Amidst celebrations and excitement over the JOBS Act’s new Title IV Reg A+ rulings going into effect this summer, some of those fully immersed in the investment world are shaking their heads. Though this new movement will allow unaccredited investors to broadly invest capital in startups for the first time in over 80 years, most don’t realize that the SEC didn’t actually do much to change the restrictive nature of the original Reg A guidelines when they created the new Reg A+ offering structure.
Before breaking down why Reg A+ isn’t a realistic option for startups raising capital, let’s first review why Reg A had been a massive failure. To avoid over complication, I’ll focus on two simple reasons. First there is a lack of state exemptions, which means that companies have to file their offering with every state in which they offer securities. Second, the startups must provide audited financials. These requirements can result in tens of thousands of dollars in legal and compliance fees (often more than $100,000). What startup has $100,000 to spend on raising capital?
Additionally, if a company wanted to raise capital from unaccredited investors, it would be better off carrying out a public offering – the fees, paperwork, compliance, and legal overhead are essentially the same. The data on Reg A going back to 1997 backs up my claims:
The number of Regulation A offerings filed and qualified since 1997 decreased from 116 in 1997 to 19 in 2011. Similarly, the number of qualified offerings dropped from 57 in 1998 to 1 in 2011.
Now let’s take a look at how the SEC made sure that the updated Reg A+ rulings remain a useless fundraising mechanism for most private companies and startups. Reg A+ Tier 1 allows a startup to raise up to $20 million from accredited and unaccredited investors. The SEC has removed the requirement to provide audited financials. Many would argue that this is progress, but not so fast. They left the state filing requirements in tact, which means a company will still need to file its offering in every single state it’s offered in. That means startups will still face legal and compliance fees in the tens of thousands of dollars.
Reg A+ Tier 2 allows a startup to raise more — up to $50 million from accredited and unaccredited investors. In this program, the SEC has created a state filing exemption, meaning that a company doesn’t need to file its offering in every state anymore. But once again, not so fast with the enthusiasm. Under Reg A+ Tier 2, companies are required to provide financial audits. So the company will be looking at accounting fees in the tens of thousands of dollars. The craziest part of this is that most early stage companies don’t normally even have financials worthy of being audited, yet they would still be required to hire an accountant costing a notably large sum.
It appears the SEC was pressured to do something by Congress. Very little has actually been implemented by the SEC since President Obama signed the JOBS Act in April 2012. The SEC has rightful concerns about deregulating the private markets too much and creating a bubble. The solution was to push forward Reg A+ to generate some goodwill for taking action. But the move has generated a fair amount of backlash. In fact, the states of Montana and Massachusetts recently announced that they are suing the SEC because they believe the agency violated congressional intent by passing the Reg A+ rulings, which reduce state power to review local companies’ deals before they are sold to the public. In the end, the law was structured in such a way that nothing has really changed, and the outcome will create no impact for startups.
Vincent Bradley is CEO and cofounder of FlashFunders. He is a serial entrepreneur with a diverse background in business and product development. Before cofounding FlashFunders, he consulted for several technology startups, providing them with growth and product development services. Prior to consulting, Vincent cofounded Ridotto, a virtual currency sports betting startup. Vincent also spent time working with Osprey Global Solutions, a frontier market consulting firm. While at Osprey, he focused on growth development efforts for the firm throughout the Middle East, Europe, and North Africa. Prior to Osprey, he worked for FindTheBest. He holds Series 7 and Series 63 securities licenses.