A new investing and finance rule that will provide more opportunities for startups to attract early-stage capital and more options for investors to get involved in the space took effect last Friday. Passed on March 25, 2015, and taking effect last Friday, the United States Securities and Exchange Commission (SEC) adopted a new version of Regulation A, which provides an exemption from the SEC’s registration requirements for smaller companies making an initial public offering, like AgTech startups and similar entrepreneurs.
Often referred to as Regulation A+, the new rules allow smaller companies to offer and sell up to $50 million of securities to accredited and non-accredited investors in a 12-month period, subject to eligibility, disclosure, and reporting requirements. “These new rules provide an effective, workable path to raising capital that also provides strong investor protections,” said SEC Chair Mary Jo White. “It is important for the Commission to continue to look for ways that our rules can facilitate capital-raising by smaller companies.”
Regulation A+ recognizes two tiers of offerings. Tier 1 is designed for offerings of securities of up to $20 million in a 12-month period, with not more than $6 million in offers by selling security-holders that are affiliates of the issuer. Tier 2 is for offerings of securities up to $50 million in a 12-month period, with not more than $15 million in offers by selling security-holders that are affiliates of the issuer.
Both Tier 1 and Tier 2 are subject to a number of basic requirements, while Tier 2 offerings are subject to an additional set of disclosure and ongoing reporting requirements. One of these additional requirements includes a limitation on the amount of securities non-accredited investors can purchase in a Tier 2 offering of no more than 10 percent of the greater of the investor’s annual income or net worth.
One aspect of Regulation A+ that could be particularly interesting to start ups is the “testing the waters” rule, allowing startups to essentially go out and ask anyone whether they’d be interested in investing in their company, after performing the required due diligence with a securities lawyer. During the test, potential investors can express their interest without having to make a securities purchase. In return, the startup can gather a mailing list of potential future investors and use a licensed broker dealer to sell the equity to those investors. Many are referring to this new marketing option as Kickstarter-Lite. The startup can advertise its product or service and drum up interest in the business without actually selling during the campaign. For many small-scale startups, this provides a more economically feasible way to go about early-stage fundraising.
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The regulation also removes major hurdles to amassing capital from non-accredited investors. For the past 80 years, only accredited investors have been authorized to invest in American startups. An accredited investor is an individual that meets the net worth requirements established in SEC Regulation D. Individuals who do not meet the minimum threshold of Regulation D are called non-accredited investors. In general, a non-accredited individual investor is someone who has a net worth of less than $1 million, including a spouse, and who earns less than $200,000 annually, or $300,000 including a spouse, in the last two years.
In ordinary circumstances (Reg D, Rule 506(b)/(c) offerings), companies must choose between being limited to having up to 35 non-accredited investors during a round, or being completely prohibited from onboarding non-accredited investors entirely. Considering that accredited investors make up less than one percent of the entire United States population, welcoming the other 99 percent to the table creates huge opportunities for startups seeking capital.
Allowing a larger role for non-accredited investors–and the general public–to participate in early-stage fundraising marks a major opportunity for growth in the AgTech sector, particularly for startups that engage in substantial pre-market testing. Many farmers and agriprofessionals are skeptical of new products, wary that they are being sold snake oil. As a good faith gesture and indication of a company’s confidence in their product or service, many startups have offered limited-participation trials for farmers interested in seeing what the product or service is all about. In many instances, this creates a loyal fan base that has seen firsthand how beneficial the startup’s technology can be.
Now, Regulation A+ allows these early supporters to provide early-stage capital support in addition to promoting the product among their fellow farmers. This also creates an increased incentive for entrepreneurs to offer pre-market trials to farmers with the hopes of selling them on the product and engaging them as an early-stage investor. First-users of a product are often the most loyal customers and believe wholeheartedly in the company behind the product or service. Allowing those individuals to snag a stake in the company during its infancy provides even more incentive for investors and entrepreneurs to hit the soil running.
Removing some of the restrictions regarding non-accredited investors also allows investors outside the food and agriculture who truly believe in a startup’s product or service to become involved earlier in the process. Many investors are turning their attention and wallets towards socially conscious startups that are aiming to find sustainable solutions to many issues surrounding food production and supply, like hunger, resource conservation, and sustainable farming. Regulation A+ will allow these non-accredited altruistic investors to jump into the AgTech sector, where many companies are hot on the trail of innovative solutions to many of the current issues facing modern farmers.
Some commentators, including Peerbackers and Crowdcast Network CEO and Co-Founder Sally Outlaw, have expressed a number of reservations regarding the new rules, particularly for small and medium-sized companies. According to Outlaw, a major danger of Regulation A+ is that companies who pursue funding through this avenue will become a public company, “and it comes with all the costs, compliance, and distractions that this implies.” Crowdfunding expert Dara Albright, agreed, adding that Regulation A+ may lure some companies into going public before they have really proved their business model. On top of these concerns, seeking funding through Regulation A+ will cost many startups a substantial amount of money, particularly when it comes to paying SEC compliance lawyers’ fees.
There are equal risks on the investor side of the Regulation A+ equation. Some investors eager to get involved with a startup may lack the necessary education to understand a business venture and whether making a contribution adds up to a smart investment.
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