Reg A and Reg CF: How Does a Company Receive The Capital It Raises?
Part Two of a Six Part Series Comparing Regulation A and Regulation Crowdfunding. See Part One Here
So you have decided to hold either a Regulation A or Regulation Crowdfunding offering. There are a few things to consider when deciding whether Reg A or Reg CF is the best fit for you. One thing to consider is how and when your company will receive your new capital infusion once you launch and start raising funds from investors. The rules surrounding this for Reg A and Reg CF are very different.
Minimum or Target Amount
One big difference between Reg A and Reg CF is the concept of a “target offering amount.” Under Reg CF, a company raising capital cannot hold a “closing” and receive any investment funds until the “target offering amount” is reached. There is no such requirement under Reg A, and an issues can start taking funds out on most Reg A offerings as soon as funds are raised.
The target offering amount is the amount of money set as a minimum raise by the company raising funds. This is not the same as the maximum amount allowed by law (Reg CF — $5,000,000 in any 12 month period, Reg A Tier II $75,000,000 in any 12 month period), but rather a number that is often artificially set as a floor — if the Reg CF issuer doesn’t raise this target amount, the offering is terminated and all investors are refunded their money. Some funding portals require an issuer to raise $50,000 to $100,000 as a target amount, meaning the issuer cannot take any funds to use for any purpose until $50,000 to $100,000 is raised.
Reg A has no “target amount” legal requirement, but in some cases a company raising funds can have a self-imposed requirement of a target or minimum amount. These offerings are known as “Min-Max” offerings — the company raising funds does not want to accept funds until their “min” or target amount is reached. A great example of this would be an issuer who needs to raise $100,000 to buy a new piece of equipment. If they raise $40,000, or even $90,000, they will not be able to purchase the equipment. In this instance, an issuer may choose to refund all the potential investors rather than accepting a fraction of the money they needed to fulfill the reason for the raise. This min-max type of offering is purely voluntary in Reg A offerings.
21 Days
This is the second big difference between Reg A and Reg CF when it comes to a company receiving funds from its offering. No company can actually accept investments in a Reg CF offering until 21 days after the date on which the Reg CF offering is live and publicly displayed on a funding portal or broker-dealer website. In other words, while investors can see the offering online, and can fill out the forms and process their payments, none of those investors can be accepted and no money can be released to the issuer until the Reg CF offering has been online for 21 days.
Reg A has no such time limitation. Unless it is a min-max Reg A offering, the issuer can close on and take investment funds as soon as it wants after launching its Reg A offering.
Reg CF Rules Allowing Investors To Opt Out
This is the third, and perhaps biggest difference between Reg A and Reg CF when it comes to an issuer being able to receive the new capital it has raised. Let’s start with Reg A. With Reg A, once an investors makes an investment commitment — they fill out the online forms, process their payment and sign their subscription documents — that investor is basically locked into their investment, and once the issuer holds a closing — and countersigns the subscription agreement — that investor is issued their securities and the investor’s funds are sent to the issuer. It’s very simple and straightforward.
Not so with Reg CF.
In a Reg CF investment application, there are several rules to be aware of, and these rules allow an investor to cancel their investment prior to a closing. And, I can tell you from experience, some investors will cancel their investment commitment for various reasons when given the chance to do so. This means an issuer cannot rely on the investment funds it believes it has raised based on investment commitments, until a few hoops are jumped through.
Let’s start with the most basic of these rules: in Reg CF an issuer launching and offering must set a “deadline” date to reach it’s target amount. If the issuer doesn’t reach it’s target amount by that deadline, then typically (a) the issuer will extend the deadline — which subjects the issuer to a new set of “material change” rules below — or (b) the offering ends and the investors are refunded all of their money.
So let’s look at what happens if a Reg CF issuer reaches its target goal before the deadline, and wants to hold a closing — take the funds it has raised to date and issue securities to the investors. Under Reg CF (again — this is not required under Reg A) if an issuer reaches the target offering amount prior to the deadline, it may hold a closing earlier than the deadline if it (a) provides notice about the new, earlier offering deadline at least five business days prior to such new offering deadline and (b) gives a description of the process to complete the transaction or cancel an investment commitment, letting investors know they can cancel their investment until 48 hours prior to the new deadline and © the investor does not cancel its investment commitment before the 48-hour period prior to the offering deadline.
As you can imagine, this notice to investors that they can cancel their investment is not a great thing for issuers. Particularly if some time has passed between the investment commitment and the proposed closing — some people may decide they’d rather have their money back than invest. Not to belabor the point — but this cancellation feature can cost Reg CF issuers a lot of money in lost investments — and it is not something a Reg A issuer has to deal with.
This same procedure must be undertaken by a Reg CF issuer every time they hold a closing with any potential investors in that closing. Again, no such requirement for Reg A issuers.
Here’s another one that applies to Reg CF and not Reg A. If a Reg CF issuer makes a “material change” to the terms of its offering or to the information it provides to investors, a notice must be sent any investor who has made an investment commitment explaining the material change and telling the investor that its investment commitment will be cancelled unless the investor reconfirms his or her investment commitment within five business days of receipt of the notice. If the investor fails to reconfirm its investment within those five business days, the investment is cancellated and the investor refunded. As you can imagine, this is another situation where issuers can easily lose investors. Unlike the other notice provision of Reg CF where no material change has occurred, and an investor is simply given notice of the change, with a material change the investor must affirmatively respond to the notice or they are automatically cancelled.
There is no such requirement of automatically cancelling investor commitments under Reg A, although a Reg A issuer does have required SEC filings when a material change occurs.
Multiple Closings and Escrow
Both Reg A and Reg CF allow for multiple “closings” throughout an offering. This means a company raising funds can take in investment dollars and issue shares as often as they want, by law. With Reg CF, the first closing is subject to the 21 day rule mentioned above, but after that there is no limit on the number of times a company may choose to hold other closings.
However, there are costs to each closing that vary depending on whether you are using Reg CF or Reg A. For Reg CF, investor funds must be held in a “qualified third party” account (typically an escrow account) until the target amount is raised and the 21 days since launch have passed, before an issuer can request a closing. Every funding portal and broker-dealer, and every qualified third party have their own rules and costs associated with holding a closing, or a series of closings known as “rolling closings.” These fees can get expensive and are one of the fees that issuers should ask about before choosing a funding portal or broker-dealer. Some typical changes surrounding these closings are a per closing fee (which can be several hundred dollars), fees to transfer the funds to your account, and sometimes other administrative fees which add up and make it economically unfeasible to hold closings, for example, every day.
With Reg A, there is no requirement to hold investor funds in a qualified third party account or an escrow account, unless the offering is a Min-Max offering, in which case funds must be held in an escrow account until the minimum is met and a closing takes place. As a result, closing costs can be less expensive in Reg A, but some Reg A offerings use escrow regardless of the legal requirement, and therefore end up in a similar situation to Reg CF when it comes to frequent rolling closings.
There are also other limitations that may be imposed by the funding portal or broker-dealer who is acting as a legally required “intermediary” on Reg CF offerings. At one point, funding portals were not allowing multiple closings, and some limited rolling closes to only 2 per offering. While this is not quite as limited today as it used to be, an issuer preparing to raise capital who wishes to hold multiple closings should inquire in advance with the funding portal or broker-dealer to see if there are any limits on the number of closings they can hold during the offering.
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Coming next week: Part 3 of the 6 part series: Marketing and Distribution. Also, this article is not and should not be considered legal advice. Yes, I am a securities lawyer but no, you did not hire me to provide you with legal advice. In all cases, consult with your own lawyer as every legal situation is unique and do not rely on my educational and informative article as legal advice.
