Q U A R T E R LY
ALTERNATIVE INVESTMENTS QUARTERLY
SUMMER 2015 VOLUME 9 ISSUE 3
Everything You Need to Know About
Reg A+
I Retail Property—Refreshing the Business I ADISA News
Q U A R T E R LY
SUMMER 2015 VOLUME 9 ISSUE 3
ALTERNATIVE INVESTMENTS QUARTERLY
ADISA EDITORIAL BOARD Chair I Brandon Raatikka I FactRight, LLC Brandon Balkman I Orchard Securities Linda Dewlaney I Preferred Partnership Services
1 Executive Director’s Letter Uphill Values
2 Everything You Need to Know About Reg A+
4 A New Era in Capital Raising: Regulation A+ —An Overview
Eric Perkins I Perkins Law PLLC
12 CONTACT INFORMATION ADISA I 10401 N Meridian St., Suite 202 I Indianapolis, IN 46290
Weighing the New ‘IPO Lite’ Option of the Jobs Act: Pros and Cons of Raising Growth Under Reg A+
Direct: 317.663.4180 I Toll Free: 866.353.8422 Fax: 317.815.0871 I E-mail: adisa@adisa.org
16
John Harrison I Executive Director I 317.663.4172
How Can the New Regulation A (A+) Benefit Financial Advisors?
Adam Abubakr I Director of Accounting & Data Systems I 317.663.4177 Tanisha Bibbs I Education & Meetings Coordinator I 317.663.4174 Jennifer Fitzgerald I Director of Marketing I 317.663.4175 Tony Grego I Director of Business Development I 317.663.4173 Design I DesignMark I Susie Cooper
adisa.org Copyright © 2015 By ADISA (Alternative & Direct Investment Securities Association), formerly REISA, formerly the Tenant-In-Common Association.
18 Regulation A+: A Worthy Challenger to Regulation D?
22 Regulation A+: The Pluses and Minuses
24 Retail Property—Refreshing the Business
All rights reserved. Readers may copy sections of this publication for personal use. However, it is a violation of U.S. copyright laws to copy substantial portions of the publication for any reason without permission. The Copyright Act of 1976 provides for damages for illegal copying. If you wish to copy and distribute sections of this publication, contact Jennifer Fitzgerald at jfitzgerald@adisa.org.
28 ADISA 2015 Due Diligence Forum Preview
Executive Director’s Letter
Uphill Values By John Harrison, Executive Director, ADISA
Many years ago, when my then-fiancée and I were in the church’s required pre-marital counseling, the clergyman talked about three types of disagreements: disagreements about fact, disagreements about methodology, and disagreements about values. Arguments about facts occur most frequently, but are actually the easiest to solve: find out the facts. Disagreements about methodology also happen a lot, and those are best solved with experiments or evidence or other sane discussions. It’s disagreements about values that are the toughest to solve. And, I can report from another trip to Capitol Hill, that it is indeed a values disagreement going on in our nation’s capital. Normally, it’s more tilted toward methodology, but sad to say, we’ve deteriorated into values, I’m afraid. “Never have we seen it so bad,” said a friend of mine, who works for a Democratic congressman, about the relationship between the executive branch and the legislative branch. I won’t even bother to tell you what my Republican friends on the Hill are saying. It is a malaise of resignation and disengagement all around. The two sides just don’t seem to value the same lawmaking process. What does this mean for us? It means that a regulatory agenda, fueled mostly by an ethos of unilateral decree—almost just for the sake of it—is probably going to be our lot for about another two years at least. It is making a lot of groups and a lot of associations reformulate their leg/reg thinking. How so? Some trade associations make their living trying to move the Washington needle. And when the needle can’t be moved, they then try to make a living out of pretending they’re still almost moving the needle. It’s like Sisyphus trying to move the rock up the hill. He’s not going anywhere, but man doesn’t he look busy. We can argue about whether or not the rock should be placed at the top of the hill in the first place, but we can all agree Sisyphus’ method isn’t actually getting anywhere. Let’s take the Department of Labor’s Fiduciary Rule, for instance. According to my sources, it’s a decree that’s probably rooted in a vague attempt to “help the little guy” against the big bad financial services people. After all, didn’t those Wall Street types cause the last meltdown? (Never mind that it was federal housing policy mostly to blame in the first place). We don’t know yet what the ramifications will be of this rule, but it is very probable it is not at all going to be what the originators envisioned. And this, perhaps, is the best tactic for fighting: show convincingly in numbers and sound predictions what the cost will be and how it may not at all accomplish the goal (we must cede to them that their goal has value because, after all, it is a decree, and it’s unrealistic not to). So, what’s to be done with this bad news? First, ADISA’s role is to educate ourselves and other players on the ramifications of the rule—what does it look like, whom does it affect, how to deal with it, etc. We are already doing this—go online to our latest webinar at adisa.org in case you missed it earlier. Secondly, should you still send in a comment letter to the DOL? Yes, it can’t hurt. You have until July 6 and potentially longer for another round. I’d save the Word version for later use, by the way (the later use is an eventual call for defunding from the House side). If you’d like basic text or sample comment letters (lots of law firms have them out there), just let us know at advocacy@adisa.org. Now the good news: the efforts on 1031 Like-Kind Exchange. Even though the administration has proposed a $1 million limit on LKEs in the upcoming budget, this is an issue that is mostly in the hands of Congress. I met recently with a Ways and Means Committee tax policy advisor, and—especially with the studies now coming out (co-sponsored by ADISA)—the demonstrable math is firmly in favor of preserving 1031s. And with Paul Ryan now as chairman of Ways and Means, good math should go a long way. We still have our work cut out for us, but the mood is hopeful and the process is much more the standard one with plenty of vetting. This is a rock I feel we can actually move up the Hill. ▲
SUMMER 2015 AI QUARTERLY
1
Everything You Need to Know About
2
AI QUARTERLY
SUMMER 2015
Reg A+ We are dedicating most of this issue of AI Quarterly to the recently revamped Regulation A (Reg A+) as it has already proven to be of great interest to ADISA’s membership. Much has been made of the previous Reg A regime’s failure to gain favor—according to the SEC, issuers made only 26 Reg A offerings between 2012 and 2014. But Reg A+’s Tier 2 offering rules might overcome its predecessor’s shortcomings by, among other things, increasing the maximum offering size and exempting issuers from state blue sky laws.
Coupled with the prior ability to publicly test the waters and solicit nonaccredited investors, will Reg A+’s enhancements open up significant new sources of capital for private companies in our space? Will Reg A+ steal dollars from other capital-raising channels, like Regulation D? Will it catch on at all? The articles that follow illuminate multifaceted answers to those questions. Our correspondents draw somewhat incongruous conclusions about the future impact of Reg A+. Rob Kaplan (Kaplan Voekler Cunningham & Frank PLC) heralds a new era of capital raising in his Reg A+ overview. Meanwhile, in reviewing their similarities and differences, Richard Levin and Gerard Deffenbaugh
By Brandon Raatikka FactRight, LLC ADISA Editorial Board Chair
(Bryan Cave LLP) questions whether Reg A+ will displace much Reg D capital raising. Darryl Steinhause (DLA Piper) weighs the pluses and minuses of the revised regulation to chart a middle course and suggest that certain deals may be appropriate for a Reg A+ wrapper. Michael Raneri (Venovate) frames Reg A+ as an IPO-lite for mature private companies. Steve Sadler (Alligency) believes that Reg A+ will catch on with early stage companies and crowdfunding platforms, and explores how financial advisors can take advantage. The various perspectives reflected this issue will likely presage interesting days ahead for our industry. ▲
SUMMER 2015 AI QUARTERLY
3
A New Era in Capital Raising: Regulation A+ — an Overview By Robert R. Kaplan, Jr. Kaplan Voekler Cunningham & Frank PLC
1
SUMMER 2015
ER
R
AI QUARTERLY
TI
TIE
4
2
On March 25, 2015, the Securities and Exchange Commission adopted final rules to amend Regulation A as required under Title IV of the JOBS Act. The final rules provide an exemption for U.S. and Canadian companies that are not required to file reports under the Exchange Act of 1934 to raise up to $50 million in a 12-month period. The final rules create two tiers: Tier 1 for smaller offerings raising up to $20 million and Tier 2 for offerings raising up to $50 million.
The new rules amend Regulation A by, among other things, requiring that disclosure documents be filed on EDGAR, allowing an issuer to make a non-public submission with the SEC, permitting certain test-the-waters communications and disqualifying bad actors. The final rules impose different disclosure requirements for Tier 1 and Tier 2 offerings, with more disclosure required for Tier 2 offerings, including audited financial statements. Tier 1 offerings will be subject to both SEC and state blue sky pre-sale review. Tier 2 offerings will be subject to SEC review but will be preempted from state review; however states will be able to require notice filings. Investors in a Tier 2 offering will be subject to investment limits, except when securities are sold to accredited investors or are listed on a national securities exchange, and
The final rules impose different disclosure requirements for Tier 1 and Tier 2 offerings, with more disclosure required for Tier 2 offerings, including audited financial statements.
Tier 2 issuers will be required to comply with periodic filing requirements, including filing current reports upon the occurrence of certain events, semi-annual reports and annual reports. The final rules provide a means for an issuer in a Tier 2 offering to concurrently list a class of securities on a national exchange through a short-form Form 8-A. The new rules also allow for the sale of securities by existing stockholders, subject to limitations on the amount.
Offering Amounts Prior to final adoption of these rules, Regulation A was limited to offers of up to $5 million in securities in a 12-month period. Title IV mandated that the SEC adopt rules to permit for raises of up to $50 million, in addition to the $5 million exemption. Under the originally proposed rules by the SEC, the rules contained two tiers—Tier 1 for original raises of up to $5 million and Tier 2 for raises of up to $50 million. The SEC has opted to liberalize these standards under the final rules. Under Tier 1, an issuer may offer and sell up to $20 million in a 12-month period, of which up to $6 million may include secondary sales by affiliates of the issuer. Under Tier 2, an issuer may offer and sell up to $50 million in a 12-month period, of which up to $15 million may constitute secondary sales by affiliates of the issuer. However, the SEC has also adopted a unique corollary to this rule. That being that secondary sales offered as part of an offering, irrespective of whether those securities are owned by an affiliate of an issuer, cannot exceed 30% of the aggregate offering price of the issuer’s first offering or any subsequent Regulation A offering qualified within one
SUMMER 2015 AI QUARTERLY
5
year of the issuer’s first offering. So, for example, if an issuer were to qualify $15 million of new issuances in its first Regulation A offering, and then qualifies another $35 million offering six months thereafter, only $10.5 million can be comprised of securities currently held by existing holders and offered for secondary sale through that offering.
The proposed rules required an investment cap of 10% of the higher of any investor’s net worth or income in an initial issuance under Tier 2. The final rules have relaxed this requirement.
Investment Limitation The proposed rules required an investment cap of 10% of the higher of any investor’s net worth or income in an initial issuance under Tier 2. The final rules have relaxed this requirement. The investment limit will not apply to accredited investors. Non-accredited natural persons are subject to the investment limit in an initial issuance of not more than 10% of the greater of the investor’s annual income and net worth, determined as provided in Rule 501 of Regulation D. The offering material must notify Investors of the investment limitations. An issuer need only rely on a representation from the investor as to compliance with these requirements, unless the issuer knew at the time of sale that any such representation is untrue. In addition, both accredited and non-accredited investors are exempt from the investment cap if the subject securities of the offering are listed on a “National Exchange” as defined in the Exchange Act of 1934 (see page 8—“The Backdoor-IPO”).
Eligible Issuers and Securities The new Regulation A+ exemption for both Tier 1 and Tier 2 will be available to issuers organized in and having their principal place of business in the United States or Canada. The following issuers will be “ineligible” to offer or sell securities under Regulation A+: 1) an issuer that is an SEC-reporting company; (2) a blank check company; 2) any investment company registered or required to be registered under the Investment Company Act of 1940 (this includes business development companies); 4) issuers that have not filed with the SEC the ongoing reports required by Regulation A during the two years immediately preceding the filing of a new offering statement, 5) issuers that have had their registration revoked pursuant to an Exchange Act Section 12(j) order that was entered into within five years before the filing of the offering statement, and 6) certain bad actors disqualified by the provisions of Rule 262 (see page 10—“Bad Actor Disqualification”). Equity securities, including warrants, debt securities and debt securities convertible into or exchangeable into equity interests, including any guarantees of such securities may be offered under Regulation A+. Asset backed securities and fractional undivided interests in oil or gas rights, or similar interests in other mineral rights are expressly excluded.
State Securities Blue Sky Requirements Title IV of the JOBS Act mandated that Regulation A+ offerings sold solely to “qualified purchasers,” as defined by the SEC in its discretion, would be exempt from state securities registration requirements under Section 18(b) (3) of the National Securities Markets Improvement Act (NSMIA). The proposed rules had defined a “qualified purchaser” as any offeree in a Tier 1 offering, and any offeree or purchaser in a Tier 2 offering, thus preempting the state securities regulators from requiring registration of Regulation A securities prior to a sale in the Tier 1 context, and entirely in the Tier 2. The final rules eliminate the offeree in Tier 1 offerings from the qualified purchaser definition. As such, the entirety of the Tier 1 offering process will remain subject to state securities law registration and merit review requirements. Those offerings should be eligible for use of NASAA’s newly established coordinated review program.
6
AI QUARTERLY
SUMMER 2015
The issuer must file its solicitation materials with the SEC, but, may now can use a plethora of materials to market the offering throughout the process.
out-of-this-world
Marketing
Consistent with the proposed rules, however, Tier 2 offerings will not be subject to state registration requirements or merit review. States will, of course, continue to have authority to require notice filing of offering materials and enforce antifraud provisions in connection with a Tier 2 offering. In addition, the SEC has mentioned that it intends to allow the states to designate a representative to participate in the SEC review process.
Offering Communications Regulation A+ will allow substantial flexibility regarding marketing
Regulation A will allow substantial flexibility regarding marketing of the offering— referred to by the SEC as offering communications— prior to and during the pendency of an issuer’s filing.
of the offering—referred to by the SEC as offering communications—prior to and during the pendency of an issuer’s filing. Under the previous rules for Regulation A, an issuer must stop using broad marketing materials once an initial filing under Regulation A pertinent to that offering was made, and had to confine themselves to the use of “tombstone” information and/or a preliminary offering circular. The issuer must file its solicitation materials with the SEC, but may now can use a plethora of materials to market the offering throughout the process. Solicitation materials used after an offering circular is filed must be accompanied by the offering circular or a notice that includes a link to where the most recent offering circular may be found on EDGAR. Solicitation materials will need to contain certain legends proscribed in the rule. The release of regular factual business communications that do not implicate an offering will not constitute solicitation materials.
Filing and Delivery Requirements Regulation A+ offering statements will be filed on EDGAR. The Form 1-A has been amended to consist of three parts: • Part I, which will be an XML-based fillable form with basic issuer information; • Part II, which will be a text file that will contain the disclosure document and financial statements; and • Part III, which will be a text file that will contain exhibits and related materials. Periodic reports and any other documents required to be submitted to the SEC in connection with a Regulation A+ offering must be filed on EDGAR. As proposed, the final rules adopt an access equals delivery model for Regulation A+ final offering circulars. In the case where a preliminary offering circular is used to offer securities to potential investors and the issuer is not already subject to the Tier 2 periodic reporting requirements, an issuer and participating broker-dealer will be required to deliver the preliminary offering circular to prospective purchasers at least 48 hours in advance of sales. In addition, if the investor has previously agreed to it, electronic delivery of documents may be done. A notice of qualification is now similar to a notice of effectiveness in an SEC-registered offering.
SUMMER 2015 AI QUARTERLY
7
Section 12(g) provides a “fail-safe” for when issuers must submit to registering and reporting under the Exchange Act upon achieving a certain size.
A point of particular focus by both the private securities bar and regulators since the publishing of the proposed rules was the application of Section 12(g) of the Securities Exchange Act of 1934 to Regulation A+ securities.
Exchange Act Threshold A point of particular focus by both the private securities bar and regulators since the publishing of the proposed rules was the application of Section 12(g) of the Securities Exchange Act of 1934 (the “Exchange Act”) to Regulation A+ securities. Section 12(g) provides a “fail-safe” for when issuers must submit to registering and reporting under the Exchange Act upon achieving a certain size. Under Section 12(g) an issuer with (i) $10 million in assets, and (ii) 2,000 “shareholders of record*,” 500 of which may be nonaccredited, in a given class of equity securities, must register and report under the Exchange Act. The proposed rules maintained that standard for Regulation A securities of either Tier. Many representatives of the securities industry commented on this aspect of the rules. In response, the final rules provide a specific exemption for securities issued in Tier 2 offerings from the Section 12(g). An issuer must: 1) retain the services of a transfer agent registered under Section 17 of the Exchange Act, 2) have a public float of less than $75 million or, in the absence of a float, revenues of less than $50 million, in the most recently completed fiscal year, and 3) is current in its periodic reporting obligations. At the same time, an issuer that exceeds the Section 12(g) threshold and this exemption standard will still have a two-year transition period in order to register under 12(g) of the Exchange Act, and can do so as an “emerging growth company” if they still meet the definition.
The “Backdoor IPO” The final rules facilitate the ability of a Tier 2 issuer to list a class of Regulation A+ securities on a national securities exchange. The final rule permits a Tier 2 issuer that has provided disclosure in Part II of Form 1-A that follows Part 1 of Form S-1 or Form S-11 to file a Form 8-A to list its securities on a national securities exchange. Thereafter, the issuer would be subject to Exchange Act reporting requirements, but would be considered an emerging growth company.
Filings *The shareholder of record standard means that one
An issuer that seeks to rely on Regulation A+ must file and qualify an offering
ostensibly could also avoid registration by having the
Form 1-A
securities held in “street name” by nominees, pursuant
statement on Form 1-A. The offering statement is intended to be a disclosure document similar
to established jurisprudence under Section 12(g).
to those on Form S-1 and Form S-11.
8
AI QUARTERLY
SUMMER 2015
Part I As noted above, Part I requires certain basic information regarding the issuer, its eligibility, the offering details, the jurisdictions where the securities will be offered, and sales of unregistered securities. Part II Part II contains the narrative portion of the Offering Circular and requires disclosures of basic information about the issuer; material risks; use of proceeds; an overview of the issuer’s business; an MD&A type discussion; disclosures about executive officers and directors and compensation; beneficial ownership information; related party transactions; and a description of the offered securities. This is similar to Part I of Form S-1 and Form S-11, and an issuer can choose to comply with Part I of Form S-1 or Form S-11 as applicable. Tier 1 and Tier 2 issuers must file balance sheets and other required financial statements as of the two most recently completed fiscal year ends (or for such shorter time as they have been in existence). U.S. issuers are required to prepare financial statements in accordance with GAAP. The financial statements for an issuer in a Tier 1 offering are not required to be audited; however, if a Tier 1 issuer already obtained an audit of its financial statement for other purposes and such audit was performed in accordance with GAAP or the PCAOB standards and the auditors meet the independence standards, then the audited financial statements must be filed. The financial statements for an issuer in a Tier 2 offering are required to be audited in accordance with either GAAP or PCAOB standards. The auditing firm must satisfy the independence standard but need not be PCAOB-registered. The final rule also addresses that financial statements may not be older than nine months. Issuers in Tier 2 offerings are not required to provide financial statements in an interactive data format using XBRL. Part III The exhibit requirements in Part III of Form 1-A are the same, however, the final rule allows for incorporation by reference of exhibits that were previously filed on EDGAR.
Ongoing Reporting Requirements Tier 1 issuers will be required to provide certain information about their Regulation A+ offerings on a new form, Form 1-Z. Tier 2 issuers will be subject to an ongoing reporting regime and would be required to file: • annual reports on Form 1-K; • semi-annual reports on Form 1-SA; • current reports on Form 1-U; • special financial reports on Form 1-K and Form 1-SA; and • exit reports on Form 1-Z. The Form 1-K is required to be filed within 120 calendar days of the issuer’s fiscal year-end and would require disclosures: • relating to the issuer’s business and operations for the preceding three fiscal years (or since inception if in existence for less than three years); • related party transactions; • beneficial ownership; • executive officers and directors; • executive compensation; • MD&A; and • two years of audited financial statements.
SUMMER 2015 AI QUARTERLY
9
The semi-annual report is required to be filed within 90 days after the end of the first six months of the issuer’s fiscal year and would be similar to a Form 10-Q, although it would be subject to scaled disclosure requirements. A current report on Form 1-U must be filed within four business days of the triggering event and will be required to announce: • fundamental changes in the issuer’s business; • entry into bankruptcy or receivership proceedings; material modifications to the rights of securityholders; • changes in accountants; • non-reliance on audited financial statements; • changes in control; • changes in key executive officers; and • sales of 10 percent or more of outstanding equity securities in exempt offerings. An exit report on Form 1-Z would be required to be filed within 30 days after the termination or completion of a Regulation A+-exempt offering.
The periodic reports of a Tier 2 issuer’s will satisfy Exchange Act Rule 15c2-11 brokerdealer requirements in connection with publishing quotations on any facility other than a national securities exchange.
Rule 15c2-11, Rule 144 and Rule 144A The periodic reports of a Tier 2 issuer’s will satisfy Exchange Act Rule 15c2-11 broker-dealer requirements in connection with publishing quotations on any facility other than a national securities exchange. The final rule does not establish that these reports would constitute “current information” for Rule 144 and Rule 144A purposes. A Tier 2 issuer that voluntarily submits quarterly information in a form consistent with that required for semi-annual information would be able to satisfy the “reasonably current information” and “adequate current public information” requirements. The securities sold in a Regulation A+ offering are not considered “restricted securities” under Securities Act Rule 144. As a result, sales of the securities by persons who are not affiliates of the issuer would not be subject to any transfer restrictions under Rule 144. Affiliates, of course, would continue to be subject to the limitations of Rule 144, other than the holding period requirement. This is important to an issuer that would like an active trading market to develop for its securities following completion of a Regulation A+ offering.
Securities Act Liability Sellers of Regulation A+ securities would have Section 12(a)(2) liability in respect of offers or sales made by means of an offering circular or oral communications that include a material misleading statement or omission. While an exempt offering pursuant to Regulation A+ is excluded from the operation of Section 11 of the Securities Act, those offerings are subject to the antifraud provisions under the federal securities laws.
Bad Actor Disqualification Pursuant to Rule 262 of Regulation A+, an issuer will not be eligible to use the Regulation A+ exemption if it, or any of its “covered persons” are subject to one of several events of disqualification set forth in the Rule. In addition to the issuer itself, an issuer’s covered persons are: 1) a predecessor of the issuer; 2) an affiliated issuer; 3) any director, executive officer, other officer participating in the offering, general partner or managing member of the issuer; 4) Any beneficial owner of 20% or more of the issuer’s voting securities; 5) Any promoter connected with the issuer at the time of the filing of the offering statement, any offer after qualification, or a sale;
10
AI QUARTERLY
SUMMER 2015
6) Any person that has been or will be paid (directly or indirectly) remuneration for solicitation of purchasers in the offering (a “compensated solicitor�); and 7) Any general partner or managing member of a compensated solicitor or any director, executive officer or other officer participating in the offering of a compensated solicitor or any general partner or managing member of such compensated solicitor. The following are events of disqualification: 1) Criminal conviction within ten years prior to the filing date of the offering statement (or five years, in the case of issuers, their predecessors and affiliated issuers) that are (i) in connection with the purchase or sale of a security; (ii) involve the making of any false filing with the SEC; or (iii) arise out of the conduct of the business of an underwriter, broker, dealer, municipal securities dealer, investment adviser or paid solicitor of purchasers of securities; 2) Orders, judgments or decrees of courts entered within five years before the filing of the offering statement that, at the time of the offering statement filing, restrain or enjoin the subject covered person from engaging or continuing to engage in any conduct or practice: (i) in connection with the purchase or sale of a security; (ii) involving the making of any false filing with the SEC; or (iii) arising out of the conduct of the business of an underwriter, broker, dealer, municipal securities dealer, investment adviser or paid solicitor of purchasers of securities; 3) Final orders of certain state regulators (such as state securities, banking and insurance regulators) and certain federal regulators (such as federal banking agencies, the CFTC or NCUA), if the order (A) at the time of filing bars the covered person from: (i) association with an entity regulated by the applicable state or federal regulator; (ii) engaging in the business of securities, insurance or banking; or (iii) engaging in savings association or credit union activities; or (B) is a final order based on violation of law or regulation prohibiting fraudulent, manipulative or deceptive conduct entered within ten years prior to filing; 4) Certain SEC disciplinary orders relating to brokers, dealers, municipal securities dealers, investment advisers and investment companies and their associated persons to the extent such order is in effect at the time of filing; 5) Cease and desist orders of the SEC to which the applicable covered person is subject as of the filing and which were entered within five years before the filing for scienter-based antifraud violations and Section 5 registration violations; 6) Suspension or expulsion from, or suspension or barring from association with a member of, a registered national securities exchange or a registered national or affiliated securities association (such as FINRA), for any act or omission constituting conduct inconsistent with just and equitable principles of trade; 7) Has filed, or was named as and underwriter in, any registration statement or Regulation A+ offering statement filed with the SEC that, within 5 years prior to filing of the offering statement, was subject to a stop order or order suspending the Reg A exemption, or at the time of the filing is subject of an investigation to determine whether to issue such an order; and 8) Is subject to a USPS false representation order entered within 5 years prior to the filing date of the offering statement. An issuer will not be subject to disqualification for an event of disqualification that occurred
Effective Date The final rules will be effective 60 days following publication
prior to the effective date of the revised Regulation A rules. However, an issuer will be required
in the Federal
to disclose in its offering circular any matter that would have been an event of disqualification
Register.
but for its occurrence prior to the effective date of the rules. â–˛
SUMMER 2015 AI QUARTERLY
11
Weighing the New “IPO Lite” Option of the Jobs Act: Pros and Cons of Raising Growth Under Reg A+ By Michael Raneri Founder, Chairman and CEO, Venovate
L I T O E IP
12
AI QUARTERLY
SUMMER 2015
If you’re looking for growth capital to fund your private company’s ambitions, you have a range of options. Spurred by the 2012 JOBS Act, and following the introduction of “general solicitation” under SEC Regulation D in 2013, we’re now seeing additional new ways to raise growth capital under the new Regulation A+ rules, most notably opening up this so-called “IPO-Lite” to non-accredited investors. Let’s take a closer look at Reg A+, and examine how an IPO-Lite compares to a full IPO. The Cost of Going Public Going public through a full IPO has become a very expensive and time-consuming process. Consequently, many private companies are waiting until much later in their growth trajectory to go public than before, as exemplified by the record number of businesses in the billion-dollar club that are still private. In contrast, an IPO-Lite under Reg A+ is much less costly. Between legal, auditing, filing, reporting, and other fees, an IPO-Lite is more likely to cost in the range of high five to low six figures. That is relatively modest compared to a full IPO, which costs well over a million dollars according to PWC data. Still, preparing an IPO-Lite takes time. The disclosure requirements are lighter than those for an IPO S-1, but they’re still significant. Plus, the process of SEC review will take several months from the day of filing to getting “qualified” to raise capital, whether directly, through a placement agent, or a broker-dealer.
Going public through a full IPO has become a very expensive and time-consuming process. In contrast, an IPO-Lite under Reg A+ is much less costly.
$ SUMMER 2015 AI QUARTERLY
13
Chart 1
Raising Growth Capital Using SEC Regulation A+
Issuers
Tier 1
Tier 2
Minimum fundraise
Maximum fundraise
SEC filing requirement
Form 1-A
SEC review
Yes
State (Blue Sky) registration requirement
Yes
No
Annual audit/financial reporting requirement
No
Yes
General solicitation allowed
Open to non-accredited investors Investors
Regulation A+
n/a
$20M
$50M
Yes
Yes, non-accredited investors can invest up to 10% of their annual income net worth
Open to accredited investors
Investor verification required
No, self-certification by investor
Yes
Tier 1 and 2 of Reg A+ The old Reg A had such a low fundraising limit and high compliance cost that it was almost never used—Ben & Jerry’s being a notable exception back in the 1980s. Companies could only raise up to $5 million in capital, from accredited investors only, and they had to file the offering in every state in which they were selling their investment opportunity (the so-called “Blue Sky Laws”). The new Reg A+ now allows private companies to raise more capital, and from both accredited and non-accredited investors. It comes in two flavors: Tier 1 and 2. Tier 1 is for fundraises up to $20 million, yet still requires state registration. Under Tier 2, companies can raise up to $50 million, and offerings do not have to be reviewed by every state, which significantly reduces the cost of compliance. Other differences between Tier 1 and 2 are related to the SEC requirements for initial filing and ongoing reporting, with Tier 2 generally being more strict and burdensome.
Deciding if Reg A+ Is Right For Your Company Reg A+ won’t suit every company, or growth stage. Reg A+ can be the right solution for companies in a later stage in their growth trajectory, by providing an intermediate step between traditional venture capital funding and going fully public. Yet, Reg A+ is not necessarily the appropriate fundraising option for early stage startups. Why not? The Reg A+ preparation, filing, and reporting requirements aren’t as rigorous as those for a full IPO, yet they are a significant step beyond the business plans and budgets startups typically show angel investors or VC firms. For many early stage companies, meeting these requirements will be too expensive or too time-consuming to be practical. That’s why Reg A+ is most useful for a mature, later stage private company that is prepared to do the work, take the time, and bear the cost required for this more formal type of offering.
14
AI QUARTERLY
SUMMER 2015
Stages of a Reg A+ Offering Companies that are considering conducting a Reg A+ offering should understand the five key stages of the process, from start to finish, and beyond: • Getting Ready • Testing the Waters • Filing with the SEC • Conducting the Offering • Filing Ongoing Reports Stage 1. Before you embark on a Reg A+ offering, you’ll want to make sure your company is structured properly, that you’re ready to take on a new group of shareholders, and that your intellectual property is secure enough that you feel comfortable releasing information to the public. Stage 2. You’ll be able to “test the waters” before undertaking the time-intensive process of creating a full offering statement. This means you can publically promote your potential offering and gather indications of interest—after which you can decide to proceed (or not). There are rules regarding what can and can’t be said during this preliminary interest-gathering phase, so working with a securities specialist to review all communications is essential. For instance, as soon as a Reg A+ offering is filed with the SEC (Stage 3), you need to communicate your filing documents. Stage 3. Depending on the type of Reg A+ offering (Tier 1 or 2), your company may need to file audited financials, as well as an offering circular, with the SEC. These materials have to be filed through EDGAR, the SEC’s online filing system. The SEC will review the offering circular, ask questions, and request amendments to the disclosure, and then “qualify” it, allowing you to proceed. Note that SEC “qualification” by no means should be interpreted as a recommendation—it simply means that you are allowed to make an actual Reg A+ offering now. Stage 4. Once your offering circular has been “qualified,” you can’t test the waters anymore. At this point, you’ll need to be working with a licensed broker-dealer who can legally sell the securities you’re offering. Stage 5. After your offering has closed, depending on the type of offering, you may need to continue filing ongoing reports, including semi-annual and annual financial reports and current event reports. Events that require reporting include, for instance, a principal executive leaving the company, a private sale of a large number of outstanding shares, or changes in the rights of shareholders. Those are just the basics of the five stages of course, each warranting a much more elaborate examination.
Conclusion Reg A+ offers private companies looking for growth capital meaningful new avenues for substantial funding, while complying with reasonable and manageable reporting requirements. Reg A+ can especially be an attractive new option for mature private companies that want to raise capital without going fully public (yet), providing liquidity for early investors, and creating an intermediate capital formation step on the road to a full IPO. Slowly but surely, the JOBS Act is changing the investing landscape for the better, for issuers and investors alike. ▲
SUMMER 2015 AI QUARTERLY
15
How Can the New Regulation A (A+) Benefit Financial Advisors? By Steve Sadler CEO, Allegiancy
The headline poses a great question, but perhaps the more important one is, “How can financial advisors deliver more value to their clients using the new Regulation A?” Financial advisors who help their clients navigate and understand the rapidly changing securities world stand to benefit mightily from the new rules for Reg A. The rules become effective June 19, 2015, according to the U.S. Securities and Exchange Commission (SEC). With new Reg A offerings expected to hit the market in September, now is the time for financial advisors to get up to speed.
16
AI QUARTERLY
SUMMER 2015
The new Reg A increases the amount a private company can raise through a public securities offering from $5 million to $50 million in a year. It allows securities to be sold in all 50 states, and non-accredited investors to buy in. In short, Reg A now eliminates the barriers that have prevented both smaller companies and everyday investors from gaining favorable access to the capital markets. The potential for economic growth is vast. The private company market is estimated at nearly $70 trillion, far exceeding that of public companies. Think about it: if the new Reg A helps private companies grow by 20 percent, they will create as much new value as the entire public market. Here are some key benefits for broker-dealers and other investment professionals: 1) The new Regulation A creates a new class of securities, for which the expertise of an investment advisor will be highly valued. Because companies offering public securities under Reg A will be smaller or in earlier growth stages, the value of an advisor’s expertise will be greater than for traditional public offerings, which are already covered widely by Wall Street analysts. The new Reg A can offer investors liquidity and transparency with access to the audited financials of private companies, but clients will need and want a financial advisor’s expertise in reviewing them. Local and regional financial firms can readily develop expertise in their markets and add tremendous value for clients.
2) An advantage of investing in the new Reg A companies is that they likely will be “closer to the ground”—that is, their products and services will be familiar to everyday investors because they touch their lives. For example, the company that fills your typical investor’s propane tank could easily become a new Reg A issuer. An issuer could be a restaurant entrepreneur who owns three restaurants in a smaller market, or one large in a metropolitan area; a dry cleaning business, auto dealer, or plumbing and HVAC contractor. In other words, small and medium-sized businesses that a typical financial client can understand—perhaps even ones within the investor’s own community—may offer new investment options to the people who know them well. Efficient access to capital will help the good companies grow—add more trucks, more staff, provide better service. And this all benefits the local economy —the one you live in and see every day. 3) Financial advisors also know that early investors in growing companies can make serious gains. Your clients may not be the Warren Buffet-type, but the new Reg A can give everyday investors access to young companies with huge upside potential much earlier in the game than an initial public offering (IPO) would. Today, the early opportunities are almost exclusively reserved for hedge funds and private equity firms. With the new Reg A, your clients will have the opportunity to make those investments while there’s still a 10 to 20 times growth story to be told. By the time Facebook and LinkedIn went public, most of the enormous returns were monopolized by the early private equity investors. As just one example, Accel Partners invested $12.7 million in Facebook when it was a private company. In Facebook’s IPO, Accel’s stake was valued at $11.4 billion—a return of nearly 1,000 times the original investment. With the new Reg A, everyday investors could have those types of opportunities, and financial advisors will have the chance to help them. 4) Financial advisors to wealthy clients often work regularly with entrepreneurs and business owners who could benefit from new, more efficient sources of capital
as well. Chances are your best clients are entrepreneurs. Ask yourself how much they know about the opportunity of the new Reg A. The expertise and infrastructure of respected financial firms and investment banking services could be extremely valuable to these clients who want to raise new capital. With the new Reg A, many smaller companies will gain access to capital without selling their souls (and giving up control of their businesses) to private equity firms. Reg A gives smaller companies access to the public marketplace—which means the capital to grow, to provide more and better service to clients, and to hire more people. Smaller companies can issue stock that’s traded like any public company’s, but they will need the solid infrastructure, trading platforms, and the expertise of respected financial firms to make it happen. This is another place to add meaningful value for your clients and community.
Conclusion Within much of today’s traditional market, investors can’t earn sizable returns, and small business can’t grow without capital. The new Regulation A has the potential to change all this. It has the potential to help investors gain more profitable portfolios. It has the potential to give entrepreneurs access to capital at far more attractive rates. However, financial advisors do face a risk: It’s likely that the new Reg A will become the darling of new crowdfunding platforms. If financial advisors fail to get involved early and add meaningful value for their clients around Reg A, they risk losing at least part of their investment dollars to the up-and-comers in the crowdfunding space. At Allegiancy, we know something about Reg A. We raised $5 million in 2014 under the old rules and have grown our company by 400 percent. With the new rules making access to markets even easier, we plan to raise more capital in 2015, so that we can continue growing. With the new Reg A, we believe the winners will be small businesses, investors, and financial advisors who recognize and take advantage on this vast opportunity. And of course, the communities they help to prosper will benefit as well. ▲
SUMMER 2015 AI QUARTERLY
17
Regulation A+: A Worthy Challenger to Regulation D? By Richard Levin and Gerard Deffenbaugh Bryan Cave
18
AI QUARTERLY
SUMMER 2015
The Securities and Exchange Commission (“SEC”) recently adopted final rules to amend Regulation A under the Securities Act of 1933 (the “Securities Act”).1 The amendments—to be effective June 19, 2015 — were required by the Jumpstart Our Business Startups Act of 2012 (the “JOBS Act”).2 Colloquially called Regulation A+, the amendments provide two tiers of offerings exempt from Securities Act registration. It is unclear if eligible issuers will use Regulation A+ instead of Rule 506 of Regulation D.
Regulation A The potential import of Regulation A+ is best understood in the context of the existing Regulation A exemption. Section 5 of the Securities Act requires the registration of securities with the SEC or reliance on a registration exemption.3 Section 3(b)(1) of the Securities Act provides an exemption for offerings of less than $5 million.4 The SEC implemented this exemption through Regulation A to provide small businesses a method to raise limited amounts of capital without registering the securities. Regulation A has some advantages including a mechanism to “test the waters” to determine interest in a proposed offering prior to filing the Form 1-A.5 Moreover, the securities can be sold
Two main problems with Regulation A offerings are the relatively low $5 million threshold and the requirement to comply with state blue sky laws, which increases the complexity and costs of the offering.
to unaccredited investors,6 and once issued, resale of the securities is unrestricted except for securities held by affiliates.7 Even with these advantages, companies have historically shunned Regulation A. In 2011, there were 19 Regulation A offerings, compared to 8,194 Regulation D offerings under $5 million that same year.8 Two main problems with Regulation A offerings are the relatively low $5 million threshold and the requirement to comply with state blue sky laws, which increases the complexity and costs of the offering.9 In contrast, offerings under Rule 506(b) or Rule 506(c) of Regulation D have no dollar threshold and are exempt from state blue sky laws.10
Regulation A+ Regulation A+ creates two tiers of securities offerings: Tier 1 for offerings up to $20 million in a 12-month period, with not more than $6 million in resale to affiliates of the
5
$
MM
issuer; and Tier 2 for offerings up to $50 million in a 12-month period, with not more than $15 million in resale to affiliates of the issuer. For offerings up to $20 million, the issuer can select to make an offering under either Tier 1 or Tier 2. Tier 1 Tier 1 offerings are similar to Regulation A offerings in that the issuer must comply with state blue sky laws. Issuers making Tier 1 offerings will need to submit reviewed financial statements as part of their Form 1-A filings and are subject to certain “bad actor” disqualification, disclosure and certification requirements. There is no periodic reporting requirement for a Tier 1 offering, after the SEC reviews and qualifies the Form 1-A.
SUMMER 2015 AI QUARTERLY
19
An issuer can raise up to $50 million using a Tier 2 offerings. The issuer is exempt from the registration and qualification requirements of state blue sky laws, but is still subject to state filing and anti-fraud authority.
Tier 2 An issuer can raise up to $50 million using a Tier 2 offerings. The issuer is exempt from the registration and qualification requirements of state blue sky laws, but is still subject to state filing and anti-fraud authority. Issuers making Tier 2 offerings will need to submit audited financial statements as part of their Form 1-A filings and are subject to certain “bad actor” disqualification, disclosure and certification requirements. As part of a Tier 2 offering, the issuer must make current, semiannual, and annual reports to the SEC. Unless the securities are listed on an national securities exchange upon qualification of the offering, purchasers in Tier 2 offerings must either be accredited investors as defined in Rule 501(a) of Regulation D, or if they are non-accredited investors, they will be limited to investing no more than 10 percent (10%) of the greater of their annual income or net worth in a Tier 2 offering as provided in Rule 501 of Regulation D. Preemption of State Securities Laws For Tier 2 offerings, an issuer is exempt from the registration and qualification requirements of state blue sky laws if the offerings are made to “qualified purchasers” or the securities are listed on a national securities exchange. During the comment period for Regulation A+, one of the main areas of focus was the preemption of state securities law, and specifically how the SEC would define a “qualified purchaser.” The SEC defined a “qualified purchaser” very broadly as any person to whom securities are offered or sold in a Tier 2 offering. Even with the preemption of state registration and qualification, issuers are still subject to state filing and anti-fraud authority. “Bad Actor” Disqualifications The SEC decided to disqualify certain felons and other “bad actors” from participating Tier 1 or Tier 2 offerings. The covered individuals and triggering events are essentially the same as those included in Rule 506(d) of Regulation D. The covered persons include managing members of limited liability companies, compensated solicitors of investors, underwriters, executive officers and other officers participating in the offering and beneficial owners of 20% or more of the issuer’s outstanding voting securities. Regulation A+ has two new disqualification triggers, final orders and bars of certain state and federal regulators, and SEC cease-and-desist orders relating to violations of scienter-based anti-fraud provisions of federal securities laws. Initial Offering Statement A Tier 2 issuer will be required to file an offering statement, Form 1-A, electronically on the Electronic Data Gathering, Analysis and Retrieval system (“EDGAR”). The offering statement will be composed of three parts: Part I presents key information about the issuer; Part II presents the body of the disclosure document and the audited financial statements; and Part III contains the offering statement signatures and exhibits. Tier 2 issuers will need to submit financial statements from the past two years that are audited in accordance with GAAP or the standards set by Public Company Accounting Oversight Board (“PCAOB”). The SEC must qualify the offering statement before any sale takes place. Ongoing Reporting Requirements A Tier 2 issuer will need to electronically file on EDGAR current reports (Form 1-U), semiannual reports (Form 1-SA) and annual reports (Form 1-K). The level of reporting for a Tier 2 issuer will fall between the extensive reporting required of public companies pursuant to the Securities Act and issuers engaged in private placements under Regulation D that have no ongoing reporting requirement.
20
AI QUARTERLY
SUMMER 2015
Offerings Under Rule 506 of Regulation D Regulation D contains three separate registration exemptions. Rule 506 is the most commonly used and was recently amended in 2013, as required by the JOBS Act. The amendments resulted in the creation of Rule 506(b) and Rule 506(c).11 Rule 506(b) The provisions of Rule 506 before the Jobs Act, are now set forth in Rule 506(b).12 Under Rule 506(b), issuers can raise an unlimited amount of capital through a securities offering to an unlimited amount of accredited investors and up to 35 non-accredited investors. Rule 506(b) offerings are exempt from state blue sky laws under the National Securities Market Improvements Act of 1996 (“NSMIA”).13 However, issuers are banned from general solicitation for Rule 506(b) offerings. Rule 506(c) The SEC adopted Rule 506(c) to comply with the JOBS Act’s mandate to lift the Rule 506 ban on general solicitation.14 Rule 506(c) permits issuers to raise unlimited amounts through a securities offering to an unlimited number of accredited investors. Rule 506(b) offerings are exempt from state blue sky laws by NSMIA. Issuers making a 506(c) offering may engage in general solicitation, subject to certain conditions, including taking reasonable steps to verify that each investor is accredited.
Conclusion Regulation A+ is a marked improvement over Regulation A. That said, we believe it is unlikely to displace Regulation D offerings as the preferred means for early and mid-stage companies to raise capital. Regulation D offerings will likely remain the preferred means for issuers to raise capital because of the unlimited amount capital that can be raised, the preemption of state blue sky laws, the lack of a cap on the amount of funds that can be invested by an accredited investor, and the lack of ongoing reporting requirements. Regulation A+ appears to be designed for use by national securities exchanges as a means to compete with private offerings of unregistered securities under Rule 506. However, even with the increased dollar limits and the preemption of state blue sky laws for Tier 2 offerings, Regulation A+ is unlikely to challenge the popularity of Regulation D. ▲
1—Amendments for Small and Additional Issues Exemptions Under the Securities Act (Regulation, Rel. No. 33-9741 [80 Fed. Reg. 21,806 (Apr. 20, 2015) (the “Adopting Release”), available at: http://www.gpo.gov/ fdsys/pkg/FR-2015-04-20/pdf/2015-07305.pdf. 2—P.L. 112-106, 126 Stat. 305 (2012). 3—15 U.S.C. § 77c (2015).
5—17 C.F.R. § 230.254 (2015).
9—Id. at 15-18.
6—15 U.S.C. § 77c (b) (2015).
10—17 C.F.R. § 230.506 (2015).
7—17 C.F.R. § 230.251 (2015).
11—P.L. 112-106, 126 Stat. 305 (2012).
8—U.S. Gov’t Accountability Office, GAO12-839, Securities Regulation, Factors that May Affect Trends in Regulation A Offerings, 9-11 (2012).
12—17 C.F.R. § 230.506(b) (2015). 13—P.L. 104-290, 110 Stat. 3416 (1996). 14—17 C.F.R. § 230.506(c) (2015).
4—Id. at § 77c (b)(1).
SUMMER 2015 AI QUARTERLY
21
Regulation A+: The Pluses and Minuses By Darryl Steinhause Partner, DLA Piper
The Securities and Exchange Commission (the “SEC�) recently adopted changes to Regulation A that allow issuers to raise up to $50,000,000. The increase in the amount that can be raised under new Regulation A+1 makes Regulation A+ a viable option to raise funds. However, Regulation A+ is not without challenges, particularly for real estate sponsors. The following summarizes the positive and the negative aspects of Regulation A+.
22
AI QUARTERLY
SUMMER 2015
First, the securities issued under Regulation A+ are freely transferable. In theory, this gives the investors a liquidity option that is not present in private offerings like Regulation D. Second, Regulation A+ provides issuers with the ability to publicly solicit and access non-accredited investors without having to go through the expensive process of completing a registered offering and obtaining state level approval. Tier 2 Regulation A+ offerings (over $20 million) are not subject to state review. Third, Regulation A+ allows sponsors to have a product that has been reviewed by the SEC and is accompanied by public disclosure documents. Further, the issuer is required to provide ongoing public reporting. It is possible that broker-dealers and investors will prefer selling (and buying) a product with these public disclosure obligations over private transactions. However, it is important to note that Regulation A+ securities are still considered “exempt” securities and are not registered securities. Fourth, Regulation A+ has made it easier for an issuer to enter the market and grow by (i) allowing an issuer to engage in a new $50 million offering each year, (ii) deferring the public company reporting requirements, (iii) simplifying the process of becoming a reporting company and (iv) with freely traded securities, making it easier for a resale market to develop. First, the process is likely to take significantly longer to complete than a private placement, including the time to draft the disclosure documents and the SEC review process. Second, the cost of the offering will be significantly higher than a private offering, both from a legal and an accounting standpoint. Pursuant to prior SEC guidance, Industry Guide 5 applies to Regulation A and the SEC has indicated that it will apply to Regulation A+.2 Third, the ongoing reporting and financial requirements in a Regulation A+ offering will increase the operational costs of the issuer. Fourth, Regulation A is viewed as a “public” program by FINRA. Consequently, the compensation limitation and approval requirement of FINRA Rule 5510 apply. Fifth, the perceived benefit of having freely transferrable securities will be tempered by the following factors: (i) most nonregistered real estate offerings are done through limited liability companies or limited partnerships which must comply with the publicly traded partnership rules which limit the total transfers in the issuer to no more than 2% per year, other than certain private transfers and redemptions, (ii) most real estate funds (other than certain REITs) have a limited life and do not have a goal of “going public,” (iii) most investors do not transfer private securities and (iv) most real estate issuers will not raise enough equity to allow for a realistic traded market. Finally, persons selling securities under Regulation A+ are subjected to a higher liability standard under Regulation A+ (often characterized as strict liability for materially false or misleading statements, subject to a reasonable care defense) than under Regulation D (a Rule 10b-5 standard requiring “scienter,” among other requirements).
Conclusion. The long-awaited changes to Regulation A provided real estate sponsors with an alternate method of raising money. The time and cost required to complete a Regulation A+ offering fall somewhere between a private transaction under Regulation D and a registered offering. While Regulation A+ will not likely be a suitable offering structure for certain transactions (i.e., specified deals which require relatively quick money raising), it is likely that many real estate sponsors will view Regulation A+ as
1—For purposes of this article, we have assumed that issuers will offer tier 2 offerings under Regulation A. 2—Compliance and Disclosure Interpretations 128.06 and SEC Release 6900 (June 17, 1991).
an option for long-term offerings such as unspecified funds or REITs. ▲
SUMMER 2015 AI QUARTERLY
23
Retail Property: Refreshing the Business By David Harris and Laura Sexton SK Research
24
AI QUARTERLY
SUMMER 2015
We provide an update on news from the retailers focusing on the implications for the demand for retail space.
The early months of the year are usually a time of plenty of news from the retail sector. Against a backdrop of a positive, but still rather subdued, consumer and in light of the transformational changes being wrought by e-commerce, some retailers continue to expand their physical presence and add new stores, while others are seeking to reduce store counts and otherwise rationalize their businesses. While the current nature and pace of change in retailing may seem unusual, change is a fact of life within the sector. The rise and fall of retail tenants is an ongoing feature. Most retail landlords who have survived a business cycle or two have learned by necessity to adapt to change. We are of the view that investors need to look carefully at the underlying quality of the assets and, in particular, for REIT management that is capable of responding to the changing needs of retail tenants. Retailers have been responding to the changes in the consumer environment. Virtually all major retailers have embraced omni-channel strategies to include e-commerce and an expansion of tech-related capabilities. Some have announced larger scale business
We are of the view that investors need to look carefully at the underlying quality of the assets and, in particular, for REIT management that is capable of responding to the changing needs of retail tenants.
rationalization plans that have included a focus on opening smaller stores, store closings and in some cases, corporate mergers that feature cost reductions that are likely to involve future closings of stores. For many established retail businesses, the physical store remains the principal means of contact with their customers. We have few doubts that good old “bricks and mortar” retail properties will continue to have an important role for most retailers for the foreseeable future.
Macro Data — Generally Supportive Notwithstanding a weak Q1, the generally positive momentum of the economy is expected to support the outlook for consumer spending. Q1’15 GDP of +0.2% was sharply down from 2.2% growth in Q4’14 and 5.5% in Q3’14. Expectations are for growth of around 2.5-3% for FY’15. Job growth rebounded in April (+223k) from the March gains of only 85k. Unemployment has dipped to 5.4%. In March, consumer spending increased 0.4% m/m and retail sales (ex autos) increased 0.5% m/m. The price of crude oil has bounced up a little over recent months after declining by about 50% in 2H’14. Though there has been little evidence of the benefits of lower gas prices in the spending data, it is generally thought that some additional spending will kick in.
SUMMER 2015 AI QUARTERLY
25
Chart 1
Retail Sales YoY% Change
15% 10% 5% 0% -5% -10% -15% 1995
1997
1999
2001
2003
2005
2007
2009
2011
2013
2015
Chart 2
E-Commerce as % of Retail Ex-Autos & Gasoline
15%
12%
9%
6%
3%
0% 2000
2002
2004
2006
2008
2010
2012
2014
Omni Channel/e-Commerce Omni-channel can be described as multiple ways of selling goods and satisfying the consumer that includes mobile devices, computers, TV, catalog and bricks and mortar. Critical to successful implementation is flexibility of the supply chain and the maintenance of data. Most attention has been paid to traditional retail business models bolting on e-commerce; however, there are now examples of e-commerce businesses adding physical stores. According to the Department of Commerce, e-commerce sales in 2014 grew at 15.4% and amounted to 6.5% of total sales, or 10.1% excluding autos & gasoline sales. Total sales grew at 3.8% in 2014, a quarter of the pace of e-commerce growth. E-commerce as a percentage of total sales has roughly doubled since the late 2000s and appears likely to continue to steadily grow and take market share.
26
AI QUARTERLY
SUMMER 2015
There are implications for the use and demand of property associated with the rise of e-commerce. Some retailers may reduce the amount of space needed because they now carry less inventory as they have moved towards more efficient and responsive supply chains. The development of “buy-online/pick-up-in-store” programs adds a function to stores and will work best in those locations with superior access. For high-end retailers, the desire to have a physical store to showcase goods is supporting strong demand in the best locations. Some retailers are less vulnerable to tech related disruption. Consumers still appear to be happy to visit a physical store to purchase goods from home improvement and pet stores, for example. More generally, some landlords have leased more space to service tenants, such as health care providers, sports clubs and professional services, which have helped maintain shopping center occupancy and relevance.
Selected Recent Retail Company News The department stores continue to rationalize their property use and ownership. Sears plans to sell 200-300 of its best stores for around $2bn to a new REIT that would be spun-off to SHLD shareholders. Sears closed about 234 stores in 2014 to shrink its store count to 1,725. J. C. Penney is to close 40 stores in 2015. The company will then operate about 1,020 stores. Macy’s is to close 14 stores in 2015. The company operates 790 stores in total.
The discounters are also actively adapting their businesses and property needs. Target is to cut several thousand jobs over the next two years and plans to invest $2.2bn on its on-line capabilities and on remerchandising. The company has 1,790 discount stores in the U.S. WalMart plans to open 200-220 new stores in 2015 with the focus on smaller properties: Discount stores of 106,000sq. ft. (compared to the Superstores of 186,000sq. ft.). Family Dollar shareholders have approved the $8.5bn bid from Dollar Tree to acquire their company. Assuming the deal closes, it is expected that there could be about 300 store closings.
Other retailer news includes: Office Depot and Staples have announced a deal to merge the companies that appears likely to result in store closings. RadioShack has filed for Chapter 11 bankruptcy after agreeing to sell 1,500-2,400 stores to Standard General, an investment company. Standard General intends to partner with Sprint Corporation to operate up to 1,750 stores. Wet Seal has closed 338 stores (two-thirds of the total) and has filed for Chapter 11 bankruptcy. Aeropostale is looking to close 50-75 stores in 2014, and 175 over the next few years after closing +100 stores in 2014. Abercrombie & Fitch is planning to close 180 (~20%) of its U.S. stores in 2015. Also adding to supply, JP Morgan is to close 300 bank branches (~5% of its total count) as customers move online and the bank seeks to reduce costs.
Space Taken up by New Retailers Rent the Runway, the online designer dress rental business, is expanding into physical space. Successful European fashion retailers including Primark (which is taking space from Sears), H&M and Top Shop are continuing to expand their store counts in the U.S. And, in a much publicized move, Amazon is set to open a store on 34th Street, Manhattan, later this year.
Conclusion. Good quality, well located retail property has historically proved to be an adaptable asset. Operated well by good management with appropriate capital investment, retail properties can
Disclaimer: The information contained in this article has been assembled using publicly available information. While SK Research believes it to be reliable, there is no guarantee that all of the information contained in this article is or will be accurate. This article does not constitute investment advice and is intended for informational purposes only. This article does not constitute an offer to sell or the solicitation of an offer to purchase, nor should it be considered a recommendation of any security referenced herein.
have long and productive lives. ▲
SUMMER 2015 AI QUARTERLY
27
Schedule of Events Tuesday, July 14 8:30-8:45am – Welcome & Introductions 8:45-9:45am – FINRA 2015 Regulatory and Examinations Priority Letter 9:40-10:30am – Ks and Qs for REITs and BDCs: An Interactive Exploration 10:30-11:00am – Exhibition and Break 11:00am-12:00pm – Keynote Speaker Barry Goldwater, Jr. 12:00-1:30pm – Exhibition and Lunch 1:30-2:20pm – New Twists: Reg A+, Platforms and 506(c) 2:25-3:15pm – Mock Decision Tree Between Two Products 3:15-3:45pm – Exhibition and Break
ADISA 2015 Due Diligence Forum July 14-15 • Eden Roc Hotel • Miami Beach, Florida ADISA’s Due Diligence Forum is designed for industry professionals who are employed with a Broker-Dealer, RIA, Due Diligence Firm, or select others, that offer alternative investments in their business. • Network with more than 200 industry professionals • Learn about today’s issues and business opportunities • Discover advance due diligence techniques, processes, tools and resources
3:45-4:45pm – 1031 Due Diligence: Time is of the Essence 5:00-6:30pm – Exhibition and Welcome Reception
Wednesday, July 15 7:30-8:25am – Exhibition and Breakfast 8:30-9:20am – Latest Research on Real Estate and Direct Investment Issues 9:30-10:25am – Legislative & Regulatory Update, Including 15-02
Who will attend? • Broker-Dealers • Registered Investment Advisors (RIAs) • Due Diligence Professionals • Compliance Officers • Sponsors • Affiliates
28
AI QUARTERLY
SUMMER 2015
10:30-11:00am – Exhibition and Break 11:00-11:55am – Energy Programs: What Are the Risks and Opportunities at Today’s Prices? 12:00-12:15pm – Closing Remarks
Featuring Keynote Speaker
Registration Information
Former Congressman
Broker-Dealers and Registered Investment Advisors*
Barry Goldwater, Jr. served for 14 years
in Congress. During his political and government service, he has expressed his superb knowledge, experience and feelings before many diverse audiences. Goldwater has a lifetime experience in and around government and politics at the local, state and federal level. For the past 23 years Barry has held responsible positions involving finance and management including eight years as a member of the New York Stock Exchange. He has used his government experience and knowledge like a knife to pry open and get to the heart of a problem affecting business impacted by regulation or law. His business career has not diminished his compassion for the people and his commitment to making this a better and safer world in which we live.
Complimentary registration and two (2) hotel room nights (Limited to two Broker-Dealers/RIAs per firm. Room nights subject upon hotel availability.) Additional attendees: $99 registration fee *Only Retail BD/RIA principals, officers, and owners doing business with the public (not a wholesale distributor) and selling the products of more than one unaffiliated product company in good standing with FINRA/SEC.
Sponsors/Affiliates Visit adisa.org/Events/2015-DueDiligence-Forum for registration rates. Onsite registration rates will increase by $200— be sure to pre-register online.
Hotel Information
The Eden Roc Hotel is offering ADISA Due Diligence Forum attendees the room rate of $189/night for Monday, July 13, and Tuesday, July 14. Reservations need to be made online. For more information, visit adisa.org/Events/2015-Due-Diligence-Forum.
Chart 1
adisa.org
Membership
Correction: In the Spring 2015 issue,
4000
the story on page 2,
Sponsors/Affiliates
ADISA Membership...
3500
is growing, contained a
3000
labeling error on a chart. This is the corrected chart.
BD/RIA/RR
2500 2000 1500 1000 500 0
2011
2012
2013
2014
2015 Q1
SUMMER 2015 AI QUARTERLY
29
10401 North Meridian Street Suite 202 Indianapolis, IN 46290
S A V E T H E D AT E
October 12-14 The Cosmopolitan of Las Vegas adisa.org
ADISA 2015 ANNUAL
CONFERENCE & Trade Show