Guest Post: Investing in Mini IPOs

This articled was originally posted at Inc.  You can follow Ryan Feit on Twitter.

Historically, investing in startups and small businesses has been reserved for accredited investors, or just the wealthiest 2% of Americans. Now, after three years of anticipation, investing in pre-IPO companies will be opened up to the other 98%. Title IV of the JOBS Act which kicks on Friday, June 19th enables the fastest growing private companies in America to conduct Mini-IPOs and raise up to $50 million from everyone.

Although these sweeping changes hold enormous potential, the investment options for retail investors will initially be limited and will not open all private investment opportunities to all investors. Individual private companies which choose to conduct fundraises with all investors will need to prepare and file a registration statement with the SEC and receive SEC approval prior to launching a Mini-IPO.

There are a few points which new potential investors should keep in mind as they begin to explore this new asset class:

1. Testing the Waters

In most cases, companies will “test the waters” prior to undergoing the full SEC registration process. This means that companies will start talking to investors, marketing the opportunity, and collecting “Indications of Interest.” Essentially companies will solicit expressions of interest from potential investors and to determine whether investors are interested before they spend time and money pursuing a full-blown Mini-IPO. You should be aware that these “Indications of Interest” are non-binding and do not compel you to make a future investment.

2. Investment

For new investors, there will be a cap on the amount you can invest, generally up to the greater of 10% of your annual income or net worth. For example, if you make $75,000 of income per year with little savings, you will be able to invest up to $7,500 in a given opportunity. Regardless of the congressionally imposed investment limits, it’s not prudent for investors to allocate greater than 10% of their overall investment portfolios into private companies. Furthermore, as the old saying goes, “don’t put all your eggs in one basket.” Diversification is key, so make sure you are building a portfolio of at least 10 private companies.

3. Everyone Can Participate

This is the most meaningful change related to Regulation A+. Essentially all private companies which have raised capital up to this point have done so through a securities exemption called Regulation D, 506(b) which only permits accredited investors (ie. the wealthiest 2%) to participate. Although there are limits on what individual retail investors can invest, anyone in America will now be able to invest in private companies. As a reminder, companies will ultimately decide whether to open up to all investors, so investors will only have limited selection initially.

4. Unrestricted Shares

Unlike typical private investments, there are no restrictions on the resale of Regulation A securities so theoretically investors will be able to sell their shares the next day. That being said, in actuality, secondary markets for these securities are currently very limited. Eventually a robust secondary market will develop, but in the meantime, investors should plan on investing and holding for 5-7 years (until an acquisition or IPO occurs). Additionally, shares could also be subject to contractual transfer restrictions from the company itself. Pay careful attention to these transfer restrictions for any securities that you purchase.

5. The Nitty Gritty

Consult with your legal and tax advisors prior to making any investments so that you fully understand the terms of the offering. You should be wary of investing at a different valuation than institutional or larger investors investing around the same time. In addition, each company will be required to file a detailed disclosure document called a Form 1-A with the SEC. You should read this document thoroughly prior to making an investment. Finally, most Regulation A+ offerings will be conducted by broker-dealers, including those that operate online platforms like SeedInvest. You should do diligence on your broker-dealer and/or platform prior to making an investment through them.

This regulatory change marks a key development in the democratization of the private capital markets. 240 million Americans will now have the opportunity to enrich their portfolios of stocks and bonds by adding alternative assets, just like sophisticated institutional investors. However, with new opportunity comes new risks and it’s critical that new investors learn how to navigate this new asset class before taking the plunge.


Guest Post: Investing in Mini IPOs

Game Changing: New JOBS Act Rule To Allow Raising Money From The General Public

Kiran Lingam is the General Counsel & VP Business Development at SeedInvest, an equity crowdfunding platform that connects accredited investors to high-quality start-ups and small businesses seeking funding.  He explains how this breaking development from the SEC has the potential to disrupt the fundraising landscape for early stage and growth companies.  This article originally appeared on the SeedInvest blog.  You can follow SeedInvest on Twitter here.

In a stunning development earlier today, the SEC released final Regulation A+ rules under Title IV of the JOBS Act that pre-empts state law, paving the way for $50M unaccredited investor equity crowdfunding. Growth companies will soon now be able to raise up to $50 million from unaccredited investors in a mini-IPO style offering serving as a potential alternative to venture capital or other institutional capital. Imagine Uber or AirBnb, instead of going to big institutions for capital, now offering their stock directly to their drivers, riders, renters and tenants as well as the general public.

When the JOBS Act was passed in April of 2012, many believed that Title IV would actually be the most powerful change, but given that there was no deadline for implementation of the rules, most ignored Title IV as too remote to pay serious attention.  There was also concern about the same problem that haunts existing Regulation A, namely state securities laws that would require registration in every individual state where securities are sold, making it too expense/complicated to be workable. The infamous example of this was in 1980 when Massachusetts deemed the offering of Apple Computer stock to be “too risky” and did not allow its citizens to participate in the offering.

Last November, however, the SEC shocked the securities community by introducing Proposed Regulation A+ rules that, through a clever legal maneuver, pre-empted state securities regulation.

Since that stunning announcement, there has been great uproar about “pre-emption,” whether it is legal and whether it is appropriate for a federal agency to pre-empt the states in this manner.   Most in the pro-business community ardently support pre-emption and argue that securities offerings constitute interstate commerce and that state by state regulation is antiquated in a world where the internet blurs state lines. Many regulators, investor protection groups and even one crowdfunding platform opposed such pre-emption, arguing that state review adds value and necessary investor protections.   In response, the states introduced a coordinated review process, which was designed to address these concerns. Critics argued that this was too little, too late and only resulted from the states being forced to act by the threat of pre-emption.

In the final rule release, the SEC settled the dispute through a brilliant compromise by confirming pre-emption for Tier II Regulation A offerings up to $50M but also increasing Tier I Regulation A offerings from $5M to $20M and leaving pre-emption intact, thus giving “coordinated review” a chance to prove itself.   This appears to be the result of an extensive negotiation between Commissioner Stein who opposes pre-emption and several of the other Commissioners. In coming to this decision, the SEC noted that:

  • Coordinated review is new and unproven and pre-emption is necessary at least until there is a track record of a functioning coordinated review program
  • Coordinated review has great potential if the states can stick together and maintain a seamless process
  • NASAA may appoint an individual to serve with the SEC internally on implementation of Reg A+
  • States will retain full enforcement and anti-fraud jurisdiction in all cases

Now, with pre-emption under Tier II and coordinated review under Tier I, it looks like Title IV (Reg A+) could make Title III Crowdfunding a relic. 

Regulation A+ will likely go into effect 60 days after publication in the Federal Register (June 2015). Here are the highlights of the new Regulation A+ exemption:

  1. High Maximum Raise:  Issuers can raise up to $50,000,000 in a 12 month period for Tier 2 and $20,000,000 for Tier 1.
  2. Anyone can invest:  Not limited to just “accredited investors” – your friends and family can invest.  Tier 2 investors will, however, be subject to investment limits described below.
  3. Investment Limits: For Tier II, individual investors can invest a maximum of the greater of 10% of their net worth or 10% of their net income in a Reg A+ offering (per offering). There are no investment limits under Tier 1.
  4. Self-Certification of Income / Net Worth:  Unlike Rule 506(c) under Title II of the JOBS Act, investors will be able to self-certify their income or net worth for purposes of the investment limits so there will be no burdensome documentation required to prove income or net worth.
  5. You can advertise your offering:  There is no general solicitation restriction so you can freely advertise and talk about your offering, including at demo days, on television, and via social media.
  6. Offering Circular Approval Required:  The issuer will have to file a disclosure document and audited financials with the SEC.  The SEC must approve the document prior to any sales.   The rules indicate that the Offering Circular may receive the same level of scrutiny as a Form S-1 in an IPO. This is the biggest potential drawback of using Reg A+.
  7. Audited Financials Required:  For Tier 2, together with the Offering Circular, the issuer will be required to provide two years of audited financial statements. Tier 1 offerings require only reviewed financials (not audited).
  8. Testing the Waters:  An issuer can “test the waters” and see if there is interest in the offering prior to spending the time and money to create the Offering Circular.  This would be “Preview” mode on SeedInvest where investors can express interest, but can’t yet invest. This is important so that companies don’t have to gamble on their fundraise and can see if there is interest prior to investing in legal and accounting fees.
  9. Ongoing Disclosure Requirements:  For Tier 2, the issuer will be required to make an annual disclosure filing, a semi-annual report, and current reports, each of which are scaled back versions of Form 10-K, Form 10-Q and Form 8-K, respectively.  These reports will also require ongoing audited financials.  These disclosures can be terminated after the first year if the shareholder count drops below 300. There are no ongoing disclosure requirements for Tier 1.
  10. State Pre-Emption:  As discussed above, the old Regulation A (now Tier I) was never used because it required registering the securities in every state that you make an offer or sales.  New Reg A+ Tier 2 preempts state law – again – this is huge. Tier 1 Reg A+ again does not have state pre-emption but will be a testing ground for NASAA Coordinated Review.
  11. Shareholder Limits:  In a welcome departure from the proposed rules, it appears that the Section 12(g) shareholder limits (2,000 person and 500 non-accredited investor) will not apply to Reg A under certain circumstances. This fixes a major problem from the proposed rules which would have limited the potential for very small investments (i.e. $100).
  12. Unrestricted Securities:  The securities issued in Reg A+ will be unrestricted and freely transferable, though many issuers may choose to impose contractual transfer restrictions. Many believe this will pave the way for a secondary market for these securities in the form of Venture Exchanges.
  13. No Funds: Investment companies (i.e. private equity funds, venture funds, hedge funds) may not use Reg A to raise capital.
  14. Integration:  There are several safe harbors so it seems that you can use Reg A+ in combination with other offerings.  There are safe harbors for the following:
  • No integration with any previously closed offerings
  • No integration with a subsequent crowdfunding offering
  • No integration where issuer complies with terms of both offerings independently – can conduct simultaneous Reg D – 506(c) offering.

The Fate Of Title III

Interestingly, the SEC did not mention Title III Equity Crowdfunding a single time either in this meeting or in Chairman White’s recent testimony before Congress. This furthers the belief by many that Title III Equity Crowdfunding is dead in the water as it currently stands and may only be revived by an act of Congress.

Equity Crowdfunding Rules Comparison Chart

Check out this chart comparing Reg A Tier 1, Reg A Tier 2, to Reg D: Rule 506(c) and Regulation Crowdfunding. Choosing among the various options will require careful consideration by issuers and their counsel.

Regulation A Equity Crowdfunding

You can also download the PDF version of the Comparison of Equity Crowdfunding Regulations.

Which exemption would you use?

This is all subject to the final rule announcement to be published later today.

We will endeavor to update this post and chart based on the text of the rules.

Game Changing: New JOBS Act Rule To Allow Raising Money From The General Public