Form 1-A Offering Circular Requirements – Regulation A Lawyers
The Regulation A exemption from registration under the Securities Act of 1933, as amended (the “Securities Act”). was designed to provide small companies with streamlined rules to facilitate the capital-raising process. Securities offerings under Regulation A must be qualified with the Securities and Exchange Commission (“SEC”) using Form 1-A in a process very similar to that of registration statements under the Securities Act. The exemption can be used in combination with direct public offerings and initial public offerings as part of a going public transaction. The exemption simplifies the process of obtaining the seed stockholders required by the Financial Industry Regulatory Authority (“FINRA”) while allowing the issuer to raise initial capital. Regulation A also provides issuers with the opportunity to test the waters using social media or their preliminary offering circular prior to qualification of their offering.
Issuers using Regulation A+ to conduct their offerings must file and qualify an offering statement with the SEC. The offering statement is intended to be a disclosure document that is similar to Form S-1 with scaled down disclosures. A notice of “qualification” is similar to a notice of effectiveness for a Form S-1 registration Statement.
REGULATION A FORM 1-A OFFERING STATEMENT REQUIREMENTS
A Form 1-A offering statement has three parts: Part I, which requires basic issuer information such as the details about the security being offered, the jurisdictions where the securities will be offered, and recent sales of unregistered securities. Part II, requires the business, management, financial statement, and other substantive disclosures. Part III, contains exhibits and related documents.
SUBMISSION OF NON-PUBLIC DRAFT OFFERING STATEMENTS
Issuers whose securities have not been previously sold pursuant to a qualified offering statement under Regulation A, or an effective registration statement under the Securities Act, may submit a draft offering statement to the SEC for non-public review. All non-public submissions of draft offering statements, and the initial non-public submission, all non-public amendments thereto, and correspondence submitted by or on behalf of the issuer to the SEC staff must be publicly filed and available on EDGAR as exhibits to the Form 1-A not less than 21 calendar days before qualification of the offering.
The SEC and its staff will not make draft offering statements publicly available on EDGAR as a matter of course.
ADVERTISING AND SOLICITATION MATERIALS
Issuers using Regulation A must submit or file solicitation materials as an exhibit when the offering statement on Form 1-A is either submitted to the SEC for non-public review or filed (and updated for substantive changes in such material after the initial nonpublic submission or filing). However, issuers are no longer required to submit solicitation materials at or before the time of first use. Although the SEC does not pre-review pre-filing advertising, you are cautioned to be very careful what you say in the offering materials. Solicitation materials are subject to the antifraud and other civil liability provisions of the federal securities laws and you can be sued for what you say in your advertising even if you don’t include that information in the 1-A offering circular itself. Our general advice is that if you think anything in your advertising may be problematic, don’t use it.
Solicitation materials used before qualification in a testing the waters transaction are required to bear a legend or disclaimer stating that:
- no money or other consideration is being solicited, and if sent, will not be accepted,
- no sales will be made or commitments to purchase accepted until the offering statement is qualified, and
- a prospective purchaser’s indication of interest is non-binding.
Solicitation materials used after you publicly file an offering statement must be accompanied by a current preliminary offering circular or contain a notice informing potential investors where and how the most current preliminary offering circular can be obtained. This requirement may be satisfied by providing the URL where the circular may be read. If you use testing the waters materials after publicly filing the Form 1-A offering statement, you must update and redistribute them should it become outdated or inaccurate in any way.
The SEC has said it understands that the increased use of solicitation materials after filing may result in investors receiving more sales literature in marketed offerings. However, the SEC also believes that in such circumstances potential investors will also be afforded more time with the preliminary offering circular before making an investment decision. Testing the waters materials used by an issuer or its intermediaries after the issuer publicly files an offering statement must be accompanied by a current preliminary offering circular or contain a notice informing potential investors where and how it can be obtained.
Additional requirements that the SEC believes will result in investor protection include:
- making the most recent preliminary offering circular available with solicitation materials after filing;
- redistributing solicitation materials after filing to the extent that either the material itself or the preliminary offering circular attached thereafter becomes inadequate or inaccurate in any material respect;
- delivering the preliminary offering circular at least 48 hours in advance of sale if the issuer is not subject to a Tier 2 reporting obligation;
- delivering the final offering circular (or a notice of the final offering circular) no later than two business days after sale in all instances;
- applying the minimum 21-calendar-day filing requirement for issuers that submit non-public draft offering statements; and
- continuing to apply the antifraud provisions of the federal securities laws.
Materials Not Constituting Solicitation Materials
Ordinary factual business communications do not constitute solicitation of interest materials under Regulation A. Ultimately, whether or not a communication is limited to factual business information depends on the facts and circumstances, but issuers may generally look to the provisions of Rule 169 of the Securities Act for guidance in making this determination in the Regulation A context. “Factual business information,” generally means information about the issuer, its business, financial condition, products, services, or advertisement of such products or services. It does not include such things as predictions, projections, forecasts, or opinions with respect to valuation of a security.
CONTENTS OF THE FORM 1-A OFFERING STATEMENT
Regulation A requires that the issuer provide disclosures on Form 1-A which consists of three parts:
- Part I. Notification
- Part II. Information Required in the Regulation A Offering Circular
- Part III. Financial Information
Part I. Notification
Part 1 of Form 1-A captures key information about the issuer and its offering, similar to Form D, with drop-down menus, indicator boxes, and text boxes. The form also assists issuers in determining their ability to rely on the exemption. The fillable form provides a convenient means of assembling and transmitting information to EDGAR, without requiring the issuer to purchase or maintain additional software or technology. The information required to be included in Part I must be certified and is as follows:
- Item 1. (Issuer Information). This item requires information about the issuer’s identity, industry, number of employees, financial statements and capital structure, as well as contact information.
- Item 2. (Issuer Eligibility). This item requires the issuer to certify certain factual information that establishes its ability to use Regulation A.
- Item 3. (Application of Rule 262 “Bad Boy Disqualification”) This item requires the issuer to represent that, as of the time of the filing, each person described in Rule 262 of Regulation A is either not disqualified under that rule or is disqualified but has received a waiver of such disqualification.
- Item 4. (Summary Information Regarding the Offering and Other Current or Proposed Offerings). This item requires the issuer to provide an overview of information related to the Regulation A offering including whether the issuer intends (i) to offer the securities on a delayed or continuous basis pursuant to Rule 251(d)(3) (ii) for the offering to last more than one year, (iii) to price the offering after qualification pursuant to Rule 253(b), (iv) to include shares for resale that are held by its affiliates, and (v) to conduct the offering on a best efforts basis. The issuer must also disclose if it has used solicitation of interest communications in connection with the proposed offering, the amount of the anticipated fees in connection with the offering and identify the names of its service providers.
- Item 5. (Jurisdictions in Which Securities are to be Offered). This item requires the issuer to disclose where it will offer and sell the securities covered by the Form I-A.
- Item 6. (Unregistered Securities Issued or Sold Within One Year). This item requires the issuer to provide details about its securities offerings during the last year.
Part II—Information Required in the Form 1-A Offering Circular
Part 2 of the Form 1-A is a simplified and scaled down version of the information required in registered offerings on Form S-1. The information must be provided in either:
- The offering circular format described in Regulation A, or
- Part I of Form S-1 or Part I of Form S-11, except for the financial statements, selected financial data, and supplementary financial information called for by those forms. An issuer choosing to follow the Form S-1 or Form S-11 format may follow the requirements for smaller reporting companies if it meets the definition of that term in Rule 405. An issuer may only use the Form S-11 format if the offering is eligible to be registered on that form. Regardless of which of the two formats you select, the financial statement requirements will remain the same.
For the purpose of this discussion in this section, we will assume that you will, like most Regulation A Tier 2 issuers, choose to follow the Form S-1 (or S-11 if your offering involves real estate such as a REIT) disclosure requirements with certain modifications as described below. Note that if you choose to follow the straight Regulation A disclosure requirements some of this disclosure may be modified or eliminated, but as that won’t be most users of Regulation A, we’ve described S-1 disclosure guidelines. There are additional disclosure requirements if you are engaged in the real estate business and thus also have to follow S-11 disclosure guidelines, so please consult your securities professional.
Item 1. Cover Page of 1-A Offering Circular
The cover page of the Form 1-A is not a place to get creative. The SEC tells you exactly what you can include on these pages. Items 501 and 502 of Regulation S-K specify the content requirements for a registration statement cover page and the front and back cover pages. The disclosure on each page must be limited to the information the disclosure items require and should not extend beyond one page each. You include nothing else. And you must write the disclosure in the style required by the SEC, called “Plain English.”
On these pages you include only:
- Number of shares being registered for sale;
- Price at which the shares will be sold;
- Offering commissions and offering expenses;
- The existence or non-existence of a trading market for the securities;
- A standard warning and reference to risk factors;
- A warning stating that the offering is highly speculative, and these securities involve a high degree of risk and should be considered only by persons who can afford the loss of their entire investment. See “Risk Factors” below; and
- The date of the Form 1-A offering circular.
The SEC frequently reminds companies to present the cover page disclosure in plain English and to limit that disclosure to what is required by the disclosure items. The SEC’s Plain English Handbook is a helpful resource.
For Tier 2 offerings where the securities will not be listed on a registered national securities exchange upon qualification, the offering circular cover page must include the following legend highlighted by prominent type or in another manner:
“Generally, no sale may be made to you in this offering if the aggregate purchase price you pay is more than 10 percent of the greater of your annual income or net worth. Different rules apply to accredited investors and non-natural persons. Before making any representation that your investment does not exceed applicable thresholds, we encourage you to review Rule 251(d)(2)(i)(C) of Regulation A.”
Item 2. Table of Contents
In this section, it is important to include all major headings set forth under the Item numbers below. Once the filing has been sent to the Edgar filer, it will add the correct page numbers to the Table of Contents.
Item 3. Summary and Risk Factors
In this section, you must summarize the basic information to be presented in your Form 1-A offering circular. Specifically, Item 503 of Regulation S-K requires that you provide a plain English summary of the key aspects of the offering.
You cannot just copy these sections from elsewhere in the Form 1-A and paste them into the summary section. When companies merely restate information from elsewhere in their filings, the SEC reminds them to present abbreviated information in their summaries. In addition, you cannot merely present positive information about your company and your business in the summary section. The SEC also frequently reminds companies to present balanced accounts of both the positive and negative aspects of your businesses and the offering.
In the summary information section, you:
- Describe the organizational history of your company—all the way from where you started up to today. Where and how your company was formed. Whether your company has undergone any changes, such as name changes or mergers and acquisitions;
- Summarize your key products or services;
- Describe the status of your products and services. Have you sold any? How much revenue have you generated? If you have sold no products, what do you need to do before you can begin selling them, how much will it cost to get them to the point you can sell them, and when do you think you will be able to start selling them?’
- Answer whether your audit firm issued a “going concern” opinion expressing its concern about your company’s ability to implement its business plan and stay in business; and
- Provide summary financial statements showing the major line items of your company’s balance sheet and income statement.
Note that Regulation A requires you to include in the summary section a carefully organized series of short, concise paragraphs summarizing the most significant factors that make the offering speculative or substantially risky. Issuers should avoid generalized statements and include only factors that are specific to the issuer.
Item 503 of Regulation S-K requires a company to discuss the most significant facts that make its offering speculative or risky. A company should limit each risk factor to one or two short paragraphs in which it identifies the risk and explains, in plain English, why it applies to the company.
Most filers dislike this section, for several reasons:
- Look where it comes in the document: Right up front. Before you even get to tell investors and stockholders about your business, you have to offer a number of reasons why they shouldn’t invest in and become stockholders of your company. And the list required by the SEC is long, running pages and pages.
- You cannot add any mitigating language in risk factor discussions, such as clauses that begin with “while,” “although,” or “however.” Even though you have good reasons to believe these factors don’t present a significant risk in the case of your company, you cannot present this additional information to investors and potential stockholders.
Risk Factors are not so easy to write. The SEC has specific writing guidelines:
- Clearly and concisely identify a risk in each risk factor subheading;
- Limit each risk subheading to one risk. Instead of discussing multiple risks under one caption, break the discussion into separate, appropriately captioned, risk factors;
- Generic risk factor discussions that do not describe how a specific risk applies to the company or to an investment in the offering are not helpful for understanding the risk; and
- Set out the extent of each risk plainly and directly. It is rarely helpful to state that there is or can be no assurance of a particular outcome.
Translating these guidelines into acceptable writing, however, is not so simple. The Risk Factors section can be broken up as follows:
Current Financial Condition
- What is your operating history?
- How much cash or borrowing ability do you have?
- Do you have enough financial resources to stay in business for the next twelve months?
- Do you have enough financial resources to implement your business plan?
- Do you have any sources of potential funding identified?
- Has your auditor expressed substantial doubt about your ability to continue as a going concern?
Risks Related to Products and Services in a Particular Industry
- What factors could cause demand for your products to decrease, including external factors such as decreased market demand or internal factors such as your actions or failure to take action, either of which could harm your standing in the market and with potential customers or cause problems in complying with governmental regulations?
- Are your sales concentrated in one or just a few customers?
- Do you have limited sources of supply for key components in your products?
- How is your intellectual property such as patents or trade secrets protected?
- Do you have competitors in your business that have greater financial and marketing resources than you do?
- Is demand for your products seasonal or cyclical?
- If you are a foreign company or sell in a foreign company, what are the additional risks you are exposed to?
Management of the Issuer
- Does your company depend heavily on certain key personnel, the loss of which could harm your business?
- Does your company’s management have experience in managing the day-to-day operations of a public company?
- Does your company’s management have adequate internal controls in place over financial reporting, as required under recent legislation requiring companies to evaluate internal controls over financial reporting?
- Does your company have independent directors on its board?
- Does management hold a significant percentage of your company’s outstanding voting securities, which could reduce the ability of minority stockholders to effect certain corporate actions?
Market for the Issuer’s Stock
- What is the extent of the market for your company’s stock?
- Do you expect your company’s stock to trade at less than $5.00 per share, which means your stockholders will be subject to penny stock regulations and restrictions that may increase their difficulty in selling shares of your common stock?
- Does your company have such a large number of free-trading common shares that significant sales could reduce the price of your stock?
Item 4. Dilution
If you aren’t raising money with your filing, this section is not applicable. However, if you are raising money, then you must disclose dilution information in your filing. This is not a simple section to write, so you’ll need input from whomever is preparing your financial statements.
Dilution information starts with a determination of your current net tangible book value per share. The net tangible book value of a company is the accounting value of all assets on the company’s balance sheet after subtracting all liabilities and all intangible assets. Intangible assets that appear on the balance sheet usually include such items as patents, copyrights, franchises, trademarks, operating rights, and goodwill. Various costs incurred in the formation of the company are also treated as intangible assets. You must base the net tangible book value on the company’s most recent balance sheet prepared according to generally accepted accounting principles consistently applied, or GAAP.
To compute the net tangible book value per share of common stock, divide the total number of common shares outstanding immediately prior to the offering, by the net tangible book value related to common stockholders. The net tangible book value will be computed based on the company’s latest balance sheet.
When determining the number of outstanding shares, also take into consideration any shares issued between the date of the last balance sheet and the time of the offering.
Item 5. Plan of Distribution
Item 508 of Regulation S-K requires a company to describe how it will offer its securities to the public. If you have an underwriter, this requires disclosure about agreements with the underwriter and how the offering will be conducted. If there is no underwriter, then disclosure about a self-underwritten offering is required. Please consult our chapter “Paying People to Raise Money for You” to review the guidelines applicable to your officers and directors as well as to any consultants offering to raise money for you in a self-underwritten offering.
When a company indicates in what is called a selling stockholder registration statement that its officers or directors, or any person(s) other than an underwriter, will sell its securities, the SEC asks you to name those persons and describe the process through which they intend to offer and sell the company’s securities.
In addition to selling its own securities, companies can register securities owned by their stockholders for resale. Remember: one of the most significant differences between Regulation A and Form S-1 is that selling stockholders in a Regulation A offering must sell their securities at the same fixed price at which the company is offering its securities, while in a Form S-1 offering selling stockholders can sell their shares at market prices. The following disclosure which you may have seen in Form S-1 registration statements cannot be used in a Regulation A offering:
“The selling stockholders will offer their shares at $___ (insert specific fixed price) per share until our shares are quoted over-the-counter (OTC), and thereafter at prevailing market prices or privately negotiated prices.”
As a practical matter, this means that if you want to do an effective selling stockholder offering, you will need to use Form S-1.
One more thing to remember here: When companies state that their securities were, or will be “listed” OTC, usually on one of OTC Markets Groups “markets,” the SEC reminds them that “listed” is the wrong word. Rather, they are “quoted” on the OTC, which is not a national securities exchange. If your Regulation A offering circular includes securities to be sold by existing security holders for their own account, however, Item 507 of Regulation S-K requires that you make the same disclosure as if you were conducting a selling stockholder registration statement on Form S-1, as follows:
- Name each selling security holder;
- Identify any special business relationships, such as working for your company, which the selling security holders have had within the last three years;
- Disclose the amount of the selling security holders’ holdings (including the percentage of the overall outstanding shares of the class being sold);
- Disclose the amount of securities each selling security holder seeks to sell; and
- Disclose the number of shares still owned and percentage of ownership after the sale.
If a selling stockholder is a business entity rather than a natural person, you must identify the natural persons with voting and dispositive authority—meaning the power to vote or to order a sale of the security—over the securities the business entity holds.
None of your selling stockholders can hide his identity if selling stockholders wish to have free-trading stock. They all must be named in this section. And they cannot hide behind a trust or corporate entity either. The names of the persons behind the trust or corporate entity must be disclosed.
Item 6. Use of Proceeds
In this section, you have to tell the SEC how you intend to use the money you raise from the offering. This disclosure is presented in a table showing each of the major items on which you intend to spend the offering proceeds.
Item 504 of Regulation S-K sets forth the requirements for companies to disclose the principal purposes for which the net proceeds of the offering will be used, and the approximate amount intended to be used for each purpose. When a company makes its offering on a best-efforts basis, its intended use of proceeds may change depending on the volume of shares sold. The SEC frequently suggests that a company pick benchmarks for the amount of securities that it may sell; for example, 25 percent, 50 percent, 75 percent and 100 percent, and indicate how it will allocate the proceeds for each benchmark.
The SEC requires a higher level of detail than you may think. Assume you intend to use some of the offering proceeds to purchase equipment. You must include a footnote to the table that lists the major pieces of equipment you want to buy and how much each piece costs. You also must specify which pieces of equipment you will buy first if you don’t raise all the money from the offering.
Item 7. Description of Business
Finally, after all this disclosure, you get to describe your business. But the SEC mandates the items about your business that must be disclosed and the way in which your disclosure must be written. This section requires disclosure of the following subjects:
- Organizational History. Describe the organizational history of your company, when and where your company was formed, and any mergers, acquisitions, name changes, and similar corporate events that have occurred, all the way back to the date of its formation.
- Principal Products and Services. Describe the principal products made and services rendered by your company. If any products are under development (e.g., whether in the planning stage, whether prototypes exist, the degree to which product design has progressed, or whether further engineering is necessary), you must state what you need to do to be able to complete development and commence selling your products, how much it will cost to do that, and how long you estimate it will take.
- Multiple Products and Services. If you sell multiple products and any products have accounted for over 10 percent of your total revenue, you must include a chart showing how much total revenue each product has generated in the periods covered by your company’s financial statements.
- Seasonality. If your business is or may be seasonal, you must also describe the effect of this seasonality on your business, revenues and profits.
- Principal Markets. Describe the principal markets for your products and services. Where do you currently sell your products? Who are your customers or potential customers? Do you have any contracts with customers? If so, describe the details of those contracts.
- Distribution Methods. Describe the principal methods of distribution of your products and services. Do you only sell through your officers or an internal sales force? Do you have third party distributors selling your products? Do you have any contracts with distributors? If so, you will need to describe the details of those contracts.
- Sources and Availability of Raw Materials. Provide details about the availability of raw materials used in making your company’s products. If your purchases from any supplier account for over 10 percent of your total expenses, you must include a chart showing the total amount of expenses each supplier has generated in the periods covered by your financial statements.
- Suppliers. Do you have any contracts with suppliers? If so, you will need to describe the details of those contracts. How difficult is it to obtain raw materials from alternate suppliers? What would be the effect on your business, such as increased costs or decreased revenues, if you had to find alternate suppliers?
- Intellectual Property. Describe all your intellectual property, including the duration and effect of all patents, trademarks, licenses, franchises, and concessions held.
- Inventory. Disclose whether you carry significant amounts of inventory to meet rapid delivery requirements or to assure yourself of a continuous supply of goods from suppliers.
- Return Policies. What are your return policies? Do your customers have the right to return merchandise? If so, what has your return experience been?
- Warranties. Describe any warranties you offer and what your warranty experience has been.
- Backlog of Orders. Do you have an order backlog? If so, you will need to describe the dollar amount of backlog orders believed to be firm, as of a recent date and as of a comparable date in the preceding fiscal year, together with an indication of the portion of the backlog that is not reasonably expected to be filled within the current fiscal year, as well as seasonal or other material aspects of the backlog.
- Sales to Government Agencies. Do you sell to government agencies? If so, include a description of any material portion of your business that may be subject to renegotiation of profits or termination of contracts or subcontracts at the election of the government.
- Competitive Conditions. Describe competitive conditions of your business, including the identity of the markets in which your company competes, an estimate of the number of competitors and the company’s competitive position, if known or may easily be discovered. If you know that one or a few competitors is dominant in your industry, you must name these competitors in your filing. You must also disclose the size of your company in relation to those competitors. You must also identify the principal methods of competition (g., price, service, warranty, or product performance) and both the positive and negative factors affecting your competitive position.
- Research and Development. If you have any research and development expenses recorded on your financial statements, disclose the estimated amount spent during each of the last two fiscal years on company-sponsored research and development activities determined in accordance with generally accepted accounting principles. In addition, you must state the estimated dollar amount spent each year on customer-sponsored research activities relating to the development of new products, services, or techniques or the improvement of existing products, services, or techniques.
- Impact of Federal, State and Local Laws. Disclose the material effects that compliance with federal, state, and local laws enacted or adopted regulating the discharge of materials into the environment, or otherwise relating to the protection of the environment, may have upon your capital expenditures, earnings, and competitive position. You must disclose any material estimated capital expenditures for environmental control facilities for the remainder of the current fiscal year, the succeeding fiscal year, and for such further periods as you may deem to be material.
- Employees. Indicate the number of persons you employ, by category (g., management, sales, production, etc.), and how many are full-time and how many are part-time employees.
Item 8. Description of Property
In this section, the issuer should provide details about any real estate it leases or owns including location, rental amount, mortgage and other information. If the issuer is in the real estate acquisition or development business, it must provide additional details about its acquisition and financing methods, policies and procedures. Certain other specific information is required if you are in the oil and gas industry.
Item 9. Management’s Discussion and Analysis of Financial Condition and Results of Operations/Plan of Operations
Issuers (including predecessors) that have not received revenue from operations during each of the three fiscal years immediately before the filing of the offering statement must provide a little bit different version of MD&A called a Plan of Operations showing how you intend to operate your business in the coming years even though you haven’t yet generated revenues. Just as with financial statements, your audit firm cannot write your MD&A. And just as with financial statements, many companies do not have the ability to prepare the MD&A themselves. In this case, they use the same accounting/consulting firm they used to prepare their financial statements and work with the audit firm in the audit to prepare MD&A.
In this section, you are doing two primary things:
- Performing a variation analysis of each line item in your income statement, indicating the variations between the periods in the financial statements included in your filing, and giving the reasons for these variations. In your MD&A, you must address known trends, demands, commitments, events, or uncertainties that will have, or are reasonably likely to have, a material impact on your company’s financial condition, operating performance, revenues and/or income, or results in its liquidity decreasing or increasing in any material way. You must also provide additional information about the quality and variability of earnings and cash flows so readers can evaluate whether past performance is likely to be indicative of future performance. You must also discuss whether your company expects its financial position to remain at its current level or to increase or decrease.
- Doing an analysis of your company’s current financial position, describing all debt or other obligations and all potential sources of capital or other financial liquidity.
Issuers (including predecessor companies) that have not received revenue from operations during each of the three fiscal years immediately before the filing of the offering statement must provide a slightly different version of the MD&A called a Plan of Operations, showing how they intend to operate the business in the coming years, even if it hasn’t yet generated revenues.
MD&A is divided into several sections, as follows:
Introduction or Overview
In this section, you must provide a balanced, executive-level discussion of the most important matters management is concerned with in evaluating your company’s financial condition and operating results. A good introduction or overview should do the following:
- Include economic or industry-wide factors relevant to the company;
- Inform the reader about how the company earns revenues and income and generates cash;
- Discuss the company’s line of business, location of operations, and principal products and services; and
- Provide insight into material opportunities, challenges, and risks on which the company’s management are most focused for both the short term and long term, as well as the actions they are taking to address these opportunities, challenges, and risks.
Results of Operations
The most common mistakes made in preparing this section of MD&A are a failure to provide a detailed discussion of your company’s results of operations and a failure to explain the reasons for period-to-period changes. If you do not give the SEC this information, they will ask you to:
- Identify the causes for period-to-period changes in results of operations for each material line item in the financial statements;
- Disclose the reasons underlying these causes for the period-to-period changes; and
- Identify changes in items that are caused by more than one factor and then quantify the effect of each factor on the change.
Milestones/Plan of Operations
This section is a mini-executive summary table of your business plan for the next twelve months. If you haven’t been in business for a year, or if you haven’t yet generated revenues, you will only include the plan of operations and exclude results of operations as described above.
Usually the milestones/plan of operations section is done in a four-column table with the following columns:
- What major events, called “milestones,” you intend to achieve;
- How you intend to reach each milestone;
- When you expect the milestone to be reached;
- How much it will cost to reach each milestone.
Liquidity and Financial Resources
In this section, you need to disclose:
- Any known material trends, demands, commitments, events, or uncertainties that will have, or are reasonably likely to have, a material impact on the company’s financial condition and short-term or long-term liquidity;
- Any known material trends, demands, commitments, events, or uncertainties that will have, or are reasonably likely to have, a material impact on the company’s revenues or income from continuing operations;
- Internal and external sources of funds to finance operations or capital improvements;
- An evaluation of the amounts and certainty of cash flows;
- Any material commitments for capital expenditures and the expected sources of funds for such expenditures;
- The past and future financial condition and results of operations of the company, with emphasis on prospects of the future;
- Any significant elements of income or loss that do not arise from the company’s continuing operations;
- The causes for any material changes from period to period in one or more-line items of the company’s financial statements;
- Any seasonal aspects that had a material effect on the financial condition or results of operations; and
- Any additional information about the quality and potential variability of the company’s earnings and cash flows so the reader can ascertain the likelihood that past performance is indicative of future performance.
Item 10. Directors, Executive Officers, and Significant Employees
In this section, the issuer provides detailed information about its officers, directors and significant employees. For purposes of the section, the term “executive officer” means the president, secretary, treasurer, any vice president in charge of a principal business function (such as sales, administration, or finance), and any other person who performs similar policymaking functions for the issuer.
The term “significant employee” means persons such as production managers, sales managers, or research scientists, who are not executive officers but who make or are expected to make significant contributions to the business of the Issuer.
This section requires the issuer to provide a table showing detailed information about officers and directors and significant employees including name, position, age, term of office and if part-time, the number of hours of service each week. The issuer must also disclose the nature of any family relationship between any director, executive officer, person nominated or chosen by the issuer to become a director or executive officer, or significant employee.
The issuer must describe any arrangement or understanding between the persons in the table and any other persons (naming such persons) pursuant to which the person was or is to be named as such director.
The issuer should provide a brief account of the business experience of each director, executive officer, person nominated or chosen to become a director or executive officer, and each significant employee, during the past five years, including his or her principal occupations and employment during that period and the name and principal business of any corporation or other organization in which such occupations and employment were carried on. When the issuer has employed an executive officer or significant employee for less than five years, the issuer should include a brief explanation of the nature of the responsibilities undertaken by the individual in prior positions to provide adequate disclosure of such persons prior business experience. The explanation must include information relating to the level of the employee’s professional competence, which may include, depending upon the circumstances, such specific information as the size of the operation supervised.
In effect, you are setting forth resumes of all named officers and directors listed in the chart. These are not job-interview-type resumes. As with every other aspect of your filing, these are fact-specific and fact-only resumes.
The basic rules of SEC biographical information are:
- Include both month and year for all dates.
- Start with earliest to latest.
- Include at least five years.
- Leave no time gaps.
- You may not use statements such as “has extensive experience in,” “is the leading,” and the like. State the name of the company you worked for, the position you held, and the business of the company.
- Include any professional licenses held. Also include information about all college and graduate/professional degrees.
For officers only, if you are working for some other company or on any other business venture while you are working for your company, describe the other business, what you do, and the amount of time you spend each month working for that company.
Involvement in certain legal proceedings
In this section, the issuer must describe any of the following events that occurred during the past ten years (under Form S-1 guidelines) and that are material to an evaluation of the ability or integrity of any of its directors or officers or any person nominated as such were the subject of:
- A petition under the federal bankruptcy laws or any state insolvency law was filed by or against, or a receiver, fiscal agent or similar officer was appointed by a court for the business or property of such person, or any partnership in which he was a general partner at or within two years before the time of such filing, or any corporation or business association of which he was an executive officer at or within two years before the time of such filing;
- Such person was convicted in a criminal proceeding or is a named subject of a pending criminal proceeding (excluding traffic violations and other minor offenses).
- Such person was the subject of any order, judgment, or decree, not subsequently reversed, suspended or vacated, of any court of competent jurisdiction, permanently or temporarily enjoining him from, or otherwise limiting, the following activities:
- Acting as a futures commission merchant, introducing broker, commodity trading advisor, commodity pool operator, floor broker, leverage transaction merchant, any other person regulated by the Commodity Futures Trading Commission, or an associated person of any of the foregoing, or as an investment adviser, underwriter, broker or dealer in securities, or as an affiliated person, director or employee of any investment company, bank, savings and loan association or insurance company, or engaging in or continuing any conduct or practice in connection with such activity;
- Engaging in any type of business practice; or
- Engaging in any activity in connection with the purchase or sale of any security or commodity or in connection with any violation of federal or state securities laws or federal commodities laws.
- Such person was the subject of any order, judgment or decree, not subsequently reversed, suspended or vacated, of any federal or state authority barring, suspending or otherwise limiting for more than 60 days the right of such person to engage in any activity described in… this section, or to be associated with persons engaged in any such activity;
- Such person was found by a court of competent jurisdiction in a civil action or by the SEC to have violated any federal or state securities law, and the judgment in such civil action or finding by the SEC has not been subsequently reversed, suspended, or vacated;
- Such person was found by a court of competent jurisdiction in a civil action or by the Commodity Futures Trading Commission to have violated any Federal commodities law, and the judgment in such civil action or finding by the Commodity Futures Trading Commission has not been subsequently reversed, suspended or vacated;
- Such person was the subject of, or a party to, any federal or state judicial or administrative order, judgment, decree, or finding, not subsequently reversed, suspended or vacated, relating to an alleged violation of:
- Any federal or state securities or commodities law or regulation; or
- Any law or regulation respecting financial institutions or insurance companies including, but not limited to, a temporary or permanent injunction, order of disgorgement or restitution, civil money penalty or temporary or permanent cease-and-desist order, or removal or prohibition order; or
- Any law or regulation prohibiting mail or wire fraud or fraud in connection with any business entity.
- Such person was the subject of, or a party to, any sanction or order, not subsequently reversed, suspended or vacated, of any self-regulatory organization…, any registered entity…, or any equivalent exchange, association, entity or organization that has disciplinary authority over its members or persons associated with a member.
Item 11. Compensation of Directors and Executive Officers
This section requires clear, concise, and understandable disclosure of all plan and non-plan compensation awarded to, earned by, or paid to the following “named executive officers”:
- All individuals serving as the principal executive officer (“PEO”) of the Company or acting in a similar capacity during the last completed fiscal year, regardless of compensation level;
- All individuals serving a principal financial officer (“PFO”) of the Company or acting in a similar capacity during the last completed fiscal year, regardless of compensation level;
- The company’s three most highly compensated executive officers other than the PEO and PFO, who were serving as executive officers at the end of the last completed fiscal year; and
- Up to two additional individuals for whom disclosure would have been provided for this section but for the fact that the individual was not serving as an executive officer of the company at the end of the last completed fiscal year.
This information is presented in a Summary Compensation Table, which you can find in every SEC registration statement filing. If any of your named executive officers have stock grants or stock options outstanding, you also must include a table with certain information about the options. All employment agreements or other forms of compensation agreements must be disclosed. Remember that the SEC has a very broad definition of compensation, which includes things you might not think about, such as:
- Perquisites and other personal benefits, or property, unless the aggregate amount of such compensation is less than $10,000;
- All “gross-ups” or other amounts reimbursed during the fiscal year for the payment of taxes;
- Any stock purchased or issued at a discount; and
- The amount paid or accrued to any named executive officer under a plan or arrangement in connection with the following: Any termination, including without limitation through retirement, resignation, severance, or constructive termination (including a change in responsibilities) of such executive officer’s employment with the company and its subsidiaries; or a change in control.
You must include a separate table for director compensation, which you can also find in every SEC registration statement filing.
You must also describe any plans or arrangements you have to pay directors compensation or reimburse them for their expenses.
Item 12. Security Ownership of Management and Certain Securityholders
This section requires you to set forth in a table the ownership of your company’s common stock held by:
- Each director,
- Your executive officers and directors as a group in the aggregate (Note that there is no requirement to list by name the ownership of someone who is an executive officer but not a director), and
- Any person deemed to be the beneficial owner of over 5 percent of your outstanding common stock.
You must disclose if the persons named in the table have sole voting and investment power regarding such shares. More than one person may be deemed to be a beneficial owner of the same securities. If more than one person has voting or investment power over such shares, all such persons must be named in the table.
The term “beneficial owner” is defined in SEC Rule 13d-3. Under this rule, a person is deemed to be a “beneficial owner” of a security if that person has or shares the power to vote or direct the voting of the security, or the power to dispose or direct the disposition of the security. A person is deemed to beneficially own any security that such person has the right to acquire sole or shared voting or investment power within sixty days through the conversion or exercise of any convertible security, warrant, option, or other right. This means that if you have options or convertible securities that can be exercised or converted in the next sixty days, even if you don’t own the underlying securities, you must show that you are technically the beneficial owner of the securities.
This can often lead to strange results in the ownership table. The percentage of beneficial ownership by any person as of a particular date is calculated by dividing the number of shares beneficially owned by that person, which includes the number of shares that person has the right to acquire voting or investment power within sixty days by the sum of the number of shares outstanding as of that date.
The denominator used for calculating the percentage may be different for each beneficial owner, so the numbers in your table may well add up to more than 100 percent.
In this section, you must also disclose if there are any existing arrangements, discussions, or negotiations with any third party concerning any arrangements known by your company’s management or their affiliates—including any pledge by any person of the company’s securities—which may result in a change in control of your company at a later date.
Item 13. Interest of Management and Others in Certain Transactions
The information required by this item can be found in the “related party” or similar footnote in the financial statements. However, you must modify the footnote disclosure, giving the name and title of each related party in a related party transaction. This is the section where your attorney must disclose his or her stock or other interest, if any.
Item 14. Securities Being Offered
If capital stock is being offered:
- State the title of the class and furnish the following information regarding all classes of capital stock outstanding:
- Outline briefly: (i) dividend rights; (ii) voting rights; (iii) liquidation rights; (iv) preemptive rights; (v) conversion rights; (vi) redemption provisions; (vii) sinking fund provisions; (viii) liability to further calls or to assessment by the issuer; (ix) any classification of the board of directors, and the impact of classification where cumulative voting is permitted or required; (x) restrictions on alienability of the securities being offered; (xi) any provision discriminating against any existing or prospective holder of such securities as a result of such securityholder owning a substantial amount of securities; and (xii) any rights of holders that may be modified otherwise than by a vote of a majority or more of the shares outstanding, voting as a class, and
- Briefly describe potential liabilities imposed on securityholders under state statutes or foreign law, for example, to employees of the issuer, unless such disclosure would be immaterial because the financial resources of the issuer or other factors are such as to make it unlikely that the liability will ever be imposed.
If preferred stock is to be offered or is outstanding:
Describe briefly any restriction on the repurchase or redemption of shares by the issuer while there is any arrearage in the payment of dividends or sinking fund installments. If there is no such restriction, so state.
If debt securities are being offered:
Outline briefly the following:
- Provisions with respect to interest, conversion, maturity, redemption, amortization, sinking fund or retirement,
- Provisions with respect to the type and priority of any lien securing the issue, together with a brief identification of the principal properties subject to such lien, and
- Material affirmative and negative covenants.
Financial Statements for Tier 1 Offerings
For Regulation A Tier 1 offerings, the balance sheets must be filed for the prior two fiscal years (along with the other required financial statements as of the two most recently completed fiscal year-ends). Significantly, financial statements for Tier 1 offerings do not need to be audited under the SEC requirements. However, practitioners have found that many states have varying audit requirements for securities offerings. Unlike Tier 2, Tier 1 does not exempt companies from the state review process and requirements, and therefore in order for companies to utilize Tier 1 to file without audited financials, they must sell their offering only in states that do not have an audit requirement.
Financial Statements for Tier 2 Offerings
Financial statements in Tier 2 offerings must be audited, in accordance with either the auditing standards of the American Institute of Certified Public Accountants (“AICPA”) (referred to as U.S. Generally Accepted Auditing Standards or GAAS) or the standards of the public company Accounting Oversight Board (“PCAOB”). In terms of cost savings, this requirement is significantly different from registration statements on Form S-1 in that you don’t need to pay for a PCAOB-qualified firm to audit your financial statements. Hopefully, you’ll be able to secure a non-PCAOB audit significantly cheaper than an S-1 PCAOB-required audit. However, SEC independence rules apply regardless of the audit standards. Meeting these independence rules requires an increased level of accounting and financial reporting sophistication of the company, with a requirement that the company prepare the full-GAAP financial statements and footnotes for the auditor. This often leads to companies needing to hire another CPA to prepare the financial statements for the auditor.
Don’t be misled about the period the financial statements must cover. You must provide financial statements for each of the two fiscal years preceding the date of the most recent balance sheet being filed or such shorter period as the issuer has been in existence. Tier 2 requires the prior two fiscal years’ financial statements to be audited. It also requires unaudited mid-year financial statements for offerings to be qualified in the fourth quarter of the company’s fiscal year. Likewise, inception-date audited financial statements meet the filing requirements for companies incorporated during the past nine months, but the audited financial statements must be as of a date within nine months of the filing’s qualification.
If you are a startup company or a company that hasn’t been in business for two years, you can still use Regulation A, and this requirement becomes much easier as the company has less financial history to audit. Many newer companies—real estate entities in particular—have utilized Regulation A as a newly formed entity, though they are subject to some SEC predecessor rules. The audit in these situations is inexpensive and relatively easy to complete. However, companies should be cognizant of the substantially higher future audit costs if or when they successfully raise money and are then required to complete ongoing audits of what can become large and complex entities.
For companies with complex operations, or a lengthy history of financing, the upfront audits can be costly and time-consuming. This can be exacerbated by loose historical recordkeeping or poor accounting records. Documents no one thought would ever be needed must now be dug up, the capitalization table will be interfaced with agreements and cash records back to day 1, accounting needs to move from cash or tax basis to GAAP (accrual basis), and summaries of all major agreements must be honed to meet all the complex financial statement disclosure requirements and auditor’s requests. The time commitment of the audit process is often overlooked by already overworked entrepreneurs and can become a drag on the filing process and timeline. It’s a far easier process for companies with good recordkeeping, a competent CPA (other than the auditor), and/or a limited and non-complex history.
Part III. Exhibits and Signatures
Part 3 requires the issuer to provide signatures and certain exhibits to the offering statement, including the issuer’s underwriting agreement; charter and by-laws; an instrument defining the rights of security holders; subscription agreement; voting trust agreement; material contracts; plan of acquisition, reorganization, arrangement, liquidation, or succession; escrow agreements; consents; opinion regarding legality; “testing the waters” materials; appointment of agent for service of process; materials related to non-public submissions; and any additional exhibits the issuer may wish to file.
Hamilton & Associates | Regulation A+ Lawyers
Brenda Hamilton, Securities Attorney
101 Plaza Real South, Suite 202 N
Boca Raton, Florida 33432
Telephone: (561) 416-8956
Facsimile: (561) 416-2855