Last week, the Securities and Exchange Commission (“SEC”) adopted final rules that will make it easier for real estate firms to pursue capital raises of up to $50 million in a 12 month period.
The rules, commonly referred to as Regulation A+, permit eligible companies to conduct securities offerings without the onerous requirements of full securities registration. What’s more, companies can solicit funds from individuals who are not accredited investors. In other words, companies can promote their investment opportunity to any investor with an internet connection, although unaccredited investors will be limited in the amount they can invest. It’s no surprise why Regulation A+ has been called the private company’s mini-IPO law.
Silicon Valley’s legal community seemed to shrug and yawn when asked about the fundraising opportunities for startup tech companies, according to a recent article in The Recorder. Time will tell if they are right. However, in the real estate investment and development community, $50 million can help fund a very attractive real estate opportunity.
Overview of Regulation A+
Of course, the new regulation is not without its process and procedure, so real estate project sponsors need to proceed carefully. The exemption cannot be used for a “blank check” real estate business model. In addition, the new rules establish two tiers of offerings that can be made:
Tier 1: Annual offerings of up to $20 million, including no more than $6 million on behalf of selling security holders that are affiliates of the issuer. There are no minimum investor qualifications and only reviewed, but not audited, financials are required. However, Tier 1 offerings are subject to both SEC and state review.
Tier 2: Annual offerings of up to $50 million, including no more than $15 million on behalf of selling security holders that are affiliates of the issuer. A company making a Tier 2 offering must provide audited financial statements, annual reports and engage in ongoing reporting. Tier 2 offerings will be exempt from registration and full Exchange Act reporting and may list their securities on a national securities exchange by filing a short-form registration statement. Unaccredited investors can purchase no more than (i) 10% of the greater of annual income or net worth (for natural persons) or (b) 10% of the greater of annual revenue or net assets at fiscal year end (for non-natural persons). Tier 2 offerings are subject to SEC, but not state review.
Real estate companies can “test the waters” with, or solicit interest in a potential offering from, the general public either before or after the filing of a Regulation A+ eligible offering statement so long as certain conditions are satisfied. This can be an important tool for real estate developers who want to gage interest in their particular project before launch.
Some Issues Unique to Real Estate Related Offerings
Unlike a typical startup company offering, structuring a real estate offering properly is crucial to take advantage of the new regulation.
For example, asset backed securities are excluded from the list of eligible securities that can use Regulation A+. The definition of an “asset backed security” used by Regulation A+ is the definition found in Regulation AB, which reads in part: “a security that is primarily serviced by the cash flows of a discrete pool of receivables or other financial assets, either fixed or revolving, that by their terms convert into cash within a finite term period, plus any rights or other assets designed to assure the servicing or timely distributions of proceeds to the security holders[.]” The important take away from this definition for real estate companies? Regulation A+ cannot be used if a company’s offering is selling participation interests in a pool of real estate secured debt, in pools of long term ground leases, or other similar pooled real estate secured receivables.
Nevertheless, the definition of an “asset backed security” in the Securities Exchange Act does not prohibit single “asset-backed” transactions. It would be possible to structure a real estate investment transaction so that investors can participate in a single loan or single lease (in the latter case, one for a significant rental value for a long term). But again, one should proceed with caution in structuring the opportunity.
Finally, another alternative that should be considered is structuring a Regulation A+ offering with preferred equity in a limited liability company. That being said, it is important think through the structure from a legal and economic perspective before moving forward. One important consideration would be review of SEC rules at the time of the offering.
Other structuring options may be available. The good news is that one more tool will soon be available to help real estate project sponsors raise funds in the capital stack. Regulation A+ will take effect 60 days after its posting. We will see how the real estate community reacts to this new financing tool.