After nearly two decades watching the literal decimation of public small-cap companies, financial regulators and lawmakers are finally taking steps to repair this critical segment of the economy and capital market. One of the most promising new rules is a part of 2012’s JOBS Act known as Regulation A+. Having taken effect in June 2015, Reg A+ allows companies to raise as much as $50 million with significantly less regulatory red tape in the process, providing entrepreneurs and startups an avenue to the access of capital with much less arduous reporting and costly legal fees. But in the year-and-a-half since going into effect,, the traction for Reg A+ has been mixed. While there have been some very constructive milestones, the progress has mostly come gradually. So, what will it take for Reg A+ to become as robust as many had hoped?
To figure that out, industry leaders participated in a thoughtful and balanced discussion of the catalysts and obstacles facing Reg A+. Held on the floors of the New York Stock Exchange, the Bringing Back the Small Cap IPO: 2017 Reg A+ Outlook panel featured perspectives from various constituents of the capital formation process: Paul Dorfman, Managing Director, Listing and Liquidity at NYSE; David N. Feldman, Partner at Duane Morris LLP; Mark Elenowitz, CEO and Founder of BANQ®, which is the electronic division of TriPoint Global Equities, LLC; Darren Marble, CEO of CrowdfundX; and Shawn Nelson, Founder of Lovesac, which is in the process of its own Reg A+ raise.
Feldman, who served as the panel’s moderator, started by providing a progress report of sorts for Reg A+. He noted that there have been 20 deals closed to date, raising a total of $190 million. More importantly, he shed light on what the industry has seen over the past year and a half since Reg A+ went into effect.
“We are seeing, in fact, expedited SEC review with an average of 74 days to get through the SEC,” Feldman said. “We’re seeing Wall Street partnering with Main Street… where traditional underwriting is combining with the brave new world of crowdfunding. We’re seeing professional marketing firms… emerge for these testing the water campaigns. We’re seeing many deals that are seeking in the over the counter markets and others looking for the higher exchanges. We are seeing much lower costs. One thing that held us up a little bit, when the rules were adopted in June 2015, two states—Massachusetts and Montana– brought a lawsuit against the SEC seeking to invalidate the new rules saying they exceeded their statute authority. It took until April 2016 for the appeals court in DC to dismiss that case, which it finally did. So many of us feel this didn’t really start until then, because many were standing on the sidelines waiting for this to be resolved.”
Reg A+ Done the Right Way
“What we’ve seen, at least from the get-go, has been companies looking to do this on their own without utilizing an underwriter or an investment bank to help them,” Elenowitz said. “While that’s something that’s exciting, and it’s great that an issuer now has the opportunity to do that, in reality it just didn’t work. The reason it doesn’t work is people have lost the understanding that people don’t buy stock, you have to sell it to them, and you need to have a professional team around you that understands what it means to be a public company and how to go through the process to become public. It’s much more than just sending an email and expecting somebody to get involved.”
Elenowitz said his investment bank treats Reg A+ offerings exactly like they’d treat a public IPO… The only exception being that the filing process is much more relaxed, and issuers are allowed to communicate their story to investors. Or as Elenowitz puts it, “be loud and proud,” since Reg A+ requires no quiet period. Unlike a traditional IPO, Reg A+ issuers are allowed to disseminate details of their offerings and company value propositions any way they can, including on social media and online.
For this reason, Marble says issuers should view their Reg A+ raise as a great marketing opportunity, as well. It’s why companies that have done best with Reg A+ are consumer-oriented, product-driven companies with a built-in following.
“The foundation of any great marketing campaign is an incredible story, and yet, the story has been maybe the most overlooked aspect in terms of how these deals have been marketed, especially the ones that haven’t worked,” Marble said. “This is an opportunity for an issuer to inspire people to invest. The story needs to not only emotionally inspire people, but it needs to sell vision, mission, and values. Those are the things that the average, unaccredited person actually invests in. We’ve seen in the past 18 months a lot of passion investing, where, believe it or not, the primary motivation for an unaccredited person may not be financial return. Not everybody understands that, but it’s actually true.”
Once the story is crafted, the issuers must package it in a way that resonates with investors. Typically, that’s where experienced marketers come in, Marble added. He pointed to Lovesac, which is working toward a Reg A+ offering, as a good example of this.
While most companies looking to Reg A+ are newly formed startups, Lovesac has actually been around since 1998. But new isn’t necessarily a prerequisite for Reg A+. What Lovesac has that many others don’t, however, is a loyal customer base that the company can look to for potential investors.
“I think Lovesac is one of those companies that is uniquely suited for this type of financing,” Nelson said, pointing to its loyal customer base and social media following. “This loyal customer base is what we expect to be able to drive this Reg A+ offering in this fashion … It’s going to be very interesting for me to watch how this unfolds. Lovesac has raised money in the past through venture capital, through private equity rounds, and this is an entirely new possibility that’s open to us, and we’re really excited about what that means.”
But a successful raise through Reg A+ is far from the finish line. In fact, in many ways, it’s only the beginning of an issuer’s journey toward becoming a full-fledge publicly traded company.
“The opportunity for the NYSE and really for the issuer is to make that leap to become a national-exchange-listed issuer,” Dorfman said. “We think there are great opportunities for you, should you take that next step after Reg A+ to secure a national exchange listing, because it doesn’t automatically occur. Once you close your Reg A deal, you still then need to meet the initial listing standard, and those standards are out there and known by all the experts. So if a company wants that to be the endgame result, they should be mindful of how much they need to raise, and how much they need to plan their company infrastructure.”
The Next Step for Reg A+
While it’s still early, it’s clear that the past 18 months have proven that Reg A+ is a viable option for issuers looking to raise capital. Granted, there are specific attributes that make some campaigns more viable than others. But what about the companies that fall out of the sweet spot of Reg A+? Is there a place for them?
“At some point in the near future, a B2B enterprise company will be able to raise millions of dollars without having a consumer product or email list, but we’re not there yet,” Marble said. “I believe the future of online investing is data-driven, and I think the first phase is consumer products companies that have customers and fans … The final step is this data-driven future where there is going to be databases that are highly segmented where the behavior of each investor is really profiled to the nth degree. We may have 100 to 150 data points on every single person.
The role of technology to potentially reshape capital formation cannot be understated. It’s why proponents of Reg A+ and equity crowdfunding are so optimistic of the future because it may just be the key to bringing back the small-cap IPO. As mentioned before, traditional small-cap IPOs were actually very common back in the 1990s, but unintended consequences of regulation drained the financial incentives for underwriters and other market participants to support them, rendering them unviable for issuers.
“The question is, how do we make money,” Elenowitz said. “[In 1989], we had huge spreads and everybody was making money. Those spreads have changed. The ability to mark up has changed, and the competitive landscape has changed. So when we look at Reg A, and we’re looking at it from a sales perspective, we have a great tool in our arsenal now. That’s an unpaid salesman, [which is] the web and the crowd. As an underwriter, I pay my salesman and I pay my syndicate to go out and market. Well now I don’t have to pay a fee. So if I’m getting a third or a half of the offering from the crowd, myself as the firm and the underwriter, we make a lot more money. It’s not going to be quite the spreads we used to see, but we’re making it in a different way because we don’t have the sales expense that’s associated with traditional underwriting because the crowd comes without a commission.”
By creating a more efficient market structure for underwriters and institutional firms, the hope is that Reg A+ can serve to build a more friendly infrastructure for small-cap issuers. As it gains traction, larger participants will enter the arena, providing additional credibility and awareness for the ecosystem, enhancing the apparatus of this segment of the capital markets. And if there’s is any question whether Wall Street wants a part of Reg A+, just look at the NYSE.
“Companies still have to go out, they still have to raise the money, they have to do it the right way, and have the right advisors,” Dorfman said. “But they’ll need internal controls. They’ll have to act like a public company. It’s not small-time crowdfunding. If you’re going to be here on the floor of the New York Stock Exchange, you have to be prepared with internal controls, disclosure, all kinds of things a public company must do. So we need companies with scale, sophistication, good outside advice, good inside people, and if they got that, we’re ready to talk to you.”
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