Startup fundraising is a heavily regulated process. Entrepreneurs should understand the regulatory landscape before they start down the path to raise capital. There are currently two main regulations worth considering when raising capital--Regulation D and Regulation A. Both Regulation D and Regulation A are securities exemptions from registering as a public company (which clearly isn't cost effective for startups).
The vast majority of private companies (and venture capital funds) have relied on Regulation D historically because it has been the cheapest and most frictionless way to raise private capital. There are two primary options under Reg D:
- 506(b) Private Fundraise: Companies can only solicit capital from people they already have a relationship with.
- 506(c): Public Fundraise: This provision was amended by Title II of the JOBS Act and kicked-in September of 2013. It allows companies to generally solicit their fundraises to potential investors both in and outside their existing networks.
The downside? Regulation D limits companies to raising money from only "accredited investors" which means people need to have either $200,000 worth of net income (or $300,000 jointly with their spouse) over the past two years, or have a net worth of $1 million excluding the value of their primary residence.
Regulation A was recently amended under the passage of Title IV of the JOBS Act and went into effect in June of 2015. Before the amendment, next to no one used Reg A because it was overly expensive, time consuming and you could only raise up to $5 million.
However, in June 2015 Reg A+ (amended Reg A) and made Regulation A much more entrepreneur friendly. Regulation A+ now allows private companies to publicly raise up to $50 million from all investors (not just accredited investors). Furthermore, there is a much more streamlined process for qualifying to raise capital than there was previously.
Two Tiers of Reg A+
Under the new Reg A+ there are two tiers under which a company can raise capital:
- Companies can raise up to $20 million
- No ongoing reporting requirements
- Offerings require State review in addition to SEC
- Companies can raise up to $50 million
- Limited, semi-annual reporting requirements
- No State review, just SEC review
For Tier I offerings subject to State review, the North American Securities Administrators Association (NASAA) has created a coordinated review process with the intention of streamlining the State review process. While coordinated review is still unproven, it has hopes of easing the burden on companies filing for Tier I by having one point of contact at NASAA, who will coordinate comments and feedback from the States through a single NASAA representative.
Regulation A+ Timeline
The preparation and qualification process can take 3-4 months once a company decides to proceed with a Reg A offering. A few key points on the process:
- Before starting the official filing process, companies may go out and solicit indications of interest from their user base. This phase of the process is known as "testing the waters". A company can test the waters in the matter of one week, without any expense or SEC approval. The testing the waters process is optional but effectively gives startups a free call option on choosing whether or not to proceed with a Reg A+ offering.
- After testing the waters concludes, companies then formally prepare their offering documents and file what is known as the Form 1-A with the SEC. The Form 1-A includes a copy of the draft Offering Circular (the document you will present to potential investors). The Offering Circular is essentially a greatly scaled-back version of a prospectus found in a traditional public offering (~30 pages vs. 150+ pages).
- After you submit the Form 1-A and draft Offering Circular to the SEC, regulators should return comments back to you within 3-4 weeks. Responding to the SEC's comments will take about 1-2 weeks depending on how much follow-up has been requested. You will keep going back and forth until you resolve all the issues, with each round of comments getting (hopefully) shorter and shorter.
- Once all issues are resolved and the offering is qualified, you can start accepting investments from the general public.
- Once a company decides to pursue a Reg A offering, no securities can be sold without being accompanied by an Offering Circular that has been qualified by the SEC. When a company actually goes out and sells the securities they will either have to provide investors a copy of the final Offering Circular or direct investors to where a copy of it can be found.
Regulation D and Regulation A may each be well suited to a particular company at different times during its maturity. While some of the legal nuances of startup capital raising may seem overly technical at first, the structure of an offering can make a significant difference to a business over time, so founders need to become familiar enough with their options to make an informed decision. The best CEOs ensure that they understand all of their capital raising options regardless of whether they ultimately chose to pursue them.