Cryptocurrency companies have become all the rage. That trend may continue for some time. Most companies considering an Initial Coin Offering to U.S. investors have resigned themselves to the fact that their proposed offering is likely considered an offering of securities by the U.S. Securities and Exchange Commission (“SEC”). Thus, it must be made in compliance with U.S. securities laws. As the CEO of a cryptocurrency company that wants to raise capital in the equities markets your next logical question becomes, “what are my options?”
A traditional initial public offering (“IPO”) of equity securities usually requires extensive meetings with underwriters, accountants and lawyers, the preparation of audited financial statements and the filing of voluminous and detailed documents with the SEC. Once a company has completed an IPO, it must comply with the SEC’s extensive on-going disclosure requirements essentially forever.
Regulation D Private Placements
The sale of securities (including securities tokens) may also be conducted as a private placement under Regulation D of the Securities Act, particularly Rules 506(b) and (c). Rules 506(b) and (c) of Regulation D allow issuers to raise an unlimited amount of funds from “accredited” investors.
Issuers conducting an offering under Rule 506(b) may also allow up to 35 sophisticated but non-accredited investors to participate in their offering, but there are heightened disclosure requirements that apply. No such exceptions apply to Rule 506(c) offerings, which may be made only to accredited investors.
Aside from the unlimited offering potential, one other big advantage for many issuers using the Rule 506 exemptions is that the securities issued do not have to be registered with the SEC and thus there is no SEC review process. Aside from a short Form D that must be filed with the SEC within 15 days of the first sale of securities with basic details of the offering (i.e., maximum dollar amount of securities being offered, number of investors, industry group, etc.), there are no other SEC filing requirements and no on-going disclosure requirements.
Issuers using one of the Rule 506 exemptions will typically provide prospective investors with offering documents such as a private placement memorandum (which is subject to antifraud liability), but the costs, both financial and timewise, associated with Rule 506 offerings are significantly less than a traditional public offering.
There are some drawbacks to conducting an offering under Rule 506. In addition to limiting the sale of the securities to accredited investors (barring the limited exception provided under Rule 506(b)), the most significant drawback of Rule 506 offerings is the securities offered and sold in this offering are deemed “restricted” securities under U.S. securities laws. Therefore, they must generally be held by the purchaser for one year before they may be resold. In addition, while Rule 506(c) offerings permit general solicitation and advertising, issuers conducting 506(b) offerings may not participate in any general solicitation or advertising.
Reg A+ Offerings
There is an alternate path that has been gaining a lot of attention in crypto circles recently, and that is the exemption provided by Regulation A+ of the Securities Act, deemed by some the “mini-IPO.”
Regulation A+ was passed under the JOBS Act as an improvement to the predecessor Regulation A exemption. It provides a more streamlined process than the typical IPO. Like an IPO, Regulation A+ permits eligible issuers to offer securities to the general public, not just to accredited investors. Issuers relying on Regulation A+ are required to file a Form 1-A with the SEC, which is subject to SEC review and approval, unlike Regulation D offerings which are not reviewed and issuers do not need to wait for approval prior to issuance.
The crux of the Form 1-A is the offering circular, which must contain financial statements and other information similar to, but less extensive than, what would be required in a registration statement albeit significantly more extensive than what is typically included in an initial coin offering white paper.
Aside from the ability of the issuer to offer securities to the general public under Regulation A+ (subject to the non-accredited investor caps imposed by Tier 2), one of the most significant advantages of Regulation A+ when compared to Regulation D is that securities issued in a Regulation A+ offering are not “restricted” securities and are freely tradable. One should note, however, that the potential for a trading market actually developing, and the potential for real liquidity, particularly for tokens and coins, should be evaluated carefully. In reality, such markets may not exist.
Another benefit to Regulation A+ is that it allows issuers to “test the waters” or solicit interest in a potential offering either before or after the filing of the Form 1-A, subject to certain conditions. However, Regulation A+ offerings are subject to offering caps, unlike Rule 506 offerings, as described below.
Regulation A+ consists of two offering categories: Tier 1 allows offerings up to $20 million and Tier 2 allows offerings up to $50 million. Other significant differences between the two offering tiers are that Tier 2 offerings require audited financial statements, ongoing SEC disclosure requirements (albeit to a lesser extent than those required in connection with an IPO) and an investment cap for non-accredited investors. Tier 2 offerings – unlike Tier 1 offerings – preempt state securities regulatory review (similar to Rule 506 offerings), a significant improvement over the predecessor Regulation A.
So, is Regulation A+ the answer for crypto companies? Maybe, maybe not. As noted above, perhaps the most significant advantage to Regulation A+ is that investors receive unrestricted securities that are freely tradable. But how soon will a truly robust secondary trading market develop for the tokens and coins being offered by most crypto companies? And why would a crypto company subject itself to the filing requirements and on-going disclosure requirements of a Regulation A+ offering, when it could instead offer unlimited securities (albeit to accredited investors only) under Rule 506 with limited filing requirements, not to mention no SEC review, and no on-going SEC reporting obligations? The best alternative will, of course, be issuer specific, which is why it is critical for issuers to weigh the pros and cons with experienced legal counsel.