Originally Published at Entrepreneur.com on April 10, 2015
The SEC has opened the doors to JOBS Act equity crowdfunding with the recent passage of Regulation A+. In less than 60 days, this revolutionary new capital raising law will allow a small business to raise up to $50 million per year from both accredited and non-accredited investors.
Sounds simple, doesn’t it? Go online, create a Regulation A+ crowdfunding campaign, and then start cashing millions of dollars in checks.
Not so fast.
The SEC has 453 pages of rules and regulations to follow. This is not as simple as logging into Kickstarter, shooting a cool video, writing a pitch and posting a crowdfunding campaign. Regulation A+ involves the sale of securities in your company. As a result, there are a lot of laws and rules to follow.
Let’s start with the six things you should do now to be ready to use Regulation A+ to raise money from the tens of millions of potential investors in “the crowd” that were off-limits to small businesses before this part of the JOBS Act became law.
1. Incorporate or form an LLC.
Individuals cannot raise money under Regulation A+, only companies can. If you have not formed a company, then you do not have stock or ownership interests to sell.
2. Make sure you have the proper structure for your company.
It is important that your company is set up correctly to be able to sell equity to investors. There will be many different ways to do this, such as setting up a special class of shareholders, for a Regulation A+ offering. There are also numerous legal pitfalls that can occur if you do not do this correctly, so you will want to consult with an experienced attorney.
3. Pick which “tier” you are going to use.
There are two “tiers” under which you can raise capital in Regulation A+. Under tier 1, you can raise up to $20 million in a mini-IPO and there is no requirement of audited financial statements, no limit on amounts to be raised from non-accredited investors and in most cases, no ongoing reporting to the SEC. Here’s the downside to tier 1: you have to comply with the “blue sky” laws of every state in which you plan to raise money. Complying with 50 state securities regulators makes tier 1 unattractive to anyone trying to raise capital from the national crowd of non-accredited investors.
Tier 2 allows you to raise up to $50 million, with no state blue sky-law compliance. Sounds perfect, doesn’t it? But wait, the SEC added the requirement that any company attempting a tier 2 offering must have two years of audited financial statements, which can be extremely expensive. Also, in a tier 2 offering, non-accredited investors can only invest 10 percent of income or net worth. And to top it all off, there will be ongoing reporting requirements to the SEC after your raise the funds.
Tier 1 may makes sense for a business that is only raising money in a contained geographic area and does not need to comply with more than one or two state securities laws. Other than that, I believe most companies will use tier 2. The major expense of tier 2, the audited financials, will likely not be as expensive as people believe for startup and younger companies without significant financial history.
4. Get your financials in order.
As I mentioned before, if you plan to use Tier 2, you will need to have two years of audited financial statements, and the audits must be done by an independent CPA according to generally accepted auditing standards. Even if you are using tier 1, you will have financial disclosure requirements, so making sure your books are in order now is a must.
5. Make sure you have no “bad actors” on your team.
The SEC requires all officers, directors and major shareholders of your company to undergo a “bad actor” background investigation. If you have members of your team who have been in trouble with the law, had securities regulatory issues in the past, or fall into one of the many “bad actor” categories, you may need to replace those individuals.
6. Get your IP in order.
Regulation A+ requires you to disclose a great deal of information about your company to the public. You do not want someone to steal your ideas. If you have patentable technology or business processes, you should have your patents in place, or at least have filed a provisional application. Before you expose your trade name, logo, product or service to the masses, be sure you have secured trademarks where available.