Guest Blogger Jillian Sidoti: Powerful Tools to Raise Big Money

Jillian Sidoti of  Trowbrdge, Taylor, and Sidoti probably has more experience working with real estate entrepreneurs to raise money than ANYONE in the U.S. So what does she think of the Jobs Act?

POWERFUL TOOLS TO RAISE BIG MONEY: REG D, RULE 506(C), REG A+ & CROWDFUNDING 

By Jillian Sidoti

On  June  19,  2015,  the  SEC  fully  adopted  Title  IV  of  the  JOBS  Act,  with  the  objective  of  facilitating  easier   access  to  private  capital  formation  for  small  companies.  Regulation  A+  updates  and  expands  on  the  former   Regulation  A  exemption  for  unregistered  public  offerings,  which  previously  had  a  $5  million  annual  cap,  and   carves  out  two  new  sets  of  rules,  Tier  1  and  Tier  2,  (which  the  SEC  collectively  calls  Regulation  A+),  with  annual   limits  of  $20  million  and  $50  million,  respectively,  that  small  securities  issuers  can  legally  use  to  advertise  and   raise  capital  from  private  investors.1

In  September  2013  the  SEC  authorized  advertising  to  accredited  investors  under  a  new  Regulation  D,  Rule   506(c)  exemption  pursuant  to  Title  II  of  the  JOBS  Act.2  However,  because  it  is  estimated  that  only  10  percent  of   all  investors  in  the  U.S.  are  accredited,  even  with  the  ability  to  advertise,  many  issuers  found  themselves  hitting   a  wall  when  it  came  to  raising  private  money,  and  many  otherwise-­‐qualified  investors  were  left  out  in  the  cold.

Regulation  A+  seeks  to  solve  that  problem  by  allowing  advertising  of  securities  offerings  to  the  general   public  with  a  streamlined  pre-­‐approval  process.  Under  Tier  I,  anyone  can  invest  with  no  financial  limitations.   Under  Tier  II,  anyone  can  invest  up  to  10  percent  of  his  or  her  net  worth  or  10  percent  of  his  or  her  gross  annual   income  (whichever  is  greater).  This  opens  up  a  new  audience  for  issuers  who  can’t  access  enough  accredited   investors  to  fund  their  deals,  and  who  already  know  a  lot  of  unaccredited  (and  deserving)  investors  who  would   like  to  invest  with  them.

WHY  IS  THIS  IMPORTANT  TO  REAL  ESTATE  INVESTORS?    

Real  estate  entrepreneurs  commonly  raise  money  from  private  investors  in  exchange  for  “promissory  notes”   or  “investment  contracts”,  both  of  which  fall  within  state  and  federal  definitions  of  “securities”.  An  “investment   contract”  is  an  investment  of  money  in  a  common  enterprise  with  an  expectation  of  profits  based  solely  on  the   efforts  of  the  promoter.  SEC  v.  W.  J.  Howey  Co.  328  U.S.  293  (1946).  Under  The  Securities  Act  of  1933,  all  offers   and  sales  of  securities  must  be  “registered”  (pre-­‐approved)  unless  exempt  from  registration.  Serial  borrowers   whose  business  depends  on  repeatedly  issuing  promissory  notes  to  private  lenders,  and  investors  who  sell   passive  investment  opportunities  to  private  investors,  must  qualify  for  an  exemption  (by  following  a  specific  set   of  rules)  unless  they  obtain  pre-­‐approval  from  securities  regulators  to  sell  the  securities  in  a  public  offering.

Typically,  small,  private  companies  and  real  estate  syndicators  had  to  rely  on  exemptions  under  Regulation  D   of  the  Securities  Act  of  1933.  Most  Regulation  D  rules  (called  private  placement  offerings)  prohibit  general   solicitation;  restrict  offers  or  sales  to  investors  who  meet  certain  financial  qualifications,  and  some  rules  (Rule   504  and  505)  limit  the  dollar  amounts  that  can  be  raised.

1  The  term  “issuer”  refers  to  a  legal  entity  …  that  develops,  registers  and  sells  securities  to  the  investing  public  in  order  to   finance  its  own  operations.  www.investinganswers.com/financial-­‐dictionary/investing/issuer-­‐2236.

2  Per  Rule  501,  an  accredited  investor  is  an  investor  who  earns  a  minimum  of  $200,000  a  year  as  a  single  person;  earns  a   minimum  of  $300,000  a  year  as  a  married  couple;  or  has  a  minimum  net  worth  of  $1  million—exclusive  of  equity  in  their   primary  residence.

REG D, RULE 506(C), REG A+ & CROWDFUNDING

Under  Regulation  D,  Rule  506(c),  issuers  can  advertise  their  investment  opportunities  to  the  public,  and  there  is   no  dollar  limit,  but  they  are  limited  to  accepting  funds  from  accredited  investors  (as  defined  under  Rule  501).  Under   Rule  506(c),  accreditation  must  be  verified  by  tax  return  or  income  review,  or  through  third-­‐party  verification.
Regulation  A,  pre-­‐JOBS  Act,  was  the  only  federal  securities  exemption  that  allowed  issuers  to  raise  money  from   unaccredited  investors  using  general  solicitation.  However,  the  original  Regulation  A  was  not  a  popular  choice,  as  it   only  allowed  an  issuer  to  raise  up  to  $5  million  in  a  12-­‐month  period  and  required  state  pre-­‐approval  prior  to   advertising;  and  the  legal  and  filing  costs  were  prohibitive  for  such  a  small  offering.  Few  affordable  attorneys  would   take  on  Regulation  A  offerings  and  the  approval  process  could  be  challenging,  time-­‐consuming  and  frequently   delayed  by  both  the  SEC  and  the  state  securities  agencies.  For  many,  the  ability  to  advertise  wasn’t  worth  the  cost   or  the  effort,  and  they  would  instead  fall  back  on  the  federal  Regulation  D  and  its  restrictions  or  confine  their   offerings  to  a  single  state  so  they  could  operate  under  state  exemptions  (often  limited  to  $1  million).  Of  the   Regulation  A  offerings  filed  between  2008  and  2013,  Attorney  Jillian  Sidoti  of  Trowbridge  Taylor  Sidoti  LLP  filed  40%   of  the  real  estate  related  filings  and  she  filed  the  only  Reg  A  real-­‐estate  related  filing  that  was  approved  by  the  SEC  in   2011.  The  adoption  of  Regulation  A+,  with  its  streamlined  electronic  filing  process,  is  expected  alleviate  many  of   these  issues.

Regulation  A+,  TIER  1    

Regulation  A+,  Tier  1  is  an  amended  version  of  the  former  Regulation  A.  Tier  1  issuers  may  now  raise  up  to  $20   million  as  opposed  to  the  old  $5  million  limit.  It  is  also  expected  that  Tier  1  offerings  will  be  eligible  for  filing  through   the  SEC’s  Electronic  Data  Gathering,  Analysis  and  Retrieval  (EDGAR)  system,  which  was  previously  unavailable  and   required  voluminous  paper  filings.  By  being  able  to  file  Tier  1  offerings  electronically,  issuers  will  be  able  to  see  their   uploaded  filings  in  real  time.

Tier  1  does  not  have  any  audit  requirements.  This  is  great  for  those  issuers  looking  to  save  on  audit  and   accounting  costs  as  audits  can  be  expensive,  but  the  tradeoff  is  that  audits  give  investors  peace  of  mind  and  a  sense   of  transparency.  However,  Tier  1  issuers  must  still  get  state  pre-­‐approval  of  the  offering  before  they  are  allowed  to   advertise.  This  means  that  in  order  to  sell  its  securities,  a  Tier  1  company  must  subject  itself  to  the  scrutiny  of  every   state  where  it  intends  to  sell  securities.  The  review  fees  for  such  states  (ranging  from  as  little  as  $100  to  $5,000  per   state)  could  potentially  exceed  the  cost  of  an  audit.

Regulation  A+,  TIER  2    

The  new  Regulation  A,  Tier  2,  will  allow  issuers  who  meet  certain  requirements  to  raise  up  to  $50  million  in  a   12-­‐month  period.  Tier  2,  like  Tier  1,  will  allow  for  general  solicitation  and  uploading  of  filings  to  the  EDGAR  system.   Tier  2  issuers  will  be  required  to  perform  a  pre-­‐approval  audit  prior  and  for  a  minimum  of  three  years  post-­‐approval.   The  Tier  2  issuer  must  also  hire  a  ‘transfer  agent’  and  has  certain  ongoing  reporting  requirements  similar  to  a  public   ‘smaller  reporting  company,’  including  annual,  semiannual  and  current  event  reports.

Despite  the  audit  and  additional  filing  requirements,  Tier  2  pre-­‐empts  the  state  pre-­‐approval  requirements  of   Tier  1,  making  Tier  2  a  more  appealing  option  for  those  who  wish  to  raise  money  from  investors  in  multiple  states.   The  notice  requirements  required  by  the  states  are  expected  to  be  similar  to  a  Form  D  filing  under  Regulation  D.

Both  Tier  1  and  Tier  2  issuers  will  be  able  to  enjoy  the  benefits  of  “testing  the  waters.”  Issuers  will  be  able  to  file   advertising  materials  to  be  used  to  gauge  interest  prior  to  approval  of  the  offering.  This  is  helpful  for  figuring  out   what  to  offer  investors,  what  would  be  of  interest  to  investors  and  to  build  a  prospective  investor  list.  They  simply   can’t  collect  any  money  until  the  offering  has  been  approved.

REG D, RULE 506(C), REG A+ & CROWDFUNDING
 
CROWDFUNDING  YOUR  DEALS  IN  A  POST  JOBS-­‐ACT  WORLD  

Crowdfunding  is  the  latest  buzzword  in  capital-­‐raising  since  enactment  of  the  federal  JOBS  Act  in  April  of  2012.   The  word  “Crowdfunding”  has  become  a  generic  term  used  to  describe  advertising  for  investors  authorized  under   various  sections  of  the  JOBS  Act.  A  brief  history  of  Crowdfunding  follows:

  • Crowdfunding   was   allowed  pre-­‐JOBS  Act,  but  only  for  not-­‐for-­‐profit  ventures.  Pre-­‐JOBS  Act,  for-­‐profit   companies  could  not  advertise  for  investors  unless  they  had  an  approved  intra-­‐state  offering  (with  all  investors,   assets,  and  issuer  in  one  state),  an  SEC-­‐approved  Regulation  A  offering,  or  a  public  offering.
  • Title  II  of  the  JOBS  Act  directed  the  SEC  to  draft   regulations  allowing  advertising  of  offerings  limited  to   accredited  investors,  which  resulted  in  the  SEC’s  adoption  of  Regulation  D,  Rule  506(c)  in  September  2013.  After   adoption,  the  media  and  capital-­‐raising  marketplace  quickly  adopted  the  term  Crowdfunding  to  apply  to   advertising  of  such  offerings.
  • Title  III  of  the  JOBS  Act  authorized  the  SEC  to  draft  regulations  for  a  new  “Crowdfunding  exemption”  that  would   allow  issuers  to  raise  up  to  $1  million/year,  in  offerings  that  could  be  advertised  and  sold  via  SEC-­‐approved   “Funding  Portals”,  where  anyone  could  invest  up  to  $2,000  or  up  to  a  maximum  of  10%  of  their  annual  income   of  net  worth  (subject  to  certain  limitations).  In  its  proposed  regulations  for  Title  III,  SEC  introduced  the  term   “Regulation  Crowdfunding”,  to  differentiate  Title  III  offerings  from  the  media’s  generic  use  of  the  term.   Unfortunately,  the  proposed  rules  for  Regulation  Crowdfunding  appear  to  have  fallen  into  a  regulatory   quagmire,  with  dissension  among  FINRA  (the  self-­‐regulatory  organization  for  licensed  securities  broker/dealers),   the  SEC,  and  state  securities  regulators  as  to  their  final  form.  Until  the  final  rules  are  adopted  (if  ever)   Regulation  Crowdfunding  under  the  Title  III  Crowdfunding  exemption  described  in  the  JOBS  Act  is  still  illegal.  It   is  postulated  that  additional  Regulation  Crowdfunding  legislation  may  be  proposed  to  resolve  these  issues.
  • Title  IV  of  the  JOBS  Act  authorized  Regulation  A+  offerings.  So  now  advertising  of  Regulation  A+  offerings  is  also   being  lumped  in  with  the  generic  use  of  the  term  ‘Crowdfunding’.

After  the  SEC’s  implementation  of  Title  II  and  Title  IV  of  the  JOBS  Act,  many  “Crowdfunding  Platforms”  have   arisen  whose  sole  purpose  is  to  advertise  eligible  Rule  506(c)  and  Regulation  A+  offerings.  Crowdfunding  Platforms   are  merely  a  means  for  an  issuer  to  advertise  an  existing  securities  offering,  meaning  the  issuer  must  already  have   an  offering  under  Rule  506(c)  or  Regulation  A+  in-­‐hand  before  they  can  use  a  Crowdfunding  Platform  to  promote  it   to  their  investors.  These  Crowdfunding  Platforms  are  of  four  primary  types:

  1. Securities  broker-­‐dealers  who  advertise  eligible  offerings  to  their  prequalified  investors;
  2. Registered  investment  advisers  who  participate  and/or  recommend  eligible  offerings  to  their  clients;
  3. Crowdfunding  platforms  who  advertise  eligible  offerings  to  their  database  of  investors  for  a  marketing   fee  and/or  back-­‐end  profits;  and
  4. The  issuer’s  own  website.

So,  although  it  is  true  that  issuers  can  now  advertise  their  offerings  to  investors  under  federal  law,  currently   under  Rule  506(c),  and  later  under  Regulation  A+  (once  an  issuer’s  specific  offering  has  been  approved),  the  new   rules  are  not  a  wholesale  license  for  everyone  to  advertise  real  estate  investment  opportunities  to  anyone  at   anytime.  There  are  legal  requirements  for  both  Rule  506(c)  and  Regulation  A  offerings  that  must  be  met;  the  proper   disclosure  documents  and  investor  agreements  must  be  drafted;  and  regulatory  filings  must  be  submitted  to  the   SEC  and  state  regulators;  and  in  the  case  of  Regulation  A+,  the  offering  must  be  pre-­‐approved  before  funds  can  be   collected.    Only  then  can  an  issuer  advertise  and  collect  money  from  investors,  subject  to  applicable  investor   verifications,  limitations,  and  reporting  requirements.

REG D, RULE 506(C), REG A+ & CROWDFUNDING

The  Bottom  line:   Regulation  A  filers  will  be  able  to  enjoy  the  perks  of  Crowdfunding,  such  as  using  a   Crowdfunding  Platform  to  advertise  and  sell  their  securities,  or  to  advertise  their  offering  on  their  own  website.   Unlike  Rule  506(c)  filers  however,  Regulation  A  filers  will  not  be  restricted  to  accredited  investors.  Tier  I  offerings   will  be  subject  to  SEC  and  state  pre-­‐approval,  but  no  audits.  Tier  II  offerings  will  be  subject  to  SEC  approval  and  state   notice  filings,  ongoing  filing  and  annual  audit  requirements.

Is  Regulation  A+  the  right  choice  for  all  issuers?  No,  but  it  is  ideal  for  seasoned  issuers  who  have  already  had  a   number  of  private  placement  offerings  and/or  those  who  are  ready  to  take  their  real  estate  investment  companies   public,  and  who  have  time  to  wait  before  they  need  to  start  raising  money.  Due  to  the  anticipated  6-­‐month+   timeframe  for  approving  Regulation  A+  offerings,  this  isn’t  a  good  choice  for  someone  with  a  property  under   contract  and  a  90-­‐day  closing  date  (who  would  be  better  served  with  a  Rule  506  offering,  but  it  can  be  an  excellent   choice  for  hard  money  lenders,  serial  borrowers,  fix  and  flippers,  or  commercial  investors  with  track  records  who   want  to  raise  money  to  buy  multiple  properties  under  a  single  offering  or  “blind  pool”  scenario.
Below  are  some  highlights  of  the  differences  between  Regulation  D,  Rule  506  and  Regulation  A+:

graph

 

WHAT’S  YOUR  QUESTION?    

Jillian  Sidoti  and  Kim  Lisa  Taylor  are  partners  in  the  law  firm  Trowbridge  Taylor  Sidoti  LLP,  whose  law  firm   specializes  in  corporate  and  real  estate  securities  matters  such  as  private  placement  and  public  securities  offerings   including  Regulation  D,  Regulation  A+,  Form  10,  and  From  S-­‐1  filings.  Both  Jillian  and  Kim  are  frequent  speakers  at   seminars  educating  real  estate  investors  on  how  to  legally  raise  capital  for  their  real  estate  investment  projects  or   new  business  ventures.  Contact  Jillian  Sidoti  at  Jillian@SyndicationLawyers.com  or  (323)  799-­‐1342,  or  Kim  Lisa  Taylor  @   Kim@SyndicationLawyers.com  or  (904)  584-­‐4055  to  schedule  a  free  consultation.

NOTE:  This  information  is  of  a  general,  educational  nature  and  may  not  be  construed  as  legal  advice  pertaining  to   your  specific  offering,  exemption,  or  situation.  Any  such  advice  must  be  sought  from  your  own  attorney  pursuant  to  an   attorney-­‐client  relationship,  after  consideration  of  your  specific  facts  or  questions.     ©  2015  Trowbridge  Taylor  Sidoti  LLP  v2.    

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