Whether or not to engage an “underwriter” can be a critical decision in the process of planning and executing your Regulation A offering.
Many companies issuing shares under Reg A choose not to use an underwriter. According to numbers compiled by the Securities and Exchange Commission, roughly 20 percent of offerings include an underwriter, and most of those are for offerings that are larger in size.
But having an underwriter can seriously enhance distribution for the right deal, and simply having an underwriter can also provide credibility in the marketplace that the offering is a solid investment.
Using a Broker-Dealer
In most registered initial public offerings, a traditional investment bank buys up shares (usually at a discount) from the company (the issuer) and then offers them to investors. To ensure that it makes its money back, the bank generally engages in a full-on sales effort, marketing shares to key institutional investors and the public at large.
In a Reg A offering, what constitutes an underwriter is open to a looser interpretation. Issuers can engage a broker-dealer to underwrite or facilitate their Reg A+ offerings, and according to the SEC, “issuers also may retain entities that are not registered broker-dealers to assist with a limited range of offering-related activities that do not require broker-dealer registration.”
Most broker-dealers in Reg A transactions are not “underwriting” in the strictest sense of the word. They offer shares on a best-effort basis – which means they are not necessarily buying the shares and offering them to the public. Instead, they guarantee to the issuer that they will use their best efforts to sell shares at the highest-possible price. Some do engage in traditional underwriting, since Reg A securities can be traded and listed, but until significant markets develop, this is a niche.
Building A Sales Force
Having someone taking a leading role on a company’s behalf can be advantageous: Underwriters, or managing broker-dealers, create selling groups of other broker-dealers to push an offering and maximize its chances of success. They are, essentially, creating a large sales force for an offering. Companies that go it alone can run the risk of unsold shares and market skepticism about the quality of their offering.
Aside from their selling power, underwriters or managing broker-dealers also can provide issuers additional benefits by providing a buffer to state rules requiring a broker-dealer to be involved in an offering or SEC regulations on what constitutes broker-dealer activity.
With an intermediary, however, additional effort on the part of the issuer is required. An offering must now pass the due diligence scrutiny of the managing broker-dealer, as well as members of the selling group. This additional layer of scrutiny and the costs associated with it may be a determining factor in why some companies forgo an underwriter altogether.
Reg A currently has two tiers of offerings, each with their own reporting requirements to the Securities and Exchange Commission. Tier 1 offerings are capped at $20 million, and Tier 2 includes offerings of $50 million or less. Most Reg A+ offerings, whether Tier 1 or Tier 2, are below $20 million, which may account for the lower level of underwriter participation in offerings.
A number of companies have used Reg A as a vehicle to go public and get themselves listed on the exchanges. Going direct to listing can save on the legal and auditing costs associated with a typical S-1 IPO and can also provide advantages for investors, who are liquid immediately rather than waiting for lockup requirements to expire.
Here, however, a company will definitely need an underwriter. Underwriters will need to be able to form a syndicate to buy the offering, facilitate a NASDAQ or N.Y. Stock Exchange and ultimately support a sufficient supply and demand in the market (trading volume) to maintain its value. Again, for now, this is a niche but could grow rapidly in the future as SEC makes more revisions to help Reg A and as investors seek values in an over-valued market.
Kaplan Voekler Cunningham & Frank works closely with companies, broker-dealers and underwriters on all aspects of the Reg A process. To learn more about the underwriting process in Reg A offerings, contact us for a consultation.