Raising capital in a mini-IPO under Regulation A can take between 4 and 6 months, which can be costly and leave many wondering how to fund the expenses of Regulation A offering. It might take longer depending on the extent and nature of SEC comments and how quickly the issuer can respond to them. Issuers cannot accept any funds in a Regulation A offering until their offering statement is qualified by the SEC which occurs at the end of the process. In the meantime, issuers must spend money on auditors, lawyers, transfer agents, EDGAR printers, and for marketing purposes. Basically, issuers have to spend a good amount of money with no guarantee that the Regulation A offering will be successful. This blog post provides a suggestion on how to fund the expenses of Regulation A offering.
One possible solution to the ‘how to fund the expenses of Regulation A offering problem’ is for the issuer to “build a Regulation A bridge.” A bridge offering is short-term financing used to cover working capital needs until a larger offering can be consummated. Bridge offerings are frequently used by startup companies to raise a relatively small amount of capital from friends and family in anticipation of a larger Series A Preferred Stock financing with a venture capital investor. This same bridge financing technique can be used to raise capital to cover the expenses of a Regulation A offering.
Issuers that plan to raise capital in a Regulation A offering can first sell securities in a private placement under Rule 506(c) of the Securities Act of 1933, as amended. Since general solicitation and general advertising are permitted under Rule 506(c), the 506(c) private placement can begin before the Regulation A offering and continue during the pendency of the Regulation A offering. The issuer does not have to file anything with the SEC before kicking off the Rule 506(c) private placement and funds received by investors may be deposited and used immediately. However, only accredited investors will be able to participate in a Rule 506(c) private placement and the issuer will have to take additional steps to ensure that the investors are accredited. These additional steps include, obtaining a copy of the investors tax return, W-2, 1099, K-1 or other IRS document to verify income, obtaining bank statements and information on indebtedness of the investor to verify net worth or obtaining a certification letter from a lawyer, CPA, broker dealer or registered investment adviser that confirms that the investor is accredited.
Ideally, an issuer that needs some capital to help cover the costs of a Regulation A offering would kick off the Rule 506(c) offering at the same time that it is testing the waters in the Regulation A offering. This way, the publicity relating to the Regulation A offering will help to create awareness of the concurrent Rule 506(c) private placement. For example, an issuer might desire to raise $30 million in a Tier 2 Regulation A offering and while it is testing the waters for that offering it could simultaneously solicit accredited investors for a $1 million Rule 506(c) private placement. It could market both offerings simultaneously, however, as the SEC noted in the final Regulation A release, the issuer should not include in the 506(c) general solicitation materials an advertisement of the terms of a Regulation A offering, unless that advertisement also includes the necessary legends for, and otherwise complies with, Regulation A.
An issuer could sell any type of security in the 506(c) private placement. It could be the same security that it intends to sell in the Regulation A offering or a different security. Taking a page from the startup bridge financing handbook, an issuer might consider issuing convertible bridge notes. As is the case with startup company bridge financing transactions, the convertible note could convert at a discount to the next financing round, which in this case would be the Regulation A financing. For example, the following terms might apply to the 506(c) private placement:
- Offering of up to $1 million of convertible notes
- Principal and interest on the convertible notes convert into the securities being sold in the Regulation A offering at, e.g., a 15% discount to the price per unit paid by investors for securities in the Regulation A offering
- Mandatory conversion upon closing of the Regulation A offering
- Interest rate of, e.g., 7% per annum
- One year maturity
- Voluntary conversion feature allowing the investor to convert at a set valuation if the Regulation A offering is not consummated prior to the maturity date
- Mandatory conversion if holders of a majority of principal amount of convertible notes agree to convert at maturity
- Premium if there is a sale of the Company prior to the conversion of the notes
One benefit of building a Regulation A bridge as compared to a bridge to a Series A Preferred stock offering is that the securities received by investors in the 506(c) private placement upon conversion of their convertible notes would be covered by the Regulation A offering statement and, therefore, would be freely transferrable and not restricted securities. The convertible notes themselves, however, would be restricted.
If you have any questions about how to build a bridge to your Regulation A offering or desire to discuss any other aspect of Regulation A or raising capital generally, please contact me for a free initial consultation at info@Bevilacquapllc.com or at 202-203-8665.