Before in an earlier blog, I addressed on some of the workings related to Regulation A. Now I need to address the problems I perceive for a startup using Regulation A. Regulation A was promulgated with the premise that startups a) could promote their stock to the public, and b) would be able to use up to $1 million, after deducting regulatory, legal and financial expenses, for one year. That is easier said than done.
My first concern would be how effective would be for a startup to sell its stock to the public. Outside of advertising for 30 seconds during the Super Bowl, capital funding is a rigorous, specialized process. In my earlier blogs, Wall Street investment banks have a built in framework with which to distribute IPO stock. During the road shows, these pre-IPO companies are trumpeted to the top investment banking clientele. Not so for a startup company, as the startup company has no access to those potential investors nationwide. (Some startups do employ investment experts for their team, if they are spreading their source of funding. I did work at one early stage company which fully employed an investment banker.)
Then there is the public perception of startup shares and possible questionable representations by some startups. After the film, Wolf of Wall Street” the public got a bitter taste of what another group of early stage stocks seeking capital – the penny stocks, that never seem to go beyond the starting gate. Startups might encounter considerable skepticism by the public. They lack branding, even track records. Not all companies grow up to be the next Google or Apple. And, if they do fit that profile, smart money – Angels and VCs — are already hovering around those companies.
Then there is the time management matter. Startup companies also must focus on its products and revenues. Raising capital is a distracting enterprise. As someone who has had some experience, I have noted that the senior management team still has to manage daily operations and, for a fast paced business, it is critical to maintain that momentum or the race is lost. Someone in the company has to handle fund raising.
The next elephant in the room will be the Regulation A limitation of $ 1million. Regulation A specifies that a company must wait one year before going back to the well. That is a severe restriction. I have advised or reviewed 2 companies in the last couple of months and both needed continuous financing of $6 million before hitting profitability. In one company, I calculated that $1 million could only last 4-5 months before needing additional capital. $1 million might not be enough for some companies.
Now there are other types of companies from different industries that survive with $1 million. Small software companies can work with that level of capitalization. On the other hand, healthcare, with its expensive regulatory tests, would struggle with $1 million really early.
And remember that after the funding, the company will need to pay for regulatory, attorney and account fees for the filings – and for $1 million the company must estimate that those costs run about $70k – $80k, less than 8%. I doubt that these costs would fall proportionally to lesser amounts being raised. Similar costs of an IPO run about 2-3% of the funds: the dollar amounts are substantially higher.