At the birth of any new industry, the early players never “get it right” at first as there is always a learning curve and some growing pains.
In the early 90’s AOL, Compuserve, Netcom, Microsoft and others absolutely refused to interconnect (aka “inter-network”, aka “internet”) their private islands of electronic communities to each other. The industry paradigm was to run an exclusive service of content and tools (e.g. “email”) only accessible by their customers (“users”). They felt it made no economic or marketing sense to allow users of other private networks to access their proprietary content or communicate with their paying users.
This didn’t diminish the future of what was to become the internet,
…it just slowed down its development as the early players figured things out.
Likewise the early players in this new world of technology-driven capital formation are still figuring things out. And it’s causing the market to develop more slowly than people had hoped. But it doesn’t diminish what will become the future of capital markets – a world where the vast majority of wealth creation and liquidity occurs in the private markets.
Let’s take a look at some early missteps…
Issuer Marketing – or, rather, a lack thereof. A company can NOT solely rely on a single funding platform (e.g. StartEngine, SeedInvest, etc) or broker-dealer to get the deal sold for them. Nor should an issuer rely exclusively on their own efforts. The issuer should budget for their own direct marketing efforts AND carve out compensation to pay platforms and broker-dealers to help find investors. It takes a LOT of people, time and money to pull off a successful Reg A. Underestimate that and you’ll have wasted the opportunity. A classic mistake we are seeing is issuers who spend the entire 4 month period 100% focused on their SEC filing when they should have been putting significant effort and resources to generally promote their brand and products to develop a loyal, social following (absolutely not to be confused with “testing the waters”).
Manual Processes – this is technology-driven finance, yet some people are still sending documents to investors and requiring manual signatures on forms. Crazy. If an investor can’t click a button and easily 100% complete their investment in one simple uninterrupted contiguous process then they most likely just aren’t going to invest.
Budget – a Reg A offering is expensive just to get launched with substantial non-recoverable costs for legal, accounting, due diligence, regulatory fees, technology setup, and marketing preparation. Company’s considering a Reg A offering need to plan for this with their eye wide open, along with budgeting for the time and costs of marketing and conducting the offering once it’s live. If it doesn’t succeed, you don’t get that money back.
Time – while a 506(c) or Title III/4(a)(6) offering can be launched quickly, a Reg A will take at least 4 months, probably more. Lawyers have to draft documents and file forms with the SEC and FINRA. Accountants have to audit the issuers’ financials. Regulators have to review and ask questions. The company has to undergo due diligence for broker-dealers (if involved). And marketing has to be extensively prepared (videos, social media, advertisements, email programs, etc). This all takes time. A lot of time.
DVP/IPO – broker-dealers who think that a Reg A is an IPO and can be settled as if it were a regular ol’ “new issue”. It’s not, and it can’t. This is a new paradigm. Non-accredited investors have limitations which must be enforced but clearing firms are not yet equipped to handle. And if OTC then FINRA requires evidence of a signed purchase agreement, which clearing firms are not yet equipped to handle.
No “Crowd” – an issuer who isn’t a consumer-focused company or who is but doesn’t yet have a passionate, rabid base of fans (and an easy way to communicate with and engage them) is probably not going to have a successful Reg A. Time and again, successful crowdfunding campaigns demonstrate the need for a large, engaged constituency of the company, and failed campaigns are usually exactly the opposite. The company has to be something that a crowd cares about. As they say in the broker world, it’s got to have a good story.
OTC/NASDAQ – just because a company is doing a Reg A does not mean it is ready for listing on OTC or, especially, NASDAQ. And if a company is not ready to be listed, that does not mean that it isn’t right for Reg A as this can be a nice stepping stone towards becoming a “fully reporting” public company; the in-between stage for a company that has some traction with customers, has raised money via Reg D or Reg CF, and isn’t ready for the corresponding regulatory, accounting, and ATS/exchange listing requirements. So while we all applaud the handful of Reg A candidates who are ready for the extra burden of becoming a traded company, the vast majority of Reg A’s, although perhaps great companies, are not yet ready for the costs of financial and regulatory reporting requirements required for compliance with ATS’, exchanges or the Securities Act of 1934. Note that many broker-dealers will only help sell offerings that are going to be traded on the OTC or NASDAQ listed, so that may factor into many issuers decision process (in which case OTC is usually the clear choice due to costs and requirements). Those that aren’t can still do a Reg A and let investors find liquidity on alternative trading platforms that are soon to appear as, by and large, investors don’t really care about that as their motivation for becoming your investor isn’t a quick-flip.
Exclusive Islands – we’ve seen several active Reg A’s make the mistake of locking themselves into an exclusive relationship where all investors are forced to open a brokerage account at a single firm whether they like it or not. Issuers have to be able to cast a wide marketing net and allow investors to buy securities however they want; and in Reg A the majority will want to hold stocks/bonds directly because they want that one-on-one relationship with the company as they are buying out of passion, not a desire to flip shares. Others might want to put shares in their Schwab account. Or in their retirement or custodial account at a trust company. Or wherever else. Let them.
Valuation – some issuers seem to think that a Reg A is the road to riches and price their securities at ridiculous valuations. The crowd isn’t that dumb. Plus if you don’t have the right valuation then you’ll close the door to investment banks, brokers, and professional investors who may love the company but simply won’t invest in an arbitrary valuation. And it may expose the company to a future “down round” in a subsequent capital raise, and the obvious investor issues that would cause. If you are unsure then use a professional valuation firm such as Houlihan to assist, it doesn’t cost that much.
Stocks vs Bonds – almost everyone is using equity securities (stock). That’s probably good for many Reg A’s (unlike offerings using 506(c) or Title III crowdfunding, which I think should always be some form of debt). But at times it would be better for the company and investors for the Reg A to be a debt (bond) offering instead of equity as it may attract more investors due to the specified minimum returns and clear exit strategy (maturity date), and they will be far easier to trade on alternative markets. The point is this – take the time to understand your investors before spending huge sums of time and precious working capital on the Reg A offering so you launch with something you know they will buy.
Institutional Road Show – some brokers, treating a Reg A like a full IPO S-1, hit the road to visit Janus, Vanguard, Franklin and the rest of the usual institutional buyers. Wasting their time and money as none of them are (yet) interested in Reg A offerings for a wide variety of reasons (company too small for their portfolio minimums, company not trading the way they require, not enough float or market cap, unable to acquire shares in entities which are not “fully reporting”, etc). It’s not time for the institutional crowd yet.
Fear – many people, especially broker-dealer compliance departments, are so afraid of JOBS Act-era capital raising that they either refuse to participate or put such overly-burdensome restrictions on marketing that it strangles the deal. The fact is that this new world of “general solicitation” is a game-changer that industry professionals will ultimately embrace and, so, they might as well move past their fears and get to work sooner rather than later.
Conclusion: The impact of Reg A, along with 506(c) and Title III/4(a)(6) crowdfunding will have a transforming effect on our capital markets. It’s the future of wealth creation and investment, just as the internet in the 90’s was the future of communications. The early problems will be recognized and resolved, issues of secondary liquidity will be solved, more and bigger players will come into the market, and both the private and public markets will change in profound ways. At the end of the day raising money in a tech-driven world is more than just exchanging a security for cash, it’s about building relationships with your investors and developing your “crowd” as they become committed brand ambassadors. They are investing in you, your team and your vision, and want to participate in the journey that is your company.
* Special thanks to Ron (StartEngine), Cromwell (OTCMarkets), Ryan (SeedInvest), Sarah (CrowdCheck), Jillian & Amy (Crowdfunding Lawyers), George (Alternative Finance Lawyers) and Joan (Ellenoff) for letting me pick their brains in writing this, none of whom, of course, provided any advice nor made any recommendations, just some personal opinions which no person should rely upon and instead always engage counsel directly (see the disclaimer below).
FundAmerica Technologies, LLC