Previously only the wealthiest investors in the United States and large private equity and venture capital firms were able to invest in private companies. The Securities and Exchange Commission (SEC) limited the type and number of investors that could participate in the offering of securities in private companies. This was based upon the belief that only the wealthy or those with substantial financial experience could handle the risk and uncertainty of investing in private companies.
This has changed with the adoption of Title IV of the JOBS Act. This opened investment in private companies to millions of Americans, and jump started the crowdfunding revolution. The SEC adopted new regulations in March of 2015 known as Regulation A+ (Reg A+) to implement the provisions of the JOBS Act. Reg A+ has the ability to dramatically change the landscape of private investing.
As more private companies acquaint themselves with the provisions of Reg A+, it has the ability to be a strong tool for companies seeking to raise capital. Companies may be initially be slow to use the provisions of Reg A+. As they become more comfortable with the regulations, and investor demand increases, Reg A+ is poised to change how private companies raise capital.
Regulation D Exemption
Private companies have traditionally offered stock to investor utilizing the exemptions in Regulation D (Reg D) offerings. Reg D provides an exemption to the SEC public filing requirements the offering of securities. This can save smaller private companies a great deal of time and money to gain access to capital. However, Reg D contains a number of limitations with regard to the type of investors that can participate in the offering, as well as restrictions on the sale of the securities in the secondary market.
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In most cases, only accredited investors could participate in Reg D offerings. Accredited investors are defined as those who have a net worth in excess of $1 million excluding the value of the primary residence, or have an income of at least $200,000 for the last 2 years. This severely limits the pool of investors for private securities. While the SEC rules do allow for some non-accredited investors to participate, there are restrictions on that participation making it impractical.
The rules for Reg D further restricted the sale of the securities on the secondary market. This forced the investors to stay with their investment even if they did not want to. This lack of a market prohibited investors from exiting their positions and made investment in private companies much more risky. The new provisions of Reg A+ have changed this completely.
The SEC adopted new regulations in its Regulation A in response to Title IV of the JOBS Act. Under Tier 1, companies can raise up to $20 million over a one year period. Under Tier 2, companies can raise up to $50 million. Previously, Regulation A only allowed $5 million to be raised over a year. Companies can now raise money with Regulation A+ for real estate, startups and growth companies across any sector.
There are restrictions and required disclosures under Reg A+. The securities must be offered by a registered broker-dealer. For Tier 1 offerings, companies must disclose financial statements reviewed by an accountant. For Tier 2 offerings, the financial statements must be audited in accordance with the provisions of SEC Regulation S-X.
In addition, there are limitations on how much individuals can invest in a Tier 2 offering. Investors can only invest the greater of 10% of their annual income or net worth as reported by the investor. Thus, an investor with an income of $50,000 a year can only invest $5,000 in a Tier 2 offering.
Unlike securities acquired in a Schedule D offering, there are no restrictions on the resale of Reg A+ securities. This can allow investors to exit their positions. Practically, the market for these securities will very limited and illiquid. As such, investors should plan on holding their investments for a number of years. It will take a while for a secondary market to develop. Still, restrictions on the sale of private securities was too much of a risk for many investors to participate in private offerings.
Opening of Private Markets
Reg A+ has opened a whole new frontier for smaller investors. Private capital markets are now open for participation by millions of Americans. Still, these opportunities do entail a substantial amount of risk. Investors should be careful in navigating this new landscape and seek appropriate advice before jumping in.