Diaries of an OTC Financier: Why Reg A Offerings Suck
Little Upside and A Lot Of Downside
Since the passage of the JOBS Act in 2012 and subsequent passage of Reg A+ legislation in 2015, many companies have used this new legislation to successfully raise growth capital from retail investors, both accredited and unaccredited. Crowdfunding websites have also taken advantage of the action in order to earn hefty commissions off loads of retail investors.
We talk to OTC listed companies all the time about financing options, and every once in a while we hear a CEO say “thanks for your offer, but we’re going to raise money in a Reg A offering.” Or “we appreciate your offer, but we already have a Reg A outstanding.” Funny enough, they usually call back a few months later – bear with us, we will explain why in this article.
We have nothing against Reg A offerings. In fact, we think they make a lot of sense for private companies. However, for public companies, they do not make sense and are often a poor option compared to quicker and cheaper alternatives. Let us explain.
Problem #1: The Money is NOT Guaranteed to Come.
Unfortunately, the following story is all too common: We recently spoke to a company with an existing Reg A offering outstanding. They were really unhappy that investors were not buying their Reg A offering – after all, the firm that did their Reg A offering told them it was likely going to be a massive success. They had made big growth plans, put out PR saying they were going to raise several million dollars which they needed to implement their business plan. In the end they did not even raise a quarter of what they needed.
In summary, If you take a convertible note, 3(a)(10) liability for equity conversion, or an equity line, you know exactly how much money you are going to get. Granted, you don’t know at what price you will eventually sell your equity at, but at least you know you will get what you need. This is better than being stuck without anywhere near the money you need through a Reg A.
Problem #2: The Public Market Adjusts its Price Quickly.
In the private market, investors buy a Reg A offering because it is the only way they can have a piece of your business. In the public market, they have alternatives. Therefore, your Reg A has to be priced at a sizeable discount to the public market, or else no one is going to participate.
The only problem is, as soon as you announce your Reg A, your existing shareholders will sell out of what they already own and buy the Reg A offering instead. Doing so they will save money and own your shares at a much cheaper price.. Granted, not every single shareholder will, but any of them with a brain will! Alternatively, investors will buy the Reg A and then sell ASAP to net the difference. Either behavior will drive your share price down. As a result, the public market adjusts downward quickly to your Reg A price and now the Reg A price is no longer attractive.
In the example of the company we were talking to, they were upset that, after mediocre initial interest, no one would buy their offering. We said “look, it might have been priced at a big discount when you announced it, but now it is not. The discount is not big enough for us to bother taking the risk, especially given that you have little liquidity in the name.“
In summary: You likely will end up with a beaten down share price yet still not raise your targeted amount, putting yourself in a lose-lose situation.
Problem #3: It Costs a Lot of Money to File a .
Reg A offerings require a type of prospectus referred to as “offering circular” to be filed with the SEC. When you say offering circular, lawyers see dollar signs. We know a lawyer well who charges $30,000 for an offering circular and many law firms would think this is low. This type of prospectus for a publicly traded company is a lengthy and complex document that has many required disclosures. It will require a lot of money and time to have it prepared.
In summary: While the results are questionable at best, a Reg A is highly expensive and time consuming to prepare, both for you and your counsel.
Problem #4: It Can Take Months to get SEC Approval of Your Prospectus.
Yes, this is true. The SEC will typically respond with comments about a month after you submitted the initial draft of your offering circular. It is common to have another two months go by before this document is approved. Three months is an eternity in the life of a small growing company with aggressive competitors.
In summary: The complexity of the required documentation can, and often does, lead to unknown delays. We have seen this situation force OTC companies to negotiate quicker and highly expensive bridge financings to cover their interim capital needs.
Problem #5: If You Want to Adjust the Price of the Offering, You have to Re-file the Prospectus.
Let’s assume you’re one of these companies whose price adjusted downward quickly, and now no one is buying the Reg A stock anymore. Perhaps you are interested in lowering the price further to attract more buyers.
Now you have to go back to the SEC and refile your offering circular. That costs more lawyer money and more time. Obviously, it is not a large change, but it can still take a month to get approved.
In summary: Regulatory inflexibility requires you to spend more time and money to combat some of the problems associated with Reg A offerings. Meanwhile, your cash burn persists and you may have to take an expensive bridge financing with your back against the wall.
For publicly traded OTC companies, Reg A offerings are a suboptimal solution with many drawbacks.
Here is a summary of the issues:
- There is no guarantee that you will raise any money. Likely you will raise less than you want.
- The public market will quickly adjust downward to the Reg A price, at which point no one will want to buy the Reg A shares.
- Preparing a Reg A costs a lot of time and money.
- Adjusting the offering price later costs more time and money.
- You may have to get highly expensive bridge financing in the meantime from a position of weakness, while you are waiting for the SEC to clear your registration statement.
There are many financing alternatives, like a convertible note, 3(a)(10), or an equity line, which will provide you the necessary funding more quickly, more cheaply, and with a lot less work. While all financings have their own pros and cons, all of these alternatives will provide you with a guaranteed amount of funding, vs. the hope of funding in a Reg A offering. In the end, getting the money you need for your business to succeed is the most important criteria.
In future articles we will discuss in detail the following financing structures and their benefits and drawbacks:
- Equity Lines
- Convertible Notes
- 3(a)(10) Liability for Equity Conversions
- Unit Financings
We will also cover regulatory requirements, discounts, and explain how to negotiate the best deal possible for financing your business.
Stay tuned for more and in the meantime, if you are looking for financing, don’t hesitate to contact us here.