Reg A+ Could Bring Back the Small‐Cap IPO

Our experts generally appear very optimistic that, as noted by accountant David Bukzin, Reg A+ could “reignite access to capital for small companies.” Journalist Teri Buhl thinks, however, that it may still be too early to answer this question. “It really depends on if the offers that have listed on national exchanges can show growth and the ability to trade above the IPO price,” she notes.

OTC Markets chief Cromwell Coulson votes very positively. He states,

We are strong advocates of Reg A+ and its potential to increase public capital raising options for small companies. It is part of the larger JOBS Act story, which increased opportunities for transparent and online capital raising so that small‐cap companies could use the power of technology and the Internet to improve access to capital.

Banker Dan McClory notes the benefit of smaller companies being more willing to consider going public than in the past: “The vast majority of companies pursuing Reg A+ filings and offerings have no intention whatsoever of culminating with a senior exchange listing. Most are for aspirational companies attempting to up their game and raise semi‐public capital for the first time.” He does feel, however, that “Reg A+ will definitely be a stimulant for the return of the small‐cap IPO.” He believes that the Reg A+ market will be limited to around 100 deals per year, since “many are still daunted by the costs and disclosures of even the Reg A+ Form 1‐A Offering Statement.”

Fellow banker Elenowitz perhaps is the strongest believer in the group, saying, “I firmly believe that Reg A+ is going to bring back small‐cap IPOs. It's an innovative way to market an opportunity to non‐accredited investors, across all 50 states, using general solicitation, including the Internet and social media.”

Talking further about the unique benefits of expanded testing the waters in Reg A+, he says,

The traditional IPO has a significant amount of regulation that limits what information can be communicated to potential investors and when. Reg A+ allows the use of testing the waters, which allows communication about the offering before filing, during the filing process, and after qualification. This is a huge change that allows issuers to now be able to gauge interest not only from the Wall Street community, but also from the crowd.

While he is excited, Elenowitz acknowledges it may take time for Reg A+ to take hold, noting, “I still think we have three to five years before it is mainstream and we have hundreds of deals completed annually.”

When asked what types of companies they believe will be best suited for Reg A+, the experts provided an interesting variety of responses, indicating that there may indeed be attractiveness to this approach for a number of different types of businesses. Dan McClory believes the best candidates are those that “have the ability and resources to go the route of an ‘industrial strength’ S‐1 registration statement, and we can then shrink them down into the 1‐A context.” He is also focusing on companies that can qualify for listing on a national exchange. Last, he feels it is important that the companies themselves arrange to raise the minimum offering amount to provide “skin in the game.”

Mark Elenowitz is focusing more on “companies with large consumer awareness, customer bases, and affinity groups” to take advantage of building interest at least in part through crowdfunding. His ideal Reg A+ clients “are iconic brands or have celebrity endorsement. They have revenue and have been funded previously with private equity, venture, and friends and family,” and, very importantly, “investors have 30 seconds to understand the company.” He is not optimistic that biotech companies will easily benefit from Reg A+, because he feels impatient investors “will move on their search before the story is properly explained.”

CPA Dave Bukzin is feeling less focused on industry or online following and thinking more traditionally that “the key to success will be management experience and successful marketing of an investment, allowing many types of companies to take advantage of Reg A+.”

OTC Markets head Coulson is excited about early‐stage companies taking advantage of Reg A+, but issues a warning:

Reg A+ is designed for small companies, startups, entrepreneurial innovators, and those seeking to alleviate the cost, time, and complexity associated with the traditional IPO process. It is ideal for any company with a strong business plan, a good base of operations, and a community that would support the capital raise. However, just because you can efficiently and transparently offer securities online, does not guarantee that investors will buy them.

He suggests companies utilize the testing‐the‐waters opportunity to be sure there is real interest out there for their offering. Cogently, he adds, “The most successful offerings will provide financially attractive terms that bring together a passionate community of investors who want to buy and hold their shares over the long term.”

Teri Buhl reminds us of the e‐REITS and others but also agrees with Mark Elenowitz:

Real estate–backed investment companies showed they could raise money fast as early adopters to Reg A+ offerings. But as broker‐dealers have started to embrace selling Reg A+ offers as public offerings, I see companies that can show revenue growth with a product that Main Street can visualize or touch as the best suited.

Reg A+ Is Encountering Early Growing Pains

When asked what fears the experts have about the rollout of Reg A+, Dave Bukzin says bluntly, “I have concerns about potential fraud.” He worries that, “The biggest challenges for established players is the early‐stage nature of the business and its management team.” Thankfully, in the first 2+ years under the Reg A+ rules we have not yet seen a penchant for serious problems regarding potential fraud.

Mark Elenowitz's biggest fear is much different, namely “unlicensed service providers filling the CEO with outlandish valuation dreams,” which he says has been a “huge issue.” He believes that “transactions should be structured based upon defensible projections, assumptions, and peers' valuations. Those CEOs who recognize this are the ones that will have successful offerings.”

Cromwell Coulson simply warns players to stay away from the dark side:

The JOBS Act was a monumental piece of legislation created to shine a light on an exclusive, opaque capital raising process by allowing transparent securities offerings to leverage the Internet and address many of the problems facing small‐cap companies. It has gone a long way toward democratizing the capital raising process and improving access to capital for small companies, and it works best when both companies and investors act responsibly.

That is great advice.

Another concern in enhancing adoption of Reg A+, according to banker Dan McClory, is getting away from a perception that Reg A+ is somehow “IPO Lite” or a “mini‐IPO.” He says, “Getting the investing public and institutions and funds to understand that there is no second‐string connotation or qualitative drop‐off in companies listing through a Reg A+ IPO versus a traditional S‐1 will be key.”

Journalist Teri Buhl is concerned about the SEC's limited review of Reg A+ filings. “The SEC is rubberstamping some of these offers, especially the Tier 1 offers, without a detailed review. This sets up a recipe for unethical players to file offerings that are not transparent.” She is also concerned about misleading statements being made by some and not carefully checked by regulators.

My next question was simply, “What mistakes have you seen Reg A+ promoters making?” Mark Elenowitz answers, “Backing too early of a company.” He believes a Reg A+ issuer needs to understand the costs and burdens of going public, including ongoing compliance expenses and the need to be “acting in the best interest of all shareholders.” He recommends that CEOs “look in the mirror” and make sure they are comfortable, ready, and able and can benefit from being public.

Crowell Coulson agrees, saying,

Advisors are often deal‐driven and short‐term in trying to get any transaction done quickly, without considering the long‐term sustainability of the structure. Management and directors need to be focused on building long‐term value for each share held by investors. We see banks and advisors looking to target fast money or sell private shares at a discount with dilutive terms to more sophisticated short‐term investors.

Those same advisors are often fast‐tracking early‐stage companies, to access the public markets by listing a company's stock on a national exchange before the company is truly ready, just to let their investors quickly flip the stock. This can create unnecessary regulatory complexities as well as a constraint upon the management teams' resources, saddling them with millions of dollars of ongoing compliance costs.

Dave Bukzin worries about planning for contingencies. He says the biggest mistake is “not having a backup plan for raising capital . . . spending too much of their initial funding chasing a Reg A+ capital raise.”

Dan McClory repeated the concern about marketing pitches noted earlier. “Some outlandish claims and marketing pitches are being made in mainstream media by issuers and promoters of Reg A+ offerings, on TV, radio, and print. These are borderline noncompliant and will attract a regulatory backlash, as they should.” He also worries that relying on an online following could be unsuccessful since many who show “indications of interest” do not ultimately invest.

Reg A+ Can Be Improved

I also asked the pros what changes they would like to see to Reg A+. Some of them, as we have previously discussed, included allowing at‐the‐market (ATM) offerings, allowing foreign companies and reporting companies to use Reg A+, clarifying the testing‐the‐waters requirements, and allowing resale offerings without having to conduct a contemporaneous IPO. Says Dave Bukzin of these, “All those are good suggestions.”

BANQ impresario Elenowitz agrees with allowing reporting companies access and resale registration. He separately would like to see the SEC raise the maximum Reg A+ limit to $100 million, and allow these companies to utilize short form S‐3 registration six months after the IPO rather than the one year current wait.

Somewhat different views come from Dan McClory. He is for allowing foreign and reporting companies to use Reg A+. However, he believes that “ATMs don't have a place in Reg A+.” Dan suggests that companies become full reporting and exchange listed and then have the opportunity to complete an ATM thereafter. He feels the same about standalone resale registrations without an IPO, which he believes should not be permitted.

With of course a slightly different perspective, Cromwell Coulson, consistent with his SEC petition on the subject, believes that SEC reporting companies should be permitted to use Reg A+ and that ATMs also should be permitted. He feels this would be possible “as long as they come with sufficient dilution and discount protections.” Teri Buhl also agrees that reporting companies should be permitted to use Reg A+.

Reg A+'s Attractive Features Are Working

Now that dozens of deals have closed, hundreds of millions raised, and a growing handful completed with an exchange listing, it was time to ask the experts, “What do you see as the most attractive features of Regulation A+ for companies you have been working with?”

Some of the most valuable benefits of Reg A+ are accessible only if a company trades in the over‐the‐counter markets run by Coulson's OTC Markets Inc. He says,

We let companies choose whether to be fully SEC‐reporting or use their lighter Reg A+ disclosure, which does not require Sarbanes‐Oxley reporting or certain other burdensome disclosures. We have created lighter‐touch corporate governance standards that are customized to meet the needs of early stage companies and are tailor‐made for companies completing a Reg A+ offering.

The benefit of preempting blue sky review of a Reg A+ IPO onto the OTC markets also remains a huge advantage.

The three most attractive features of a Reg A+ offering and IPO to Dan McClory are “faster approval times, lower costs as a result, and greatly enhanced marketing flexibility.” Dave Bukzin is a fan of testing the waters, general solicitation, and the ability to list directly onto a national exchange.

Testing the waters with any investor is the clear major benefit to BANQ's Mark Elenowitz.

You can now be loud and proud versus a quiet period. Issuers can now spend time developing investor interest and more importantly can do so using the Internet and general solicitation across all 50 states to nonaccredited investors using social media, text, email, and modern communication.

Reverse Mergers, SPACs, and Self‐Filings Will Continue as Viable Alternatives

Our experts offered at times differing views on the role that these additional alternatives will play in the years ahead, but the majority view was that all will and should have their place.

More Regulatory Changes from the SEC or Congress Would Be Welcome

A key question was posed to the experts: What regulatory changes, outside of Reg A+, affecting small public companies would you like to see under new SEC Chair Clayton and the Trump Administration? Mark Elenowitz, as noted, would like to see companies have the ability to use short registration Form S‐3 in as little as six months.

Dave Bukzin sounded a small alarm, noting,

I am concerned that reduction in certain regulations would increase fraud/poor reporting, and so on. No company ever went bust because they had an extra 10‐Q to do. If a company qualifies for Sarbanes‐Oxley reporting, then their market cap is high enough that they should do an outside auditor's attestation of the adequacy of their financial controls under Sarbanes Section 404(b). Rules that make it easier to access the markets and encourage investors and liquidity of the markets is the way to encourage companies to go public.

Boustead's McClory also would like to see Form S‐3 available to all reporting companies and to reduce the Rule 144 holding period to three months. He agrees with Dave Bukzin about reporting. “Quarterly reporting is essential, if only to allow smaller companies to be comparable to large caps that would most certainly continue to file every three months.” He also believes all smaller reporting companies should be eligible to be emerging growth companies under the JOBS Act.

In his typically methodical fashion, Cromwell Coulson lays out this series of changes he would like to see, stating as follows:

To lay the foundation for growing companies to benefit from more efficient capital formation and go public, we need our public markets to be a competitive source of capital.

• One easy solution is to let public companies sell their shares in the same way they can now buy them back: through brokers directly into their established public markets. Removing the outdated restrictions on selling shares publicly will significantly lower the cost of capital and attract more growth companies to our public markets.
• Existing shelf registration rules, which are intended to allow companies to issue securities rapidly to take advantage of market conditions, are only available to larger issuers. These rules need to be streamlined and broadened to cover all SEC‐reporting companies traded on an established public market.
• Public companies should not be required to file a “supplemental registration statement” to cover issuances of already authorized shares into the market. The safe harbor rule that allows a company to purchase shares in the public markets should be expanded to include sales of legally authorized shares.
• Lastly, a broker executing an order must be able to sell shares without being subjected to onerous underwriter obligations. Higher‐quality public company reporting has eliminated the need for extensive underwriter liability. The broker, as with any retailer or distributor, should play the role of intermediary and sales agent. The public company, as issuer of the shares, should be responsible for appropriate disclosure and be solely liable for any false statements.