January 27, 2017

By Grant Harvey

Reg A review: Mini-IPO, or mini-IP, oh?

This week, Scott Purcell of FundAmerica provided his take on a report released by the SEC on Regulation A. Tracking all campaigns and funds raised through Q3 of last year, the report had a lot of insight, especially for those who’ve drank enough Kool-Aid to consider launching what many are calling a “mini IPO” in place of a real IPO.

After reading through Purcell’s highlights and some other choice reading materials from last week, those of us at Crowdfunding 360 thought it would be worth putting together our own Reg A review to analyze what it would take to kick off one of these deals and make it worth an issuer’s time and expense.

First, a brief review of the SEC’s findings. Through Q3, 147 offering statements were filed, of which 81 were qualified by the SEC. 49 of those were Tier 2, and 32 were Tier 1. Personally, I’m surprised anyone would bother with a Tier 1 due to Blue Sky limitations and the $20 million cap. Out of these filings, there was an $18 million average max raise, 87% raised equity while 13% raised debt, and your typical Reg A issuer had no assets, revenue, or net income to speak of. Pretty straight forward, no real surprises.

The bigger surprise to Purcell was the SEC’s finding of an average 121 days between initial filing to qualification. This is actually in line with what I saw during my time working on Reg A marketing campaigns, where there would be a hurry to launch the testing the waters campaign as if it were the real deal, only to wait months and months to go live and subsequently, losing all momentum from that initial push.

While the report estimated an average of $50,000 in legal costs with another $15,000 earmarked for the audit, I’ve heard those numbers are a lot higher, which to me is a good thing because it’s a signal to issuers that Regulation A is not well suited for the fledgling startup.

Another interesting statistic: Only 17% of Tier 2 offerings used broker-dealers. We’ve known for a while now that issuers of these deals have been looking at Title IV more like a crowdfunding campaign than an IPO, but that thinking has been changing lately both due to the rise of Reg CF for more entry-level deals and industry pros taking aim at the lack of IPOs and the need for something to replace them.

But, as Purcell points out in his blog, if the industry is treating Reg A deals like IPOs, then broker-dealers will be expecting a higher caliber of company ready to trade on the OTC or NASDAQ. According to Purcell, just because a Reg A deal “can” trade on the OTC or NASDAQ doesn’t mean it should.

To be fair though, FINRA also treats Reg A deals like IPOs, and limits broker compensation using similar caps as an S-1 from less risky, more mature companies supported by easier settlement mechanisms. According to Purcell, this makes the risks and the work associated with selling Reg A securities “impossible to justify” for broker-dealers. This is all not to mention the SEC compliance requirements, which all but a handful of lawyers, portals, and service providers are unfamiliar with.

If broker-dealers throw their hands up and wash themselves of the responsibility of soliciting online investors, we have ourselves a serious situation where companies and third-party marketing agencies will do their own general solicitation and forgo regulated securities dealers as some type of optional luxury – essentially leaving those who are trained for this type of work completely out of the picture. Big mistake? Seems like it (especially if you’re calling these deals “mini IPOs”).

Now, this last piece of information is fascinating.

Out of the 147 offerings, only 20% used the testing the waters option to pre-sell the idea of offering securities to the crowd. Wait a minute…

The Reg CF world is abuzz about how difficult it is to build momentum without being able to test the waters. And so it’s a bit surprising that only 20% are giving it a shot. While I believe that treating a testing the waters campaign like you would a full campaign is a giant waste of time and resources, having the ability to gauge interest would seem like a pretty good idea in more than 1 out of every 5 cases.

Which brings me to our main point…

While Reg A would seem like a great fundraising tool for growth-stage, mid-tier companies, at the end of the day it’s a crowdfunding vehicle. So don’t launch that campaign unless you’ve got a crowd who LOVES what you do.

As many industry bloggers have pointed out, this has been key to the success of Elio, Brewdog, and VidAngel, whose investors feel they’re buying into a culture or mission that they’re passionate about. Even Fig investors love the concept of the games they’re buying so much that they’ll invest in the projects to the tune of millions just to get to play them.

There are other tricks too, of course.

If your company isn’t selling a consumer product or isn’t cherished dearly by adoring customers, real estate has been one of the hottest types of Reg A deals due to the clarity of returns to investors which can make them love you, too. And if your crowd doesn’t love you just yet, maybe run a Reg CF campaign and show them how much they mean to you. After all, 75% of companies looking toward a Reg A have to fundraise to even afford the deal expenses.

(As always, if you’ve got comments or your own ideas, send me an email.)

Contact Grant Harvey: grant@dealflow.com