Rather than spending large sums of money to roll out a mini-IPO with hopes of raising up to $50 million, a company can use a revolutionary provision of Regulation A+ from the Jumpstart Our Business Startups Act (JOBS Act) to “test the waters” before hitting the market. In other words, a company can legally gauge interest from prospective investors before spending more than $100,000 to see if there is sufficient interest in their stock offering to move forward.
Before the JOBS Act was enacted in 2012, companies and their representatives were generally prohibited from talking to prospective investors until they had filed their IPO documents with the SEC. Most securities lawyers also understood federal law to restrict companies from soliciting offers or even indications of interest for an IPO, even after the initial documents were filed with the SEC, until the company filed a preliminary prospectus with an estimated offering price range with the SEC. As a result, hundreds of thousands of dollars had to be spent on legal fees, compliance, due diligence and accounting before a company could talk to the people who might invest.
Investment bankers used to skirt these laws and regulations by holding thinly veiled “education meetings” with potential large investors where, legally, the only talk allowed was general discussions about the company, its industry and other general business matters. But there was a very strict prohibition on soliciting interest from possible investors or asking investors about what price they might be willing to pay for the company’s stock.
That all changes with the JOBS Act.
Now, a company relying on Regulation A+ (and before that others who used the new JOBS Act IPO rules) to raise capital can file certain documents with the SEC, and then communicate with prospective investors (both accredited investors and those in the general public) to see how much interest exists in the potential Mini-IPO. While there are other technical requirements to follow, the basic pitfalls a company has to avoid while “testing the waters” is to not solicit or accept a binding order to purchase the proposed securities, and to be certain the communications with the proposed customer are free of material misrepresentations or omissions.
Basically, this means a company can’t bind anyone to buy or mislead anyone when they test the waters.
Related: 5 Businesses on the Brink of an IPO
Should your company use this more affordable method of gauging interest before diving in with the full cost associated with a Regulation A+ offering? Most securities lawyers will advise that a company testing the waters limit the communications to prospective investors to nothing outside of the information that is going to be included in the final offering documents that will be filed with the SEC. It will also likely be a good practice to be sure all materials (written or otherwise) used to test the waters are filed with the SEC. Also, the SEC requires specific “legends” or disclaimers to be given to the prospective investor in every case.
Outside of the legal requirements, companies should consider several factors from a marketing or business perspective. On the upside, testing the waters can give valuable insight to a company about the attractiveness of their offering to prospective investors. It can “warm the market” and create marketing buzz that could be beneficial once the offering is live.
On the downside, companies need to be extremely careful to not overstep the legal bounds of the testing the waters provisions, so a carefully controlled plan needs to be put into place. Some in the marketplace may view testing the waters as a lack of confidence in the offering.
Overall, testing the waters is a more affordable method for a startup or young company to decide whether to partake in a Regulation A+ offering. I believe, with the $50 million upside of Regulation A+, testing the waters will become a fairly common practice for companies on the fence before investing in the mini-IPO process.