The SEC recently increased the funding limits for several types of exempt offerings. The increases were fairly substantial, and we believe they may create increased opportunities to raise external financing. Smaller companies in particular should be aware of these increases, as they may provide increased access to capital.
The new funding limits were included in a Final Rule entitled “Facilitating Capital Formation and Expanding Investment Opportunities by Improving Access to Capital in Private Markets,” issued by the SEC on November 2, 2020. The SEC also issued an explanatory Press Release which contains a helpful Fact Sheet regarding the Final Rule and the new funding limits. The purpose of the Final Rule was to harmonize and bring some consistency to the somewhat complex system of securities offerings that are exempt from registration with the SEC. This system is a critical component of the capital raising process, and for many smaller companies these exempt offerings are the only methods available for external capital raising. This Final Rule became effective on March 15, 2021.
This Final Rule impacted three exemptions from registration that are widely used, especially by smaller companies: Regulation Crowdfunding, Regulation A (commonly known as “Regulation A+”) and Rule 504 of Regulation D. The major changes are as follows:
- Crowdfunding: The limit on crowdfunding transactions was increased to $5 million from $1.07 million. This is a substantial increase and is potentially the most impactful component of this new structure for smaller companies. Crowdfunding certainly has disadvantages – it can be a relatively costly process, and a company must be certain that it can accept the administrative burden of having a relatively large number of shareholders whose individual investments are small. Additionally, crowdfunding investors may be unsophisticated and may not be able to provide the industry or financial “smart money” benefits that other investors can provide. The new $5 million limit should help to better justify the costs of a crowdfunding offering.
- Reg A+: The funding limit for Tier 2 offerings under Regulation A+ has been increased to $75 million from $50 million. This is obviously a much larger financing arena, but it may provide a good opportunity for companies with larger capital needs. Reg A+ now does not impose investment limits on Accredited Investors (subject to the $75 million cap), although it does impose limits on investment by non-Accredited Investors. A Tier 2 offering also imposes more stringent financial statement requirements on an issuer. Regulation A+ offers a Tier 1 alternative, but offerings done under this Tier are limited to $20 million. The caveats here are that a Reg A+ offering will be relatively costly and will impose fairly substantial compliance requirements.
- Rule 504: Offerings made under Rule 504 of Regulation allow an issuer to take advantage of the Regulation D “safe harbor” from registration while avoiding overly onerous compliance requirements. The increase in the offering limit to $10 million from $5 million may provide opportunities for companies to utilize this offering more often.
The practical impact and any potential benefits of these new funding limits remain to be seen. It’s very early in the process, but it initially appears that crowdfunding transactions may be the biggest beneficiary, as several crowdfunding financings have already been consummated using the new $5 million limit. Companies contemplating a capital raise should carefully consider these revised exempt offering structures as part of their external financing strategy.