated?
This is tricky, because there are not one, but two important dates: the date the Offering Statement is filed with the SEC, and the date it is qualified by the SEC. By definition, the date of qualification is always after the date of filing, by a month in the best of circumstances and often by many months. That means that a financial statement that was timely when the Offering Statement was filed might be “stale” by the time it’s qualified. In that case, you’ll need to submit updated financial statements before qualification.
Thus, read the term “Reference Date” in the chart below to mean the date of filing, when you’re preparing your Offering Statement. But bear in mind that eventually the “Reference Date” will mean the date of qualification. So if you’re close, you might as well use a later date.
To answer the second question, I’ve created a chart calledRegulation A Offering Team. The chart identifies the services required for a successful Regulation A offering (legal, accounting, etc.) and estimates how much each service will cost. At the end, I’ve included a pro forma chart for issuers to estimate the cost of their own offerings.
I find that many would-be Regulation A issuers find the process opaque and somewhat intimidating. I hope these two tools – the Regulation A Timeline and the Regulation A Offering Team and – can make it simpler, more transparent, and more predictable.
A couple weeks ago, Howard Marks of StartEngine and I presented a webinar about Regulation A. Listeners asked far more questions than we were able to answer in the time given, and I promised to post their questions and answers on the blog. Here goes.
What’s the difference between Regulation A and Regulation A+?
There is no difference. Regulation A has been around for a long time, but was rarely used primarily because issuers could raise only $5 million and were required to register with every state where they offered securities. Title IV of the JOBS Act required the SEC to create a new and improved version of Regulation A, and the new and improved version is sometimes referred to colloquially as Regulation A+. But it’s the same thing legally as Regulation A.
Can I use Regulation A to raise money from non-U.S. investors?
Definitely. Non-U.S. investors may participate in all three flavors of Crowdfunding: Title II, Title III, and Title IV (Regulation A).
But don’t forget, the U.S. isn’t the only country with securities laws. If you raise money from a German citizen, Germany wants you to comply with its laws.
Can non-U.S. companies use Regulation A?
Only companies organized in the U.S. or Canada and having their principal place of business in the U.S. or Canada may use Regulation A.
What about a company with headquarters in the U.S. but manufacturing facilities elsewhere?
That’s fine. What matters is that the issuer’s officers, partners, or managers primarily direct, control and coordinate the issuer’s activities from the U.S (or Canada).
Is Regulation A applicable to use for equity or debt for a real estate development project?
I believe that real estate will play the same dominant role in Regulation A that it plays in Title II. I also believe that real estate development will be more difficult to sell than stable, cash-flowing projects simply because of the different risk profile.
Is there any limit on the amount an accredited investor can invest?
No. An accredited investor may invest an unlimited amount in both Tier 1 and Tier 2 offerings under Regulation A. A non-accredited investor may invest an unlimited amount in Tier 1 offerings, but may invest no more than 10% of her income or 10% of her net worth, whichever is greater, in each Tier 2 offering.
What kinds of securities can be sold using Regulation A?
All kinds: equity, debt, convertible debt, common stock, preferred stock, etc.
But you cannot sell “asset-backed securities” using Regulation A, as that term is defined in SEC Regulation AB. The classic “asset-backed security” is where a hedge fund purchases $1 billion of credit card debt from the credit card issuer, breaks the debt into “tranches” based on credit rating and other factors, and securitizes the tranches to investors. However, the SEC views the term more broadly.
Can I combine a Regulation A offering with other offerings?
In general yes. For example, there’s no problem if an issuer raises money using Rule 506 (Rule 506(b) or Rule 506(c)) while it prepares its Regulation A offering. The legal issues become more cloudy if an issuer wants to combine multiple types of offerings simultaneously. Theoretically just about anything is possible.
Can the same platform list securities under both Regulation A and Title II?
Yes. In fact, the same platform can list securities under all three flavors of Crowdfunding: Title II, Title III, and Title IV. But on that platform, only licensed “Funding Portals” can offer Title III securities.
Does a platform offering securing under Regulation A have to be a broker-dealer?
The simple answer is No. But a platform that crosses the line into acting like a broker-dealer, or is compensated with commissions or other “transaction based compensation,” would have to register as a broker-dealer or become affiliated with a broker-dealer.
Can a non-profit organization use Regulation A?
Regulation A is one exception to the general rule that all offerings of securities must be registered with the SEC under section 5 of the Securities Act of 1933. Non-profit organizations are allowed to sell securities without registration under a different exception. So the answer is that non-profits don’t have to use Regulation A.
With that said, I represent non-profit organizations that have created for-profit subsidiaries that plan to engage in Regulation A offerings. For example, a non-profit in the business of urban development might create a subsidiary to develop an urban in-fill project, raising money partly from grants and partly from Regulation A.
Can I use Regulation A to create a fund?
If by “fund” you mean a pool of assets, like a pool of 30 multi-family apartment communities, then Yes. You can either buy the apartment communities first and then raise the money, or raise the money first and then deploy it in your discretion. If you want to own each apartment community in a separate limited liability company subsidiary, that’s okay also.
If by “fund” you mean a pool of investments, like a pool of 30 minority interests in limited liability companies that themselves own multi-family apartment communities, then No. Your “fund” would be treated as an “investment company” under the Investment Company Act of 1940, and Regulation A may not be used to raise money for investment companies.
Can a fund be established for craft beverages?
Same idea. You could use Regulation A to raise money for a brewery that will develop multiple craft beverages. You cannot use Regulation A to buy minority interests in multiple craft beverage companies.
For a brand new company, can the audited financial statements required by Tier 2 be dated as of the date of formation, and just show zeroes?
Yes, as long as the date of formation is within nine months before the date of filing or qualification and the date of filing or qualification is not more than three months after the entity reached its first annual balance sheet date.
How does the $50 million annual limit apply if I have more than one project?
The $20 million annual limit under Tier 1, and the $50 million limit under Tier 2, are per-issuer limits. A developer with, say, three office building projects, each requiring $50 million of equity, can use Regulation A for all three at the same time.
NOTE: This is different than Title III, where the $1 million annual limit applies to all issuers under common control.
What does “testing the waters” mean?
It means that before your Regulation A offering is approved (“qualified”) by the SEC, and even before you start preparing all the legal documents, you can advertise the offering and accept non-binding commitments from prospective investors. If you don’t find enough interest, you can save yourself the trouble and cost of going through with the offering.
NOTE: Any materials you use for “testing the waters” must be submitted to the SEC, if the offering proceeds.
Where can Regulation A securities be traded?
Theoretically, Regulation A securities could be registered with the SEC under the Exchange Act and traded on a national market. But I’m sure that’s not what the listener meant. Without being registered under the Exchange Act, a Regulation A security may be traded on the over-the-counter market, sponsored by a broker-dealer.
This sounds expensive! Can you give us an estimate?
On October 16th, I’m going to be talking about Regulation A at the5th Annual Global Crowdfunding Convention in Las Vegas, with Miss Nevada as my co-presenter (of course). I prepared this summary-of-a-summary for the event. For more in-depth information, here’s my Regulation A+ Primer. – MARK
The JOBS Act created three flavors of Crowdfunding:
Title II Crowdfunding, which allows issuers to raise an unlimited amount of money from an unlimited number of investors using unlimited advertising – but is limited to accredited investors.
Title III Crowdfunding, which allows issuers to raise up to $1 million per year from anyone, including non-accredited investors.
Title IV Crowdfunding, which modified the old Regulation A and is sometimes referred to as Regulation A+.
Quick Summary of Regulation A
Raise up to $50 million per year for each issuer
Raise money from both accredited and non-accredited investors
Register with the SEC
Takes about five months, start to finish
No State-level registration
Shares freely tradeable from day one
Sales by existing shareholders
Regulation A shareholders not counted toward Exchange Act limits for full reporting
Mini-IPO, but with much lower cost
Two Tiers
Theoretically, there are two “tiers” under Regulation A:
Tier One
Tier Two
Amount Per Year
$20 million
$50 million
Non-Accredited Allowed
Yes
Yes
Limits on Investment
None
For non-accrediteds, 10% of income or net worth, whichever is greater, per offering.
Audited Financials
No
Yes
Registration with SEC
Yes
Yes
Registration with State
Yes
No
Excluded from Exchange Act Limits
Yes
Yes
Shares Freely Tradeable
Yes
Yes
Post-Offering Reporting
No
Yes
Testing the Waters
Yes
Yes
Online Distribution Allowed
Yes
Yes
Bad Actor Limits
Yes
Yes
Because of the exemption from State registration, most companies will choose Tier Two.
Companies That Cannot Use Regulation A
Investment Companies
Companies that own stock or other securities in other companies.
Foreign Companies
Issuers must be organized and have their principal place of business in the U.S. or Canada.
Oil and Gas Companies
Can’t sell fractional undivided interests in oil and gas rights, or a similar interest in other mineral rights.
Public Companies
Can’t be a publicly-reporting company.
Companies Selling Asset-Backed Securities
For example, interests in a pool of credit card debt.
Where Regulation A Makes the Most Sense
Pools of high-quality real estate assets, especially REITs
High quality assets in inefficient markets
Sexy companies (companies with high social-media followers or potential)
“How long will it take?” That’s one of the two questions I’m asked most often about Regulation A.
The answer is that if everything goes smoothly, it should take about 20 – 24 weeks from the day an issuer decides to raise money using Regulation A until it begins selling securities. Every company is different, of course, and lots of things can delay the process, but 20 – 24 weeks is a good rule of thumb.
With this Regulation A Timeline, I hope to provide issuers and their advisors with a framework for conducting a Regulation A offering, with tasks and milestones. Three notes:
Don’t try to view this on your phone! There’s a lot to cover.
As you’ll see, there’s a lot to do in the first few weeks. The more thorough the attention given to the earliest tasks, the more smoothly the process will roll out.
By definition, this Timeline is from the perspective of the lawyer. Each member of the team – the accountant, the escrow agent, etc. – will have a separate timeline, all within the same 20 – 24 week framework.
What is the other question I’m asked most often about Regulation A? You guessed it. I’ll cover assembling the team and the cost of Regulation A in another post.
No disrespect to Kim Kardashian, but I think the SEC’s Proposed Amendments to Regulation A have come closer to breaking the Internet than the photos I heard about last year – although that could be a function of the circles I travel in.
My contribution started as a blog post but got too long for a blog post. Hence, I’m providing this Crowdfunding Regulation A-plus Primer. Within the primer are links to:
Amendments to Regulation A
The statements of the SEC Commissioners that accompanied the final regulations
Title IV of the JOBS Act, which authorized changes to Regulation A
I am trying to provide not just technical details in the primer – which are important – but also practical advice about the cost of Regulation A+ offerings, the advantages and disadvantages, and examples.
If you have thoughts, as many of you will, I am eager to hear them and plan to supplement the Primer.
It’s been a mere 457 days since the SEC proposed regulations under Title IV of the JOBS Act, aka Regulation A+, and a mere 1,070 days since the JOBS Act was signed into law. Yet the SEC approved final regulations today, with just a few tweaks from the proposed rules. Regulation A+ will go into effect in roughly 60 days.
The most important provisions of the proposed regulations survived intact: companies will be allowed to raise up to $50 million – from anyone, not just accredited investors – without approval from state regulators. You will still have to file a thick offering statement with the SEC, and investors – both accredited and non-accredited – will still be limited to investing 10% of the greater of income or net worth. Nevertheless, I expect Regulation A+ to be used very widely, indeed to transform the Crowdfunding landscape.
I’ll be providing a link to the final regulations shortly (as well as a bunch of other useful links), as well as some thoughts about where Regulation A+ will be most useful.
People sometimes ask “Will Crowdfunding replace REITs?” That’s not exactly the right question.
A REIT – an acronym for Real Estate Investment Trust – is not a function of real estate law or corporate law. A REIT is solely a function of tax law. Section 856 of the Internal Revenue Code defines a REIT as a corporation, trust, or association that satisfies certain criteria, including these:
At least 75% of the entity’s assets must consist of real estate assets or cash.
The entity must have at least 100 owners.
Interests in the entity must be transferable.
No more than 50% percent of the interests in the entity may be held by five or fewer individuals.
There is only one benefit of qualifying as a REIT: as long as he distributes at least 90% of its income to its owners, the entity itself is not subject to tax. Only the owners are subject to tax, when they receive dividend and capital gain distributions. The whole REIT industry is built around this tax benefit.
Because the REIT label is solely a function of tax law, not corporate or securities law, a REIT can be:
A publicly-registered company with publicly-traded securities; or
A publicly-registered company with privately-traded securities; or
A private company with privately-traded securities.
The second category of REIT is probably most common and, frankly, it is the category that has given REITs a bad name. Sold through the traditional broker-dealer channels, it is not unusual for the shares of publicly-registered, privately-traded REITs to carry a load of more than 10%, great for the broker, terrible for the customer. That’s why people say “Private REITS are sold, not bought.”
Compare a publicly-registered, privately-traded REIT to a garden-variety limited liability company owning real estate assets. In both cases, the entity itself pays no tax. And now, through Crowdfunding, the garden-variety LLC can solicit investors using the Internet, leading to transactions cost (load) much lower than the private REIT. Economically it’s a no-brainer: the Crowdfunded real estate LLC is better than the private REIT.
As I said, however, that’s really comparing apples with oranges. The REIT designation is about taxes; Crowdfunding is about how you find investors.
The real question is “Can I find investors for a private REIT using Crowdfunding, rather than through the traditional broker-dealer channels?” And the answer to that question is a resounding “Yes!” When you check the deals available at your favorite real estate Crowdfunding site tomorrow morning, you could well see a REIT.
And why would a sponsor offer a REIT rather than a garden-variety LLC? One reason – maybe the only reason – is tax reporting. An investor in an LLC receives a full-blown K-1 each year, and faces at least the theoretical risk of paying tax on “phantom” income. An investor in a REIT, on the other hand, receives only a simple 1099 and pays tax only on actual distributions.
Be that as it may, nobody should be paying a 10% commission. By connecting sponsors directly with investors, Crowdfunding promises to squeeze this kind of inefficiency out of the capital formation industry. Especially when Regulation A+ comes into effect, opening the market to non-accredited investors, there is every reason to believe that Crowdfunding will replace the traditional broker-dealer as the preferred method for distributing REIT shares.
The Securities Act of 1933. The Exchange Act of 1934. The Investment Company Act of 1940. Those are the pillars of the U.S. securities laws, as relevant today as they were 80 years ago. And here’s one more old law relevant to Crowdfunding: the Trust Indenture Act of 1939.
Here’s the idea. A company issues its promissory notes (obligations) to a large group of investors. If the company defaults on one or two notes, it might not be financially feasible for those particular investors to take legal action. Even if the company defaults on all the notes it will be a mess sorting out the competing claims. Which investor goes first? If there is collateral, which investor has priority? At best it’s highly inefficient, economically.
The Trust Indenture Act of 1939 imposes order and economic efficiency. It provides that where a company issues debt securities, like promissory notes, it must do so pursuant to a legal document called an “indenture” and, most important, with a trustee, normally a bank, to represent the interests of all the investors together. The TIA goes farther:
It provides that the indenture document must be reviewed and approved by the SEC in advance.
It ensures that the trustee is independent of the issuer.
It requires certain information to be provided to investors.
It prohibits the trustee from limiting its own liability.
Why don’t Patch of Land and other Crowdfunding portals that issue debt securities comply with the TIA? Because offerings under Rule 506 are not generally covered by the law. Conversely, because Lending Club and Prosper sell publicly-registered securities (their “platform notes”), they are covered, and have filed lengthy indenture documents with the SEC.
The real surprise is with Regulation A+. If a Regulation A+ issuer uses an indenture instrument to protect the interests of investors then it will be subject to the TIA and its extensive investor-protection requirements. If the issuer does not use an indenture, on the other hand hand, it will not be subject to the TIA as long as it has outstanding less than $50 million of debt. That’s a strange result – giving issuers an incentive not to use an indenture even though indentures protect investors.
That’s what happens sometimes when you apply very old laws to very new forms of economic activity. Welcome to Crowdfunding.
Yesterday I spoke about Regulation A+ on a panel at the National Press Club in Washington, D.C. One topic was whether offerings under Regulation A+ would be “integrated” with other offerings, including offerings under Title II.
The word “integration” describes a legal concept in U.S. securities laws, where two offerings that the issuer intends to keep separate are treated as one offering instead. For example, I raise $1 million in an offering under Rule 506(b), where I admit 19 non-accredited investors. Needing more money, I start another offering under Rule 506(b) a month later – and for the same project – and admit 23 more non-accredited investors. Wrong! The SEC says those two offerings are “integrated” and now I’ve exceeded the limit of 35 non-accredited investors.
Today, entrepreneurs can raise money under Title II Crowdfunding only from accredited investors. Under Regulation A+ they’ll be able to raise money from non-accredited investors as well, vastly expanding the potential investor base. Unlike a Title II offering, however, where accredited investors can invest an unlimited amount, an investor in a Regulation A+ offering, accredited or non-accredited, will be limited to investing 10% of his or her income or net worth.
The question naturally arises, why not do a Regulation A+ offering for non-accredited investors while at the same time doing a Title II offering for accredited investors, thus maximizing the amount raised from everyone?
The answer, unfortunately, is integration. The two offerings would be treated as one, and they would both fail as a result.
But along with that bad news, the integration rules under the proposed-but-not-adopted Regulation A+ regulations offer good news as well:
A Regulation A+ offering will not be integrated with an offering that came first. Thus, I can raise money in a Title II offering, accepting an unlimited amount from accredited investors, and the day after that offering ends conduct a Regulation A+ offering for non-accredited investors.
A Regulation A+ offering will not be integrated with an offering to foreign investors under Regulation S. The two can happen simultaneously.
A Regulation A+ offering will not be integrated with an offering that begins more than six months after the Regulation A+ offering ends.
A Regulation A+ offering will not be integrated with a Title III offering, even if they happen at the same time.
Another takeaway from the conference is that the SEC plans to finalize the proposed regulations under Regulation A+ by the end of the year (this year). Issuers and portals, get ready.
