What is a Reg A+ (SEC-registered) Token Offering?
VeradiVerdict - Issue #47
TL;DR
Historically, companies raise funding through public (stock market, available to all) or private (high-amount investments from accredited investors, called Regulation D) means. That dogma has been changing.
In 2015, the SEC passed “Regulation A+,” a rule that makes certain securities offerings exempt from registration, in order to facilitate capital raises for smaller U.S.- and Canada-based companies and startups. Reg A+ offerings allow companies to raise money from both accredited and unaccredited investors, democratizing their investing sphere greatly. There’s two major kinds of Reg A+ offerings.
Tier 1 allows companies to raise up to $20 million in one year, with fewer regulatory requirements on the company and more flexibility about who can invest.
Tier 2 allows companies to raise up to $50 million in one year, but subjects the companies to more regulatory requirements, including disclosure and public financial reporting requirements, and includes limitations on how much certain investors can own.
Both tiers place restrictions on the amount of secondary selling that can be done by company affiliates.
Reg A+ offerings might be suited for companies seeking mid-stage investment that want distance from institutional investor control over the company, and deeply care about customer engagement and support.
The offerings aren’t as well-equipped for really early, seed-stage investments, companies with unclear value for customers, and the inability to hire effective lawyers or advisors.
Blockstack and YouNow are two companies that have received approval to do Reg A+ offerings through the SEC. Both plan to launch a token that rewards its users for customer engagement and allows for the public to participate in funding; early indications show that the Blockstack offering will be promising and successful.
With the advent of tons of innovation within technology and blockchain, up-and-coming companies are looking for novel ways to raise capital to fund their growth. Historically, investing in new ventures has been limited to institutions and “accredited investors” –– wealthy Americans who had enough assets to hedge the risk of a questionable investment in a new space.
But the investing world is constantly changing––and more and more startups are looking for ways to get the general public involved in their financial growth.
What is the historic model of raising funds?
When raising funds, companies have two options: public and private investing.
Traditionally, public investing has been executed through the stock market. Once a company reaches sufficient size and scale, they decide to undergo an initial public offering (IPO) where they list their stock on a public exchange, allowing anyone to purchase stock in the company and support it. Buyers are rewarded through dividends, or fractions of the company’s revenue, and through price fluctuations in the stock market that allow them to trade their portfolio for profit. Companies take the investment from their buyers and put it towards growth and funding new products.
Stocks historically have also been a financial instrument for the wealthy of America, but recently, more average Americans have started investing in stocks too. The rise of public information regarding the stock market and how to get involved plus easily-accessible platforms like Robinhood have made public investing truly public.
Private offerings are when companies sell shares of the organization to accredited, wealthy investors. Generally, these shares amount to a much larger fraction of the company than a singular stock would––this gives private investors more stake in the company. Private offerings are generally seen as a lot more risky. The US Securities and Exchange Commission (SEC) has an offering called “Regulation D” that allows companies to raise private capital without officially registering the shares as securities with the SEC. The process involves filing several disclosure forms and ensuring compliance with various states’ corporate sales laws.
What is Regulation A+?
In 2015, Title IV of the JOBS Act went into effect––without getting caught up in the nitty-gritty specifics of the legislation, this expanded an existing regulation to allow for a new type of offering, commonly called Regulation A+.
Regulation A+ allows companies to raise up to $50 million in capital from the public without a formalized IPO. Regulation A+ offerings still require that companies file with the SEC and get approval, but the restrictions and associated filing fees are significantly less than those for IPOs, meaning it’s much easier for companies to publicly raise capital with a Reg A+ offering. In fact, it’s even donned the term mini-IPO because it functions similarly to an IPO without a formal launch on a stock exchange.
And unlike Regulation D, Regulation A allows companies to accept investments from both accredited and un-accredited investors, greatly diversifying the populations that are able to invest in such ventures. Importantly, securities sold pursuant to Regulation A are immediately freely tradeable as compared to securities sold pursuant to Regulation D which must be held for at least a year before they can be transferred by the purchaser.
What are the specific Reg A+ offerings, and how do companies go about starting one?
There’s two main Reg A+ offerings: Tier 1 and Tier 2. They’re pretty similar, aside from a few key distinctions.
Tier 1 maxes the amount of capital raised at $20 million––with this lower ceiling, it comes with less regulatory requirements. There’s no regulations on who is allowed to invest, and it doesn’t require a formalized audit from states nor public audited financial reporting. However, when filing for a Reg A+ Tier 1 offering, companies must also be reviewed by the state where they intend to raise capital in.
Tier 2 allows companies to raise up to $50 million, considerably more than Tier 1. But naturally, with this higher ceiling, it has more restrictions for the companies. First, unaccredited investors can only invest up to the maximum of 10% of their income or net worth, whichever is higher. The company is exempt from Blue Sky Laws which require separate registration and qualification in any state where the company intends to raise funds, but their financials must be audited, they must file annual, semiannual, and current event reports, and they have to annually report their financial documents to the public as well as other ongoing disclosure obligations.
In essence, Tier 1 is more geared towards companies targeting smaller investments (under $20M) who want more flexibility with how they raise capital. Tier 2 has more restrictions, but allows for a much larger capital raise (up to $50M).
At a very high level, the steps to launch a Reg A+ offering for both tie are as follows.
First, the issuer files a Form 1-A with relevant information on their company and what they plan to pursue with the SEC. After filing, companies are allowed to test the waters to gauge their probability of a successful capital raise;
Supposing the investor interest is there, the company then decides to actually pursue a Reg A+ offering the issuer continues with the approval process with the SEC.
Once all of that is done and the SEC returns approval and qualifies the offering, the company can begin selling securities according to their Tier’s regulations.
Why might companies pursue a Reg A+ offering today?
A few reasons.
It just broadens the investing pool significantly. It can be hard to convince accredited, institutional investors to take a bet on a venture, so by allowing non-accredited individuals to also invest, it greatly opens the options for a company in terms of successfully raising capital. Additionally, tons of companies end up with different visions of their future compared to their institutional investors; this can create a lot of problems later on when the company and its investors disagree as to how the company should pivot (if they even should) and what markets they should go after.
It’s a fantastic way to engage with customers. First, Reg A+ offerings essentially require that companies have robust, well thought-out value propositions that they can deliver to literally anyone. It’s no longer about convincing people that a specific business model or a specific feature can create 10x returns; it’s about showing people that they’ve made a product that meets a genuine need in people’s lives. This inherently means that Reg A+ companies are more inclined to be customer-obsessed and focused on fostering real value. Second, it’s a great way to propagate the customer ecosystem. If a customer buys products from a company, realizes how great they are, and then decides to buy a share of the company to support it, they’re essentially supporting the ongoing growth of the company; it’s incredible if the company is able to reward customers for that kind of ongoing support, creating a cycle where customers are highly engaged with the company in terms of buying more products and funding new ventures.
It’s a great model for mid-stage companies. For companies that are just making it big in the market, and have already pursued a traditional seed round and aren’t really ready for the big guns yet, Reg A+ is a great way to raise just enough money to take the company to the next level without getting excessively caught up in investor relations. It’s a, agree. Delete substantial source of capital that really allows the company to do the most with their money in a way that can gear them up for larger institutional investments later on.
What about some reasons not to?
It can be expensive. Institutional investors generally have their own lawyers that they work with to make investments a reality; hiring the right lawyers to get SEC approval and deal with all of the regulations might be too costly of a step to get companies interested in the Reg A+ model. Additionally, such approvals can take 3-6 months to close, which are critical time periods in a company’s early stages, and would increase company obligations to more investors, which can great tangles for the company’s vision and drive.
There might not be sufficient interest for the general public to take a bet on the company, or maybe the public doesn’t know enough about the problem space, so the company might not raise enough money. Institutional investors can direct you towards a better value proposition and might understand the nuances of a company’s market and see where the 100x returns can stem from in the future. Less experienced public investors may not have the same acumen, which can make it hard for more out-there companies to raise funding and create risks that investors unfamiliar with the company seeking a quick profit could sue the issuer.
If you’re still seed stage as a company, the amount of funding from a mini-IPO would greatly exceed what you’re looking for. Generally, these campaigns target investments on the scale of $3-50M dollars, even though the investor market is diversified to include the general public. This is more useful for mid-stage and later-stage companies looking for continued investment. To get a company or product off the ground, companies aren’t looking for that scale of funding; an institutional investor with a smaller amount and the wisdom to mentor the company might be a better fit here.
Managed a huge cap table can be difficult.
Have any companies pursued the Reg A+ model so far, and how has it gone?
Yes! Two of the notable ones in the crypto space are Blockstack and YouNow verify.
Blockstack is essentially a decentralized app and computing platform that lets people build their products on decentralized, distributed technologies that also gives them 100% autonomy over their data and privacy. They’ve raised funds from Foundation Capital, Winklevoss Capital, and Blockchain Capital. The Wall Street Journal reported earlier this month that the SEC has approved a $28 million offering of digital tokens under Tier 2 of Reg A+. Blockstack is offering 62 million units of a token called STX, each of which is priced at $0.30. This is the first SEC-qualified token offering, but it was costly for Blockstack, which reportedly spent $2 million just on getting SEC approval for the sale.
YouNow is an online broadcasting service where users can live-broadcast themselves, and share and interact with other live broadcasters. Their infrastructure uses an Ethereum-based token called Props that easily integrates with the application. YouNow developed the Props blockchain and intends to reward content-creators with Props for driving platform engagement. The SEC qualified YouNow’s Regulation A offering to sell 133 million of the Props tokens at a price of $0.1369 per token, with an additional 45 million tokens to be granted to YouNow’s content creators. The company pre-sold $22 million of the tokens, so it looks like the Reg A+ route is off to a good start.
Final Thoughts
Just like the tech sphere, the investment world is rapidly changing. Reg A+ presents a new, highly-customizable way for companies to raise substantial amounts of capital from unaccredited and accredit investors alike; it’s a huge step towards the vision of a decentralized, democratized financial system that enables everyone to participate. Whether Reg A+ is the end-all-be-all of mixed public- and private- mid-stage-offerings is yet to be seen, but it definitely ushers the investing sphere towards a more democratized future.
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ADDITIONAL INFO
Hi, I’m Paul Veradittakit, a Partner at Pantera Capital, one of the oldest and largest institutional investors focused on investing into blockchain companies and cryptocurrencies. The firm invests in equity, pre-sales/IEO rounds, and cryptocurrencies on the secondary markets. I focus on early investments and want to share my thoughts and what’s going on in the industry in this weekly newsletter.
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