This is another installment in a series of blogs from W.R. Hambrecht + Co., LLC. In this series, we will explore the capital raising challenges facing small and emerging companies and recent regulatory changes that should greatly help executives, venture capitalists, and individual investors meet these challenges head-on.
Growing a Small Businesses is Challenging
Even the most promising small companies have a lot of challenges. Two right at the top of the list are:
- attracting and retaining great employees and
- getting the capital they need to survive, adapt, and grow.
And as any good entrepreneur knows, the expansion from a handful of employees to the first 100 is often the hardest part. The company may be too large to keep financing it with your friends and family or with the angel investor(s) you’ve had all along. And banks won’t lend you nearly what you need.
Viable Options for Raising Capital Have Been Limited
In recent years, this dilemma has resulted in essentially one of two paths—multiple rounds of venture capital investing or selling out. Both may be viable options, but both present significant challenges for founders, employees, and early investors. With venture investors, a company’s early investors and founders may be heavily diluted each successive round—threatening the culture and vision of the firm. Although they help to pay salaries, these investments often hurt employee attraction and retention because they typically dilute employees’ interests. And being acquired is often the end of the ride.
Public financing for growth-stage companies has all but fallen off the table in recent years amid ever-climbing legal and compliance costs. Until now.
Regulation A+ Creates Viable New Options
On March 25, 2015, the SEC adopted revisions to Regulation A (often called Reg A+). This new rule puts public financing back on the table for great small and emerging companies. It allows management to raise capital from all types of investors, not just a handful of venture funds, giving them leverage to fight dilution and maintain their company’s culture. Just as important, Reg A+ opens up the valuation of the company beyond what just a small subset of the investing world might think. It gives employees freely-tradable securities that they can sell right away. If anyone wants to know the value of their holdings, they can just look to the public quote. And it gives early investors the opportunity to monetize some of their success.
Regulation A will allow companies to raise up to $50 million (including up to $15 million from selling shareholders) from the public markets. It throws open the doors to capital formation by giving a much larger pool of investors access to great companies. While there are some upfront costs and documentation requirements that don’t come with most private offerings, these costs should be less than those of a full IPO.
The Two Types of Regulation A+ Offerings: Tier 1 and Tier 2
Regulation A provides two tiers of offerings, with the filing obligations scaled to the size of the offering and the capabilities of the company. For offerings up to $20 million, “Tier 1” allows companies to raise capital without audited financials and without significant ongoing reporting requirements. For offerings up to $50 million, ”Tier 2” allows for abridged initial filings and ongoing reporting requirements, which should generally be far more streamlined than full Exchange Act reporting requirements, including the oft-dreaded Sarbanes-Oxley.
With lower costs and modest filing requirements compared to a fully-registered public offering, but with many of the advantages of one, we expect the new Regulation A to be an attractive option for founders, employees, and early investors.