Regulation A+ Raises are Here, What Does This Mean for Texas?
Competing or Complementary Frameworks?
Back in March of 2015, the SEC (U.S. Securities and Exchange Commission) announced final rules intended to allow smaller companies to access investor capital through crowdfunding. These rules, known as "Reg A+," update and expand the existing Regulation A, as part of the JOBS Act originally passed in 2012. A 60-day implementation window has now passed, and as of June 19, 2015, offerings under Reg A+ can now begin. The biggest impact of A+ at the national level is that non-accredited investors (a/k/a the general public) can invest in offerings previously restricted to high net worth accredited investors.
However, for Texas residents, this may sound familiar. Texas (and other states) have already passed laws allowing for the general public to invest locally.
In November of 2014 the Texas State Securities Board passed by 4-0 vote rules for intrastate crowdfunding. Texas Rule 139.25 follows an SEC exemption called “Rule 147” which exempts intrastate transactions from many Federal registration requirements. The rules allow retail investors to buy shares in Texas-based private companies such as real estate developments, startups and small businesses. Investors may contribute up to $5,000 in any equity offering, and companies can raise up to $1 million in a year.
So what’s different about Reg A+?
Local vs. National Character
Under Rule 147, Texas crowdfunding offerings must be limited to residents of Texas. This inherently fits well with real estate developments, community re-investment, and local businesses. It also provides for state oversight and regulation of offerings with robust policing by state securities regulators. However, companies with a national or global customer base who want to tap the widest possible investor audience may find Texas crowdfunding restrictive.
Regulation A+ offerings are designed to appeal to investors nationwide. Reg A+ sets up a two-tier system, which preempts local registration for larger Tier 2 offerings, but continues joint federal and state regulation of Tier 1 offerings.
Texas - Big State, Small Funding
Texas crowdfunding is designed to foster the growth of local investment and create jobs in entrepreneurial companies. As a result, offerings are limited to $1,000,000.00 ($1 million) per year, per company. While this limit is not generally restrictive for new businesses and startups, it can result in limitation of the total size of a real estate development, particularly if bank financing is not robust. Companies that depend on construction of facilities for shipping, warehousing, and employee growth can find the Texas cap to quickly restrict their options unless lending partners join alongside the crowd to leverage the capital raised from the crowd. Additionally, because Texas crowdfunding offers are considered to be “integrated” with other capital raises, careful planning is required to prevent crowd-funded offers from blocking other investment into the company.
Regulation A+ Goes Big
Tier 1, permits offerings of securities 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.
Tier 2, offerings are even larger, allowing 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. However, this larger cap is not without drawbacks. In a Tier 2 offering (and thereafter) the issuer must provide audited financial statements, and file annual, semiannual and current event reports with the SEC, and there are restrictions on the size of an individual investment as noted below.
Both Texas and Regulation A crowdfunding allow for sales to the general public. However, there is a limitation on the amount of securities non-accredited investors can purchase in a Tier 2 offering of no more than 10 percent of the greater of the investor’s annual income or net worth. Texas instead uses a flat-fee limit of $5,000 per investment.
Texas offerings are very low cost. Many issuers are able to obtain flat-fee legal services for formation and structuring, and portals such as MassVenture offer form documents for disclosures that issuers can take to their counsel to streamline filings. MassVenture estimates that legal fees for a well-prepared Texas issuer will be less than $5,000 in many cases.
The costs for SEC regulated A+ offerings are much greater. In both Tier 1 and Tier 2 Regulation A offerings, the cost of compliance, legal, and accounting can be significant. Legal fees for the disclosure package filed with the SEC are estimated between $25,000 and $50,000, with an additional $10,000 in accounting and compliance, before any fees for a Tier 2 audit. Many commentators believe that implementation is likely to require six to nine months of planning, and $75,000 to $100,000 in external budget.
Because of those costs, and because an issuer must wait for the SEC to review and approve the offering package, Regulation A+ provides for a limited “testing the waters.” This market test permits issuers to solicit expressions of interest from potential investors prior to filing a final offering package. However, legal counsel is still recommended during this testing period to ensure that communications do not jeopardize eventual eligibility.
Issuers in a Tier 2 offering should also plan for annual reporting costs that will be primarily driven by the number of record holders and the audit cost. For a typical issuer, an annual compliance budget of $25,000 is a reasonable starting point.
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