The Securities and Exchange Commission has proposed a series of amendments designed to simplify, harmonize, and improve the exempt offerings framework for issuers and investors, and to promote the capital creation opportunities offered via crowdfunding and Regulation A.
The proposed amendments, the SEC says, “seek to address gaps and complexities in the exempt offering framework that may impede access to investment opportunities for investors and access to capital for issuers.”
The Securities Act requires that securities be registered with the SEC, unless an exemption from registration is available. Eight years ago, Congress authorized the expansion of exempt offerings to assist businesses in their efforts to create capital. This led to the creation of crowdfunding exemptions and a dramatic expansion of Regulation A.
Currently, however, exempt offerings under Regulation D’s Rule 506(b) and Rule 506(c) are most commonly used by issuers. To spur greater interest in alternatives, specifically Regulation A and crowdfunding, the SEC has proposed a series of changes suggested by the investment community to make them more attractive for market participants.
The capital formation proposal includes the following amendments to reporting and issuing requirements:
- Regulation A. The offering limit for Tier 2 offerings (offerings of more than $20 million in securities) would increase from a maximum of $50 million per year to $75 million. The proposal would also exclude reporting issuers who have not filed required reports in the prior two years not only under Regulation A of the Securities Act of 1933, but also under Section 13 or 15(d) of the Exchange Act, from eligibility to use Regulation A. Integration rules would also be altered to create additional safe harbors for issuers to encourage them to use Reg A offerings.
- Regulation Crowdfunding. The offering limit would increase from $1.07 million per year to $5 million. Investment limits would be lifted entirely for accredited investors, and for non-accredited investors, investment limits would be based upon the greater of annual income or net worth (rather than the lesser of those factors, on which those limits are currently based). Testing-the-waters communications would now be permitted before Form C is filed (instead of after, as presently permitted).
- Regulation D: Rule 504. Offering limits would increase from $5 million to $10 million.
Discussion at the SEC
The SEC’s Small Business Capital Formation Advisory Committee discussed and voted in support of all of the proposed amendments at its meeting on May 8.
Following are a few of the issues considered by the committee:
The SEC’s Goal. SEC staff said that the goal in raising the limits for exempt offerings was to make them “more cost effective and attractive to a broader group of issuers,” thus attracting more issuers with a higher growth potential and higher capital needs. This might make the offerings “more attractive to intermediaries who could help create a robust market in these securities.
Higher limits? Committee members are grappling with whether the proposed limits are high enough. Some are calling for a higher limit increase for Reg A, bringing it to $100 million to attract a wider range of reputable intermediaries who can bring companies into the market. This, in the view of some committee members, might remove the inaccurate stigma that a Reg A offering is somehow an indication that a company is less viable than if it raised capital through a traditional initial public offering.
Potential Post COVID-19 Impact. Committee members posited that, given the exceptional financial pressures businesses are facing as a result of the COVID-19 pandemic, exempt offerings may become a more attractive option to a wider range of businesses. As one committee member noted, the pandemic has shown how larger companies are often able to access capital more quickly and easily by virtue of their strong relationships with financial institutions. An expansion of Reg A could help level the playing field for companies who might not have such access.
Demo Days. The proposed amendments are also designed to clear up confusion around “demo days,” or events organized to allow companies to present their businesses to potential investors. As described to the committee, the proposal would facilitate certain demo day events through the creation of an exemption from the prohibition on general solicitations. The exemption would be available for demo day events sponsored by certain types of organizations, including higher education institutions, local governments, non-profits, angel groups, incubators, and accelerators, and such sponsors would be subject to a limited scope of permitted activities in connection with the event. To rely on the exemption, issuers would be subject to certain limitations on the information they would be permitted to present regarding their securities offerings.
Integration Issues. Integration rules determine whether separate sales of securities are actually part of a single offering. The integration of two or more offerings can result in the loss of the exemptions for both offerings. The proposed amendment would offer four new safe harbors from integration, including one to exempt offerings that allow for general solicitation from being integrated with a prior completed or terminated offering, which the committee expects would encourage the use of the Reg A and crowdfunding options. “There would be no integration if the issuer establishes that each offering either complies with an exemption from registration or is registered,” SEC staff said.
Committee members suggested the SEC clarify whether convertible notes are covered by integration rules with respect to a public offering. Practitioners, they said, often advise clients to wait a year prior to an IPO for conversion to avoid integration uncertainties. Convertible notes are likely to become more commonplace in the wake of the COVID-19 pandemic, as companies look for a financing bridge prior to an IPO. More clarity about notes could help facilitate capital raising among companies facing this situation, committee members said.
The comment period for the proposals ends in June, and the committee will meet again in August to consider any additional changes to the framework. Kaplan Voekler Cunningham & Frank will continue to monitor developments with the SEC. If you have questions about the proposals or are interested in learning more about how we can help your business use capital formation tools to its advantage, please contact us.