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Sunday, 12 April 2015 22:00

SEC rule change allows companies to raise up to $50 million in ‘mini-IPO’

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Under a new ruling from federal securities regulators, companies can now raise up to $50 million from investors and still qualify for an exemption to the costly and extensive process involved in a typical public offering.

Through the rule change, the U.S. Securities and Exchange Commission increased the cap tenfold, up from $5 million, on what a company can raise under federal Regulation A without having to do a full-blown and expensive registration to sell shares publicly.

The move, prodded by the 2012 federal Jumpstart Our Business Startups (JOBS) Act, allows companies to do a “mini public offering,” giving them one more alternative to consider when raising capital. The removal of barriers for non-accredited investors could also make it easier for companies to use crowdfunding to access a larger pool of potential backers.

“It’s just one other way of doing things,” said Don Wierenga, senior vice president and an investment banker at Centennial Securities Co. Inc. in Grand Rapids who considers the rule change a “great idea.”

“I just look at it as a really good change that can help younger companies raise the capital that they want to go with, and it also gives investors who want an opportunity to do something a little different a chance to get into it,” Wierenga said.

TWO OPTIONS

The rule change, which takes effect 60 days after publication in the Federal Register, creates two tiers of offerings.

In a Tier 1 offering, companies can raise up to $20 million from investors within a year. The offering would have to clear review by the SEC as well as a consolidated review by securities regulators in each state where the shares are sold. State regulators would review Tier 1 offerings collectively, rather than on an individual basis, under a program developed by the North American Securities Administrators Association, avoiding the burden of an issuer having to respond to potentially 50 regulatory agencies. Under Tier 1, there is no limit on how much non-accredited individual investors can invest.

In a Tier 2 offering, an issuer can raise up to $50 million over 12 months and would have to meet certain disclosure and ongoing reporting requirements, such as filing audited financial statements with the SEC. States are exempt from reviewing Tier 2 offerings, which also limit non-accredited investors to investing no more than 10 percent of their annual income or net worth.

Public offerings made through the SEC’s Regulation A exemption under the previous $5 million cap have been infrequent over the years because the amount a company could raise was not enough to justify the cost of going through even a limited regulatory process, said Shane Hansen, a securities attorney and partner at the Grand Rapids office of Warner Norcross & Judd LLP.

There were just 19 stock offerings made in 2011 under Regulation A, down sharply from the 116 in 1997, according to a July 2012 report from the Government Accounting Office that attributed the decline to companies pursuing other avenues to raise capital.

IPO STEPPING STONE

Companies raising capital under the new rule, dubbed Regulation A+, would still need to navigate a regulatory process and incur the related costs, which could prove to be expensive. However, the potential for a much-higher capital raise could make an offering a more viable option for businesses to consider, Hansen said.

Going through Regulation A+ could become an interim step for startup companies that are on track to eventually float an initial public offering, Hansen said.

“It’s a totally different type of securities offering,” he said. “It probably would be a useful way for a company that kind of envisions itself growing into a public company. It will allow you to do that in stages.”

Hansen also sees the rule change as “very useful for companies” raising $10 million to $50 million for a specific project such as an expansion or bringing a new product or innovation to market. However, he does not see Regulation A+ getting high use because companies will still have to incur the cost of preparing a “pretty substantial disclosure document” for prospective investors.

“It’s still going to be expensive to do,” Hansen said. “It may work for some companies, but not others.”

Meanwhile, Wierenga believes Regulation A+ may get a “fair amount” of use. It could prove particularly beneficial for the ownership of a company that needs to raise growth capital but prefers not to give up an equity stake in the business through private equity or venture capital, he said.

Although venture capital may prove to be a quicker route to raise money, VC firms are known “for being very active in how your company’s managed after they put the money in. And that is the downside for an entrepreneur who wants to run the business,” Wierenga said.

“It’s all going to depend on the type of company and what the owner is going to do in terms of what they’re willing to give up,” he said.

A BOOST FOR CROWDFUNDING

The SEC’s move to allow Regulation A+ offerings could provide a boost to the fledgling security-based crowdfunding movement in the U.S. Through the rule change, companies raising startup or growth capital under Regulation A+ will have a much larger pool to solicit from by appealing to non-accredited investors to participate in the offering, Wierenga said.

“From the standpoint of companies trying to raise capital, it’s a big help because there are going to be more and more people eligible to participate in funding these startups,” Wierenga said. “It does allow you to get a lot of people involved.”

The rule also does not require issuers to go through a broker-dealer, “so using the Internet to advertise and solicit prospective investors is permissible,” Hansen said.

Tom Coke, a former state securities regulator in Michigan who’s director of compliance at Crowdfund Connect Inc., expects to see crowdfunding sites begin to list Regulation A+ offerings.

“Some people are going to treat it as crowdfunding,” Coke said, although the rule change is unrelated to the long-delayed and highly-anticipated final rule that’s still to come from the SEC for equity-based crowdfunding.

Coke expects that Regulation A+ offerings will primarily involve companies seeking growth capital. Startup companies typically aren’t raising an amount that would justify the six-figure cost of doing a Regulation A+ offering, he said.

“How many startups are raising $50 million? Not many,” Coke said.

CONCERNS OVER FRAUD

Despite praise from crowdfunding advocates, the SEC’s action did generate concerns about fraud, particularly because the change includes allowing more non-accredited investors to invest larger amounts in a Regulation A offering.

Rajesh Kothari, managing director of Cascade Partners LLC in Southfield, worries that the rule change elevates the risk for unsophisticated investors to get taken.

“The ones that are the easiest to dupe, they’re making it easier to dupe,” Kothari said. “The ability to do harm here is easier. The question is: Does it balance out making it easier for people to be able to do financing?”

While he likes making it easier for companies to raise growth capital, Kothari also questions what he considers the inconsistency of the SEC to loosen regulations at one end while it looks to tighten the rules for larger amounts of capital.

“I don’t understand the dichotomy of the thinking,” he said. “There’s a disconnect.”

LIMITED USE?

For Wierenga, he views the new rule as particularly helpful to early-stage companies moving beyond seed or angel capital. He was involved in two private placements in the last two years for companies “that could have used it” but went the other route with accredited investors. One company raised $1.4 million in a private placement and the other raised $5.5 million.

He now works with two companies “where we feel it would be appropriate for” them to consider a Regulation A+ offering.

For one key industry in Michigan that relies heavily on venture capital — life sciences — the new rule may not alter capital raises “in any meaningful way.”

Some life sciences companies are sure to try a Regulation A+ offering, although MichBio President and CEO Stephen Rapundalo doubts the rule will supplant VC’s role in the industry. VC offers the industry “the right investors” that bring experience and connections in the industry, Rapundalo said.

“VC is not going to go away” for the life sciences industry, he said.

Read 3532 times Last modified on Monday, 13 April 2015 11:08

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