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THE JOBS ACT
The JOBS Act – Jump Start Our Business Startups – was passed in April 2012 but it was not until March of 2015 that Title IV Regulation A+ was announced. The intention of the Act was to make it easier for small companies to raise capital. The first effective component of the Act was Title II which went effective in September of 2013, extending Regulation D to allow companies to market themselves to raise money from accredited investors via the internet. The biggest change under Regulation D was that it allowed for public solicitation, whereas before only solicitation from investors with a pre-existing relationship with the sponsor was permitted.
There are some nuances in Reg D that restrict the number of accredited investors depending on the specifics of the structure and approach that a company is taking. A borrower can market an offering broadly on the Internet but can only accept investments from accredited investors. The thing that 506 (C) requires though is that the issuer, the company raising money, must take reasonable steps to verify that the investors are in fact accredited. You cannot take their word for it. In 506 B, the pre-JOBS Act version, borrowers were limited to soliciting from people they knew but there was no accreditation verification requirement. If they say they're accredited that's enough. An investor would have to sign off on it, but that was enough.
Reg A+ took the old Reg A and expanded upon it dramatically. That little plus sign kind of understates how much it changed. With Reg A+ private, companies can raise money privately and raise up to $50 million a year and in some cases, more specifically in real estate cases, more by doing multiple offerings simultaneously for different geographies.
There are two types of Reg A+ offering: Tier 1 and Tier 2. A major issue is that investments can be accepted from investors worldwide at any wealth level. They do not have to be accredited anymore. And when they state their income and net worth, and whether they are accredited or not, the company selling the stock is allowed to take their word for it. They don't have to prove what the investor states.
Investors anywhere in the world can be accepted at any wealth level into a Regulation A+ and the SEC considers the shares sold through the offering to be liquid for the purchasers of them. If the company doesn't lock the shares then the shares can be traded someplace depending on whether the company lists, where it lists, or whether it provides some other form of liquidity. Options for listing include one of the OTC markets like the QB or the OTCQ or the OTCQX. These come with reporting requirements that are considerably less onerous than listing on the Nasdaq. The issuer can also retain the option of not listing at all or even locking the shares and then providing a redemption system. This has been done by some real estate companies raising money using Reg A+.
COSTS ASSOCIATED WITH A REG A+ OFFERING
An attorney providing the legal services required will charge $50,000 and up depending on the complexity of the offering. That is a front-loaded cost. In addition to this, there are marketing preparation expenses, and if it is a Tier 2 offering, the issuer will need to have an audit that goes back as long as the company has existed or two years. So those are the downsides: upfront cost and it is not a certainty that you will be able to raise the money which is basically true in any kind of capital raise. There are no guarantees.
REAL ESTATE A MAJOR USER OF REG A+
Real estate has become a very large segment of Title 2 capital raises. This is probably because investors understand the nature of real estate. Many investors would like to own more real estate but do not have the time or enough capital set aside to do so. Many of the real estate offerings already issued are paying a reasonable dividend rate or a preferred return which is also very appealing in today's low interest environment. Another reason real estate has taken off in Reg A+ offerings is that in regular business offerings under the Act, it is hard to get investors to pay attention unless they absolutely love a company. In the case of real estate, the industry has a critical mass where regular investors feel comfortable with the asset class and so more inclined to invest.
Reg A+ is not for a sole developer who has a deal in town that needs money for it; it is for established, experienced teams that have a track record and that can demonstrate that not only to the market but also to investors, platforms, marketplaces, and broker dealers.
MARKETPLACE UTILIZATION OF REG A+
The marketplace platform, Fundrise, [subscribe to the Podcast to hear Ben Miller next week, Founder and CEO of Fundrise as my guest speaker] is using a Reg A+ as a completely central part of that platform. They have three parallel Reg A+ offerings going on simultaneously because if you can divide territorially like that, and Fundrise has divided the US into three geographic regions, you can raise money simultaneously for each one, raising up to $150 million per 12 month period.
OPTIONS FOR DEVELOPERS RAISING CAPITAL
- A company like Fundrise aggregates smaller developers deals, adding layers of screening, to create a platform for capital generation. Developers list on the platform and use its’ resources to raise money.
- A developer prefers to retain closer control over who sees and decides to go it alone to generate the marketplace interest in their offering. Here they will not use a third party platform for the issue, it is conducted entirely internally.
THE CROWD AS INVESTOR; THE CROWD AS WATCHDOG
Typically, term structures in a Reg A+ offering will resemble those traditionally offered to friends and family, or to private equity, but economic terms may change as will certain key decision-making rights. In a Reg A+ offering, for example, there is no requirements that issuers have skin in the game. In pre-JOBS Act times this was also true, but investors typically expected it of the developer. In the current environment with relatively unsophisticated investors entering the market – no matter how the SEC defines ‘sophisticated’ – sponsors are listing deals where they have no risk equity of their own. Other terms highly favorable to the sponsor are commonplace so it is very important to be watchful of the fine print.
One of the big concerns about the JOBS Act from before the get-go was that there would be rampant fraud. Countering this concern is the idea that the online offering model is so transparent and so public that the likelihood of this is mitigated. When you have thousands of people examining an offering and examining the social media profiles of the principals on the transaction, word will spread quickly if something is skewwhiff. It is like having surveillance cameras in a neighborhood. It puts thieves off because they would rather go somewhere else where they will not be recorded in a similar way. That said, while the transparent access we have through online funding platforms is really good, the crowd will act as a crowd, and people tend to go with the herd, believing that if everyone else is doing it, it must be OK. And sometimes that can lead off a cliff.
INVEST LIKE AN INSTITUTION – BUT THESE ARE NOT INSTITUTIONAL DEALS
Institutional investors take a very detailed look at a sponsor and their capabilities and add multiple layers of not only due diligence but also management oversight on top of that, on an on an ongoing, real time basis for any sponsor. In Reg A these layer has been removed. Now investors are investing directly in the developer itself and so although small investors now have opportunities to invest where before they could not, they also do not have the same skillset that an institutional investor would have.
While it is true that the SEC goes through these offerings with a fine tooth comb to make sure that they are real, that the companies are real and that they are legitimate, it does not validate the merit of an investment in any way. If there's a broker dealer on an offering, or an online marketplace is making the offering, especially a platform which has a good reputation, then maybe this adds some credibility to the offering.
Bottom line: Do not invest anything that you cannot afford to lose.
Regulation CF – Crowd Fund
Reg CF is also known as Title III and is the most recent of these significant JOBS Act announcements. It went effective in June 2016 and is geared to raising capital of sub-$1 million from non-accredited investors. Reg CF issues are made through SEC approved portals that collect fees under various highly regulated formulae. The issuer must undergo background checks via the portal, and submit GAAP level annual audits; a more stringent standard than otherwise might be usual.
[Coming Soon: Listen to the National Real Estate Forum trifecta podcasts – Reg CF Portal Small Change CEO, Eve Picker, a sponsor on her site Jonathan Tate, and an exclusive interview on the Forum, the first ever CF investor Bill Bedell. Coming up soon. Don’t miss it; subscribe now on any one of these platforms]
Manhattan Street Capital
Manhattan Street Capital is essentially two things in one. The company focuses primarily on Reg A+ offerings but will do select Reg D offerings where they feel they can add value. They are also a platform which enables companies to more easily raise money through using advanced technology. The company accepts crypto-currencies as investment methods. This expands the ease with which international investors can participate in a Reg A+ offering. The company is essentially a concierge service where they introduce clients to all the different service providers needed, in order to get an offering out to market.
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