In March, the Securities and Exchange Commission (SEC) approved final rules of Title IV of the JOBS Act, changing Regulation A into “Regulation A+.” Entrepreneurs selling securities to private investors are no longer limited to using Regulation D or the old Regulation A. Entrepreneurs can now crowdfund their startup online through a “mini IPO.” Many believe these new rules show that the government has embraced technological changes. Some are optimistic about what they see as an opening of the crowdfunding floodgates, but the rules’ restrictions and requirements suggest such sweeping optimism may be misplaced.
The new rules for Reg. A+ eliminate the need for state law compliance, increase the crowdfunding cap to $50 million for companies, and allow companies to sell securities to the general public as well as accredited investors. How does this work? A company does not sell securities on Kickstarter. It gathers a mailing list from interested parties and then sells securities to them through a registered broker dealer. There are two tiers of sales:
Tier 1 includes offerings of up to $20 million in a 12-month period, with not more than $6 million in offers by selling security-holders that are affiliates of the issuer. Companies must also factor in Rule 12(g), for if it has more than 2000 shareholders it must meet heightened reporting requirements. Companies must also file their balance sheets and other required statements for the previous two fiscal years (or for such shorter time that they have been in existence). (This is explained in more detail, here, on page 106-119).
Tier 2 includes offerings of up to $50 million in a 12-month period, with not more than $15 million in offers by selling security-holders that are affiliates of the issuer. Companies are exempt from Rule 12(g) requirements. Companies must also file two years of audited financial statements with the SEC.
So does this changed rule effectively open the floodgates to crowdfunding and allow technology to benefit both companies and investors? Maybe. Even though the accredited investor requirement is jettisoned, there are still investor protections which arguably weaken the claim that this rule change broadens access to money and investments.
Regulation A+ allows investors to only invest up to 10% of the greater of their annual income or net worth, unless they are accredited investors. If an investor invests $20k, which equals 10% of his annual income, then he will be an accredited investor anyway because accredited investors must have at least $200k in annual income and $20k is 10% of $200k. Regulation A+ eliminated the accredited investor requirement to make it easier for companies to raise money and enable crowdfunding, but did it really do that? If an investor invests $20k, then they are also accredited. But how many people who make less than $200k a year have either the means or the will to invest anything close to $20k in a company they know little about, or that is just trying to get off the ground? Not many, which creates the following problem.
If a company is relatively small and chooses Reg. A+ as opposed to D, they will likely be raising funds under Tier 1. This means the company would be limited to 2000 investors/shareholders, unless it wants to start complying with Rule 12(g). The problem is that the average donation on Kickstarter is $70. Therefore, in order to remain under 2000 investors and avoid 12(g) reporting requirements, a company cannot seek to raise more than $139,930 in a Tier 1 offering. This is not enough to start or continue a business. It is also not enough to justify complying with the other requirements of Reg. A+, such as using a registered broker dealer to sell the securities.
Additionally, even if the small company decides to use a Tier 2 offering in order to avoid the 12(g) issue, it would then need to provide 2 years of audited financials. Auditing financials is expensive. As of 2011, it could cost small companies up to $75k. Clearly, then, a company wanting to use Tier 2 of Reg. A+ to get off the ground will be priced out of this capital market.
What does this all mean? Regulation A+ represents a step in the right direction in opening the capital markets to more investors and companies, as well as showing that the government is responsive to innovation. However, those who are optimistic about the coming flood of crowdfunding capital should slow down and look at these new rules more carefully. Using Tier 1 is infeasible for any company looking raise enough money to start a business, unless investors on Kickstarter start giving more than $70 on average. Using Tier 2 is infeasible for new companies looking to raise initial capital because it requires audited financials. Therefore, Regulation A+ has succeeded in making investing and raising capital easier, but it seems to have done so not for investors and companies which have previously been excluded, but for those who already had access to the capital markets under the previous rules.
Image source: http://www.southernfriedscience.com/?p=17328.