While we are waiting for the 180 days or so before Regulation Crowdfunding becomes effective, an issuer may wish to consider other options presently available that permit nonaccredited investor participation. Reg A+ offers some attractive options for a small issuer that needs to raise capital to grow its business. You can raise up to fifty million dollars. All fifty states are preempted from regulating a Tier II securities offering. Yes, and nonaccredited investors, or investors not considered to be wealthy, may invest. And the shares are free trading. But of all these benefits available with Reg A for capital raising, the best one of all may be Reg A’s testing the waters provisions.
Testing the waters refers to the ability of an issuer to solicit the general public through social media, the internet, or other advertising. Securities offerings can be expensive, and Reg A is no exception with Tier II requirements of annual and semi-annual reporting and audited financials. The Form 1-A registration process itself generally demands lots of billable attorney hours and CPA fees which can be a drain on an issuer. The expense alone, and with no assurance of success, may be enough to lead a small issuer to forgo efforts to raise capital. It makes much more sense if an issuer can first test the market to see whether there is sufficient interest, before signing on to the large financial commitment of a securities offering.
And this is exactly what the SEC allows with Reg A. Under Reg A, you may use testing the water solicitation materials before you make any SEC or (under Tier II) state filing. You may not only engage in general solicitation without pre-reporting it to the SEC, you may also target the entire population of prospective investors: nonaccredited as well as accredited investors (with certain limits on nonaccredited investors in Tier II offerings, who may invest only up to 10% of annual income or net worth). An issuer may advertise on its own, without a broker/dealer or even a funding platform, and may target those who it believes will be its most enthusiastic investors, whether it is customers, members of the community or others.
Investors who are interested can indicate their interests in participating in the securities offering. While the indications are nonbinding, they do enable an issuer to understand investor interest in the offering and its prospects for success. No sales of course are permitted until the SEC qualifies the offering. In essence, testing the waters enable an issuer to test and then if necessary abandon an offering without incurring significant expenses.
The SEC allows testing the waters as it considers there to be adequate protections for investors. These protections include the requirement to include specific legends or disclaimers, stating that the indications of interest are nonbinding and that no investments may be made or accepted before qualification. Materials used after the Form 1-A is filed also must include a legend informing prospective investors where to obtain the preliminary offering circular, thus enabling investors to access all material facts pertaining to the offering.
The testing the waters materials are also required to be filed with the SEC with Form 1-A, therefore enabling the SEC to review and comment on the materials, and require amendments if necessary. By requiring these materials be filed with the SEC, the materials become subject to public scrutiny; e.g. state regulators, lawyers, the press and others. This may cause problems for an issuer whose materials are fraudulent or misleading to investors. The materials are subject to the anti-fraud provisions of the federal securities laws, and should encourage reasonable offerors to advertise an offering with full disclosure of all material facts.
If solicitation of interest materials used after filing Form I-A contain inaccurate information or are otherwise inadequate in any material respect, the SEC may require that the issuer redistribute revised solicitation materials in a “substantially similar manner” as the materials were originally distributed. This is a provision that ensures that the public is not misled, and that accurate information is shared with investors.
Testing of the waters enables the exploration of investor interest in a securities offering before issuers are required to pay large offering expenses. Exploring investor interest through social media or other advertising before diving in saves capital and reduces the risk that the market will reject a securities offering. Issuers should consider whether Reg A, which is much cheaper than a traditional IPO, and enable a raise of up to $50 million, is the right mechanism to fund the growth of their businesses. But appropriate care is required when preparing testing the waters materials as they must be filed with the SEC and are subject to public and regulatory scrutiny.
About Scott Andersen
Scott is principal at finLawyer.com and General Counsel of FundAmerica. He was most recently the Deputy Regional Chief Counsel at FINRA, and prior to that was the Enforcement Director at FINRA and the NYSE, Co-Chief of the Securities Prosecutions Unit of the NY Attorney General’s office, and Asst. Attorney General for the State of NY. He concentrates his practice on securities and regulatory law.
The information and materials in this article are provided for general informational purposes only and are not intended to be legal advice. The issues discussed include complicated areas of law and legal advice should be obtained from a securities attorney about your specific circumstances.