Recently the SEC updated its rules to simplify the patchwork of regulations to help companies in fundraising mode. This matters to cannabis companies of all types, especially those that want to utilize the available federal exemptions in their securities offerings. In the SEC’s own words, “These amendments will promote capital formation and expand investment opportunities while preserving or improving important investor protections.” To hemp and marijuana companies, these changes mean they will have access to a wider pool of prospective investors. These amendments become effective 60 days after publication in the federal register.
The SEC is really taking big strides this fall. I previously wrote about the SEC’s recent expansion of who and what can qualify as an accredited investor. We can expect future refinements to the SEC’s rules to provide more opportunities for investors looking for opportunities and more guidance for companies looking for safe harbors from legal snags when dealing with investors.
The recently updated rules are designed to help startups and more experienced SMEs that have proof of concept in their business models and are in their first or fifth fundraising round. Below are some highlights.
Increased Offering Limits for Regulation A (Reg A), Regulation Crowdfunding (Reg CF), and Rule 504 (Reg D) Offerings.
Under Tier 2 of Regulation A, the maximum offering amount has been increased from $50MM to $75MM, and the maximum offering for secondary sales has been increased from $15MM to $22.5MM.
Under Regulation Crowdfunding, the offering limit has been increased from $1.07MM to $5MM, which will make this option more attractive to some companies where the crowdfunding model makes sense for their business plan. Accredited investors are no longer limited in the amount they can invest under a crowdfunding offering, and non-accredited investors can now use the higher of their annual income or net worth when calculating their investment limits. The financial statement review requirement has been temporarily extended for 18 months in offerings raising $250k or less within a 12-month period.
Offerings utilizing Rule 504 of Reg D can now raise up to $10MM from $5MM, which will increase the use of these already frequently utilized offerings.
Clarified Rules Governing Investment Offering Communications.
Everybody loves demo day, except for companies that have to either have their securities lawyer with them at the table or CEOs who have to continually wink and nod when they say they are not there to sell an investment opportunity in the business. The rule updates mean that issuers can generally talk openly about investment opportunities to “test-the-waters” without those communications being considered “general solicitation” or “general advertising” that make securities lawyers (and a few CEOs) sweat in their sleep.
Clarified Issuer’s Ability to Move from One Exemption to Another: Avoiding Offering Integration.
Boards and executive officers rarely think in terms of “what issuing exemption will we qualify for” when they are determining the criteria for their capital raise. Generally, they are looking at the company’s needs based on the CFO’s analysis, the availability of capital from interested investors and the CEO’s conversations with existing and prospective investors.
These rule amendments fit more with these reality scenarios – that sometimes a company’s offering may qualify for one or two different exemptions – and that the company may need to switch lanes during the offering process. This is often determined long after they have started communicating with prospective investors, soliciting offers, and probably after the company has made its first sale in the offering. Sometimes companies don’t even think about their offering parameters until well after they have received their first investor funds.
Based on a “facts and circumstances” review, the SEC will generally consider offerings as distinct from each other if they have a 30 calendar day window between them. This often matters when one offering utilizes “general solicitation” of prospective investors while the follow-on offering does not.
Offerings relating to employee benefit plans (Rule 701) or offerings by international companies (Reg S) or companies with a registered offering (as opposed to an exempt offering) will not be integrated with other offerings, subject to certain criteria.
Utilization of Special Purpose Vehicles (SPVs).
One reason why crowdfunding has not taken off in hemp and marijuana businesses is because no sane company executive team wants to deal with hundreds or thousands of investors in exchange for a $100 or even a $1,500 investment from each of the investors. They are just not worth the hassle. But the new rule amendments permit the use of certain SPVs for Reg CF and Reg A offerings. This is a boon to cannabis companies, and we may see more crowdfunding offerings by cannabis companies that are willing to deal with a single SPV investment entity as long as someone else deals with the SPV’s investors.
2020 has been a banner year for the SEC, even if the rest of the world is faltering or crumbling. We can expect continuing refinements from the SEC moving forward because the definitions of “sophisticated investors” and what it means to “protect” them will continue to shift.
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