Regulation A Stock Sales (#90)
/In this podcast episode, we discuss how fund raising can be achieved by using the Regulation A exemption. Key points made are noted below.
To return to the main premise of the last episode, you want to avoid doing a stock registration when you sell stock, because a registration is painful, and annoying, and very expensive. One way out, from the last episode, was to sell stock only to accredited investors, which are basically high net-worth investors. And in most cases, that works pretty well. But, what if you can only raise money from investors who are not accredited? Well, if you’re not trying to raise too much money, you can use the exemption provided by Regulation A.
The Regulation A Exemption
This exemption is designed for companies that aren’t going to raise much money, presumably on the grounds that they wouldn’t bother otherwise if they had to submit a full registration document. The limit on Regulation A fund raising is $5 million per year.
But there is one catch, which is that $1½ million is the maximum amount of that $5 million that can be a secondary offering. What that means is that existing shareholders may be sitting on unregistered stock that they want to sell, and Regulation A only allows them to sell $1½ million of their shares per year as part of the $5 million exemption.
And on top of that, the secondary offering cannot include stock resales by affiliates of the company if the company hasn’t generated net income from continuing operations in at least one of the past two fiscal years. Examples of affiliates are officers and directors, and significant shareholders.
And on top of those restrictions, Regulation A is no available for investment companies or development-stage companies.
The exemption is also not available if a company has been having disclosure problems with the SEC over the past five years, or if the company currently has a registration statement being reviewed by the SEC, or if any affiliates or the company’s underwriter have been convicted within the past 10 years of a crime related to a securities transaction.
So basically what all of these restrictions mean is that Regulation A is intended for smaller companies that have been around for a while, and which really need to raise money, and not to cash out existing shareholders.
Advantages of Regulation A
So, what are the advantages of a Regulation A offering? First of all, there’s no limit to the number of investors, and they don’t have to pass the qualification test that was used for Regulation D. Also, and here’s a pretty major item, there are no restrictions on the resale of any securities sold under the Regulation. And finally, the key difference between a Regulation A offering and a registered offering is the absence of any periodic reporting requirements; which can be a pretty major cost reduction.
Regulation A Steps to Follow
Here are the steps you follow to complete a Regulation A offering:
First, you issue an offering circular, to see who’s interested in investing. As you may recall from the last episode, this was not allowed under Regulation D. But, you first have to submit the offering circular to the SEC for review. And if they choose to review it, then you can count on some delays. The SEC is not known for rushing its reviews.
Also, the offering circular is not small. If you think you’ll get away with a two-page document, think again. Unless you’re using amazingly small font. The offering circular is detailed, and it takes a lot of professional input to construct.
Second, when the company is ready to start selling securities under the Regulation, it files a Form 1-A with the SEC, and then conducts a general solicitation. The company cannot complete any security sales until the SEC approves the Form 1-A, so there’s going to be a delay there.
If the information issued to investors in the offering circular becomes false or misleading due to changed circumstances, then the company has to revise and reissue the offering circular.
And the third step is, that once the security sales are under way, the company has to file a Form 2-A with the SEC every six months, which describes the cumulative sales from the offering, and the use of proceeds.
And finally, it has to file a final Form 2-A within 30 calendar days of terminating the offering.
I do not recommend trying to bootstrap your way through a Regulation A offering. There needs to be a qualified securities attorney involved in nearly every step of this process, and also to assist in communications with the SEC. And if you add legal fees to the cost of preparing the offering circular, you’ll find that it’s still a pretty expensive way to raise money. It’s less expensive than a full-blown stock registration, but it’s not cheap.
In short, Regulation A works well for smaller offerings, though it does still require some interaction with the SEC and filing of reports. Still, it does allow stock to be registered, which investors really like.