Reg A really is different than an IPO

Regulation A is an exemption from registration of securities under the Securities Act of 1933. At the same time, it is a public offering of securities. This puts Reg A in an odd place when it comes to SEC review.

For the most part, the operating companies utilizing Reg A are early stage companies. This is not entirely what the SEC envisioned when adopting its amended Reg A Rules. In that release, the SEC believed most use would come from companies opting for Reg A rather than a traditional IPO. Other observers took the view that Reg A would act as a later stage, pre-IPO round, allowing an exit opportunity for some venture investors. Instead, Reg A offerings by operating companies have come in earlier stages of operating companies’ life cycle because there is a business case for having a larger number of non-accredited investors. At these earlier stages, companies have limited history and are a higher risk investments.

To compensate for that risk, attract investors, or limit headaches for company management, many companies are including terms that are most associated with venture capital type investments: e.g., preferred liquidation rights, participation rights, registration rights, drag along rights, “Major Investor” information rights, proxy agreements, transfer restrictions, etc.

Investors and intermediaries familiar with private offerings will recognize the utility of these types of provisions and the material terms contained within each. The SEC, on the other hand, has not had as much experience reviewing these types of terms in public offerings. This makes sense; most IPO issuers have had all their preferred stock convert to unburdened common stock prior to the IPO and their investor rights agreements will likely have ceased to be in effect.

As the SEC examiners encounter these venture capital like terms in a public offering open to all investors, they are taking the view that investors need to be educated about the implications of those terms. For companies raising funds under Reg A, this doesn’t mean that they should not have these terms; that is still a decision about what is going to be most attractive to investors based on the risk profile of the company. But this does mean companies should be aware that the SEC will be taking a close look at any terms that are not typically associated with a public offering of securities, and will likely require an extended amount of detail in the company’s disclosure.

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