By Shirley Li
There’s a been a lot of anticipation building up to the passing of Regulation A+ rules by the SEC as part of the JOBS Act. The original Regulation A allowed companies to raise up to $5 million dollars in registration exempt public offerings in a 12-month period. The update increased the funding ceiling to $50 million. More importantly, for the first time, pre-IPO companies can raise funds from both accredited and non-accredited investors.
Surely this is the game-changer that fund-seeking startups have been waiting for …
Early-Stage Startups? Not So Fast
The $50 million funding ceiling looks enticing and will almost certainly lead to more and bigger deals being done under Reg A+. But upon closer examination, the two-tiers introduced under Reg A+ actually present a set of rather difficult trade-offs between the maximum funding allowed, onerous Blue Sky pre-sale review, and stricter and more frequent public disclosures.
More specifically, Tier 1 offerings, which allow up to $20 million, are subject to both SEC and Blue Sky pre-sale review in every state in which the startup plans to raise money. The notoriously burdensome state-by-state review makes it difficult for smaller, early-stage startups to tap the investor base beyond a specific geography.
Tier 2 offerings, which allow up to $50 million, may not be any easier for these smaller, early-stage startups. They must prepare two years of audited financial statements prior to filing and then are subject to an ongoing reporting regime that includes annual, semi-annual, current, special, and exit reports. All this can get prohibitively expensive for startups that do not have an IPO in sight.
It is therefore likely that smaller, early-stage startups will continue to pursue alternative paths to capital, such as Regulation D 506(b) which allows entrepreneurs to raise unlimited capital from accredited investors and up to 35 unaccredited investors. The more recent addition to Regulation D, 506( c) further relaxed 506(b)’s prohibition on general solicitation and advertising to accredited investors in exchange for stricter investor qualification requirements.
Pre-IPO? Sign Me Up … with a Side of Caution
For larger, more mature startups, Reg A+ paints a more immediately promising picture – especially pre-IPO startups that can stomach the on-going reporting burden under Tier 2 offerings. For the first time, these startups can bypass Blue Sky state laws to tap both accredited and unaccredited investors nationwide. Even though unaccredited investors can only invest up to 10% of their net worth or annual income, opening up pre-IPO investment opportunities to this population would still represent a meaningful pool of potential capital.
The combination of broader funding sources and higher funding ceilings can easily translate into greater liquidity for fueling entrepreneurial activities and innovation in general. But history also tells us speculative investing may not be far behind when it’s difficult for investors – especially those without previous exposure to more risky pre-IPO investing – to discern the good, the bad, and the ugly.
What Does It Mean for Propel(x)
As an angel investing platform, Propel(x)’s current deal flow focuses on pre-VC round startups. But as we grow – alongside startups on our platform that successfully graduate beyond Series A, Series B, etc. – our offerings will evolve. In the not so distant future, Propel(x) looks to offer registration exempt securities up to $50 million under Reg A+.
At the moment however, there’s benefit to adopting a “wait and see” stance, especially as the SEC bides its time passing equity crowdfunding rules. Propel(x) will stay the course instead of rushing to test the waters and risk becoming a “test case”. Our value proposition actually positions us well for the post Reg A+ investment landscape with a new class of non-accredited investors.
In more than one way, Reg A+ is therefore helping our case, here’s how:
- We focus on deep technology startups: by focusing on startups built around innovation and breakthroughs that are under protectable IP, we can help investors sharpen focus around fundamental value drivers as greater liquidity leads to potentially increasing speculative investing.
- We curate deal flow: with Reg A+ we are about to witness the emergence of a new class of investors – ordinary people who get to invest in what may be the next billion-dollar idea. By curating deal flow, we can help narrow the experience and information gap these new investors will no-doubt face relative to professional angels and VC’s.
- We offer diligence insights: non-accredited investors will need additional support to make informed investment decisions. Today we are already starting to influence how professional angels mitigate deep-tech investment risks through our diligence mechanism. As our offerings evolve, we can make it easier for non-accredited investors to discern diamonds from duds.
The Bottom Line
The passing of Reg A+ is likely to create more immediate impact on pre-IPO startups, while the smaller, early-stage companies continue to pursue alternatives. By broadening sources of startup funding to non-accredited investors, however, Reg A+ will fundamentally change the investing landscape. While there is no near-term change to Propel(x)’s current path, our deep-tech sector focus and diligence capability position us well for the post-Reg A+ world. This new class of emerging investors will need all the help they can get to assess investment opportunities in the face of a potential bubble. And that is where Propel(x) can make a big difference.
(Disclaimer: This article is meant to provide a simplified overview of a complex regulatory topic. It involves some interpretation and by no means should this material be considered regulatory advice.) In addition to the federal securities laws, every state has its own set of securities laws—commonly referred to as “Blue Sky Laws”—that are designed to protect investors against fraudulent sales practices and activities. http://www.sec.gov/answers/bluesky.htm