NEW RULES FOR START UPS ALLOW FOR MINI IPO's

Regulation A+ has arrived, and with it the first crop of ventures looking to take advantage of the more flexible rules for raising investor funds.

The JOBS Act rule, which went into effect on June 19, 2015, allows companies to raise as much $50 million from the public without full SEC registration.Sec. 401 of pl112-106

Since Reg A+ was adopted, a handful of startups have explored using it. In addition, a few platforms have emerged to market investments in startup companies to the public. The rule has also attracted a legal challenge from two states looking to restore their authority to review the offerings.

The startup world’s involvement with Reg A+ is still mostly tentative. The SEC rule in Release No. 33-9741, Amendments to Regulation A, allows companies to “test the waters” by advertising an offering before formally launching one, which lets them gauge investor interest. Several startups have entered that process since Reg A+ went live.

“It’s not just seeing if there’s demand, it’s creating demand,” said Sara Hanks, CEO of CrowdCheck, which provides due diligence services to the crowdfunding industry.

Hanks, who sits on the SEC’s Advisory Committee on Small and Emerging Companies, sees the “testing the waters” provisions as one of the most attractive aspects of Reg A+.

Release No. 33-9741 overhauled Regulation A of the Securities Act of 1933, which exempted a public securities offering from SEC registration so long as it stayed below a $5 million cap and passed muster with state securities regulators. Critics said the dollar cap and the state “blue sky” review requirement, taken together, made the exemption too complex and expensive to be of any use.
Reg A was only sparsely used, while exemptions under Regulation D of the Securities Act became the primary means for startups to raise capital without registering with the commission.

But Reg D, for the most part, requires investors be accredited, which means they must either have a personal income of $200,000 a year or $300,000 with a spouse, or have a net worth of $1 million, not including a primary residence.
Reg A+, by contrast, places no limits on the number of nonaccredited investors who can participate in a funding round, requiring only that they invest no more than 10 percent of their income or net worth in per year, whichever number is larger. The flexibility to sell to nonaccredited investors means a Reg A+ offering has a naturally wider base of everyday investors to market to, which is why the process is frequently likened to a “mini-IPO.”

The SEC is still working through a separate equity crowdfunding rule in the JOBS Act, which has been slowed by questions over investor protections. But with the implementation of Reg A+, proponents say crowdfunding is already here.
“It’s going to look a lot like crowdfunding,” said Kendall Almerico, a lawyer in Alexandria, Virginia, and founder of the recently launched Reg A+ platform, BankRoll Ventures LLC. “In essence, that’s what it is.”

The startups
StartEngine LLC is another online platform that helps companies place Reg A+ offerings. On the site, four early-stage companies are advertising potential deals: gaming startup XReal, nightclub software provider Surkus, e-commerce startup iConsumer Corp., and Elio Motors, a maker of fuel-efficient three-wheeled cars.
In each case, the companies feature a marketing pitch and video. Investors can signal interest with a “reserve my shares” button on the site, but they will not have the opportunity to invest until the startups file with the SEC and the filings are approved.

None of the four companies has filed a public offering document as this story was being reported. Reg A+ does allow nonpublic submissions to the SEC, similar to the JOBS Act’s confidential initial public offering filings. Sec. 106(a) of pl112-106
Visually, the marketing materials on StartEngine closely resemble a campaign on Kickstarter, the popular donations-based crowdfunding platform, which lets startups fund projects by offering gadgets, memorabilia, early access to software, or other awards — just not shares.

What sets the potential Reg A+ offerings apart from Kickstarter, however, is the presence of a “terms” page, a reminder that the introduction of equity makes the transactions far more complex.

iConsumer Corp., for example, is proposing a “tiered pricing” structure for selling shares, increasing in price if the service gains traction among users. Once the startup reaches 50,000 users, it plans to sell 1.12 million Class A preferred shares at $0.09 apiece. Once it hits 100,000 users, it will sell 770,000 shares at $0.13 apiece, and the per share price will continue to rise with the site’s growth.
At the end of each pitch is an all-caps disclaimer on forward-looking statements, akin to what one might see near the top of a prospectus for a stock offering: “INVESTORS ARE CAUTIONED NOT TO PLACE UNDUE RELIANCE ON THESE FORWARD-LOOKING STATEMENTS, WHICH SPEAK ONLY AS OF THE DATE ON WHICH THEY ARE MADE.”

The disclaimer serves as another reminder: Reg A+ may look like Kickstarter, but the resemblance is only skin-deep.

The risk
When the SEC approved Release No. 33-9741 unanimously in late March, it did so with a nod to state securities regulators, who had fought for more than year to restore their authority to review Reg A offerings.
In the December 2013 proposal in Release No. 33-9497, Proposed Rule Amendments for Small and Additional Issues Exemptions Under Section 3(b) of the Securities Act, the commission cut out the so-called “blue sky” state review. The final rule in Release No. 33-9741 divided the offerings into two tiers: Tier 1 offerings of up to $20 million carry a lighter federal reporting and disclosure burden, but are subject to state-level review. Tier 2 offerings of up to $50 million are exempt from the blue sky reviews but have more stringent reporting and disclosure requirements with the SEC.

Investor protection was at the core of the debate. A Reg A+ offering gives investors of average means and perhaps a limited understanding of the financial markets wide access to startup equity investments. The investors have almost the same flexibility to buy shares as they do with publicly traded companies. But the Reg A+ companies do not have to adhere to the same financial reporting and disclosure requirements public companies must follow. State-level review, the regulators argued, was a necessary layer of consumer protections for a new frontier of the securities market.

In early June, Montana and Massachusetts filed petitions in a federal appeals court to halt the rule, arguing the SEC’s preemption of state authority went against the intent of Congress. The suits have since been combined into a single challenge.
The SEC refused a separate request from Montana to stay the rule pending the outcome of the case, arguing the states were unlikely to succeed.

A major question, as issuers begin to raise funds via Reg A+, is whether companies will opt into state review under Tier 1, or will avoid it under Tier 2.
Filing requirements for Reg A+ are lighter than a full-fledged IPO, but they mirror many of the disclosures that a public company must make. The offering documents, for example, must include U.S. GAAP-compliant financial statements and a management’s discussion and analysis (MD&A), as well as data on executive compensation, among other disclosures. The Tier 2 documents carry additional requirements, including audits of the financial statements that follow AICPA or PCAOB standards, and periodic filings of event reports.

Almerico anticipates that “99.99 percent” of deals advertised on Bankroll, which is affiliated with a broker-dealer, will use Tier 2. Few, if any, will make use of Tier 1.
“The fact is, most people aren’t going to do them because of the blue sky requirements,” he said.

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