A common theme that CrowdCheck is hearing from potential issuers looking into using Regulation A+ is that they are not certain they want to take on the obligations of the ongoing reporting for an indeterminate length of time. While understandable, the worries about the ongoing reporting requirements do not appear to fully take into account the options that companies have under Tier 2 of Regulation A. Further, when compared to the potential cost of conducting a Tier 1 offering, the ongoing reporting does not look so bad.
The SEC gives companies with ongoing reporting obligations under Tier 2 the ability to terminate those reporting obligations. Under Rule 257(d) of Regulation A, companies with fewer than 300 holders of record of the securities sold in the Regulation A offering that have made all of their required filings, may elect to file a Form 1-Z and terminate reporting. Companies are required to have made at least one 1-K annual filing.
There are a couple of points here. First, there may only be 300 holders of record. While a company is likely to have many more than 300 beneficial owners following a Tier 2 offering, it is possible to have only a few, or even one holder of record by using a securities broker or other qualified entity to take custody of the securities for the benefit of the investors. The cost for this service varies, but is typically an upfront cost collected out of the proceeds of the offering. (Bear in mind that there may be some duplication of costs as the company is required to have a registered stock transfer agent in order to take advantage of the conditional exemption from full SEC reporting.) Second, the company must file at least one Form 1-K — meaning the company will be responsible for one additional audit of the financial statements in addition to the audit performed to qualify the offering under Tier 2 of Regulation A.
Why should a company pay these fees when it could use Tier 1 of Regulation A? A recent Regulation A filing by GoChip, Inc. shows why. GoChip is seeking to use Tier 1 of Regulation A for an offering of up to $20,000,000. In order to qualify the offering under Tier 1 with the SEC and the various state regulators, the company is estimating that it will cost $200,000 in legal fees, and an additional $50,000 in state level compliance costs. That is a lot of extra expense, plus the extra time that will be required to qualify the offering with each state securities administrator.
These fees also do not include the audit requirements for many states. While Tier 1 does not require an audit at the Federal level (except that if one exists, it must be provided), a number of states require audits to qualify Regulation A offerings. State laws are inconsistent on the topic and many have not taken steps to allow for the approval of Regulation A offerings by coordination, which likely would not require audited financial statements. Instead, most require “registration by qualification” that may require audited financial statements, depending on the particular state. These audits do not have to be compliant with Regulation S-X, which may be important for some issuers, but issuers should not expect to not have to obtain an audit in order to use Tier 1 of Regulation A.
The burden of ongoing reporting under Tier 2 of Regulation A may prove to be a manageable burden, especially when considering the ability to limit the length of time involved in ongoing reporting and the additional costs that are associated with a Tier 1 offering.