In 2015, the Securities and Exchange Commission (SEC) inaugurated Regulation A+, an expansive amendment to the existing Regulation A exemption of the Securities Act of 1933 (Regulation A). The amendment made Regulation A a more practical alternative to registered public offerings, yielding access to capital for small nonpublic companies with lower reporting requirements. But we are now seeing the downsides of expanded Regulation A, including numerous investors in Regulation A offerings that have little to show for their investments.
The Benefits of Regulation A
Regulation A provides an exemption from full SEC registration for smaller offerings of securities up to certain dollar limits. It aims to facilitate capital formation for small and medium-sized businesses that might find full registration too costly and burdensome.
As of the latest updates, Regulation A has two tiers:
Tier 1: Exempts offerings of securities up to $20 million in a 12-month period. This tier is subject to state blue sky registration and qualification requirements.
Tier 2: Exempts offerings of securities up to $75 million in a 12-month period. This tier is exempt from state registration and qualification requirements, but imposes certain additional requirements, such as audited financial statements and ongoing periodic reporting obligations.
Companies that are not SEC reporting companies and do not have securities listed on a national securities exchange can use Regulation A. This includes private companies, startups, and smaller public companies.
Regulation A offerings are also subject to state securities laws (known as blue sky laws), unless the securities are offered or sold on a national securities exchange or are exempted from state law requirements as a Tier 2 offering.
Overall, Regulation A provides a streamlined and cost-effective way for smaller companies to raise capital from the public markets while still providing some investor protections through disclosure requirements.
The Downside of Regulation A
While Regulation A has provided many companies access to capital who, in turn, returned positive cash investments, some companies are not living up to their promises. The Wall Street Journal recently published an article highlighting two companies, Aptera and Boxabl, who, to date, have failed to generate meaningful results for their investors, despite raising over $170 million.
Aptera, a company focused on bringing the first solar-powered car to the market, has been raising capital for several years. The company nearly went under in 2011 after failing to qualify for federal loans, but Regulation A and crowdfunding allowed the company to stay afloat. As of 2021, the company had raised over $120 million from 17,000 investors. Aptera has continued to push timelines and has failed to produce a working vehicle.
Aptera’s recent financial filings reveal significant expenditures, with approximately $25 million spent in the past year. By the end of 2023, the company retained only $17 million in cash. Alarmingly, Aptera issued a “going concern” notice, indicating doubts about its ability to sustain operations without securing more capital, a cautionary sign for investors.
Boxabl, known for its foldable tiny homes, has suffered similar setbacks. Boxabl has raised significant funds through Regulation A offerings, securing over $140 million from 40,000 investors. The company’s valuation was placed at $3 billion during a recent fundraising round. However, Boxabl has encountered several financial and operational challenges.
The company recently disclosed that it may not be able to continue as a going concern, citing financial difficulties and production delays. Despite raising $55 million in 2022 and another $36 million in 2023, Boxabl has struggled with the high costs associated with scaling its manufacturing processes.
Regulatory hurdles have also impacted the company’s ability to deliver its homes as quickly as anticipated. As a result, Boxabl has faced criticism from investors who expected quicker returns on their investments. Additionally, the company was under investigation by the SEC, but according to a recent 8-K filing by the company, on July 12, 2024, the SEC informed the company that it had concluded its investigation and decided not to recommend an enforcement action against the company at this time.
What to Consider If You’re Contemplating Crowdfunding
Regulation A can be a powerful fundraising tool for businesses, but it requires careful legal navigation. Below are key highlights a business owner should consider before using Regulation A to raise capital:
- Filings: Although simpler than standard SEC offerings, offering securities through Regulation A requires filings and qualifications with the SEC prior to raising any capital.
- Marketing: Any company raising capital under Regulation A must file an offering circular with the SEC, including detailed information about the company’s business, financial statements, and the terms of the offering. While marketing is allowed, business owners must carefully consider the federal securities laws’ anti-fraud provisions, ensuring that all information provided to investors is accurate and not misleading. Failure to provide accurate information can result in investor litigation and SEC penalties.
- Financial Statements: While the degree of financial statements varies depending on the tier a company is offering securities under, a company must generally provide two years of financial statements.
- Ongoing Reporting: The SEC may require annual, semi-annual, or current event reporting depending on a company’s offering.
- Investor Relations: While Regulation A may allow companies to raise significant funds, it may also result in numerous investors. Managing a large number of investors can be complex and demanding, requiring effective communication and transparency.
Ensuring clear and consistent communication with investors and government regulators is vital to a successful security offering, particularly under Regulation A. Working with experienced securities attorneys can help navigate the complexities of crowdfunding, ensuring compliance with relevant regulations and mitigating risks. Legal guidance can also assist in crafting transparent communication strategies and addressing any disputes that may arise, ultimately fostering trust and maintaining the integrity of the campaign.
If you are considering raising capital for your company and are interested in an offering under Regulation A, or any other securities law, please contact Andrew Wilber (AJW@kjk.com; 216.736.7298) or Christopher Hubbert (CJH@kjk.com; 216.736.7215) or another member of our Corporate & Securities practice group.