In March 1992, with a fair degree of fanfare, the Securities and Exchange Commission unveiled a host of rule-making proposals designed to facilitate capital raising by small businesses and reduce the costs of compliance with federal securities laws. These sweeping proposed rule changes comprise what the SEC dubbed its "small business initiatives".
Following more than four months of public comments and debate, the SEC announced early in August that the first installment of its small business initiatives had been put into place. The finally-adopted rule changes expanded the availability of two exemptions from registration, permitted a new practice called "testing the waters" (for one type of exempt offering), and introduced a new abbreviated form of registration for offerings by "small business issuers".
The first group of new rule changes focused on SEC Rule 504, which is a "safe-harbor" limited-offering exemption commonly used by start-up companies to raise seed capital. Under newly-revised Rule 504, offerings of up to $1 million in any twelve month period can be accomplished with relatively few compliance requirements.
Although offerings under Rule 504 continue to be subject to the anti-fraud and civil liability provisions of the federal securities laws, other requirements found by the SEC to be overly burdensome for start-up companies have been lifted. Thus, under new Rule 504, no specific disclosure document is required, securities issued under this exemption may be freely transferable, and there is no longer a prohibition on general solicitation or advertisement to obtain investors.
Another group of new rule changes focused on Regulation A, which previously exempted offerings of up to $1.5 million. Historically, Regulation A had been treated by small businesses as somewhat of a dinosaur, since the disclosure and filing requirements to "qualify" for exemption with the SEC were viewed as onerous as a full registration. In an effort to attract small businesses to utilizing this form of offering, permitted offerings have been increased to $5 million and disclosure requirements have been greatly eased to permit the use of a simplified question and answer format.
Of equal or greater interest to small businesses is a rule change to Regulation A which now enables them to "test the waters" for potential interest in their securities prior to incurring the costs of preparing the mandated disclosure document. This "test the waters" provision represents a radical departure from the SEC's historic stance that no verbal offers or written solicitations of interest may precede the filing of required documents with the SEC.
The SEC's policy objective with this innovative rule change is to remove a significant up-front cost impediment to small businesses and allow them to explore the viability of their offerings in advance of substantial involvement by their professional advisers.
To comply, the company must "test the waters" by way of a written solicitation which must be submitted to the SEC concurrently with its first use. The written solicitation material must contain several mandatory statements to the effect that it is non-binding and that no investment money will be accepted until a definitive offering circular is distributed. The writing must also briefly identify the company's business, products, and chief executive officer.
The final group of new rule changes focused on an abbreviated form of registration for public offerings known as form S-18. As was the case with old Regulation A offerings, Form S-18 registrations had been perceived by small businesses as only slightly less rigorous than full-blown registrations. As a result, Form S-18 registrations were relatively under-utilized. The rule changes rescinded Form S-18 and replaced it with a more simplified registration form known as Form SB-2.
This new registration form may be used only by "small business issuers", which are defined to be companies with annual revenues of less than $25 million and whose publicly-owned stock has a market value of less than $25 million. In addition to capturing small businesses conducting initial public offerings, the SEC's definition is expected to pick up an estimated 3,000 existing reporting public companies.
At about the same time the SEC adopted this first wave of small business initiatives, it also produced for public comment a second installment of proposed rule changes. These proposals, if adopted, would establish a transitional system for small businesses entering the SEC's periodic reporting system and would revise the audited financial statement requirements for targeted exemptions benefiting small businesses.
In sum, the recently announced rule changes, constituting "scene one" of the SEC's small business initiatives, should be enthusiastically embraced by start-up and emerging businesses. The anticipated reductions in overall offering costs and the simplification of required disclosures are, in this author's mind, well overdue.