First Reg A Issuer to Complete State Review Process Would Do It Again

A company that focuses on micro-lending for independent builders in real estate is now the first Reg A issuer to complete the coordinated process for state-level review developed by the North American Securities Administrators Association (NASAA). The process was born out of the desire to streamline state-level reviews of small securities offerings in light of proposed Securities and Exchange Commission rules that would preempt state review of Regulation A offerings altogether.

An Atlanta-based peer-to-peer lending company, Groundfloor Finance, started by lending up to $50,000 per deal, promising 8-12% annual returns to investors who crowdfund housing loans in Georgia. Groundfloor’s first offering was a $1 million unsecured note, and within nine months $500,000 of investments were sold. Investors are already seeing returns on six of the seventeen loans funded. When the company founders thought they were ready to expand to more states they choose to go through the coordinated review process rather than await the outcome of SEC rule proposals that would eliminate state regulation of so-called Reg A+ offerings.

Groundfloor’s SEC Form 1-A filing states that the company wants to raise $5 million via a Reg A offering, proceeds of which will fund loans from $25,000 to $500,000 with 5-15% coupon rates, with terms of six months to five years. The issuer choose to apply to California, Georgia, Illinois, Maryland, Massachusetts, Pennsylvania, Texas, Virginia, Washington, and the District of Columbia.

Groundfloor was warned by their attorneys at Smith Anderson LLP about the time and cost the company could go through and still face the chance of not being approved by states securities regulators through the coordinated review process.

Smith Anderson partners Benji Jones and Merrill Mason wrote in a note to clients, “Regulation A offerings are often referred to as “mini-public offerings.” Unlike the typical private placement exemption, such as Rule 506(b) under Regulation D, securities are offered publicly under Regulation A. There is no prohibition on the use of general solicitation or advertising in Regulation A offerings; nor are there suitability or qualification requirements for investors. But, like a registered offering, to conduct such an unrestricted offering, an issuer must first file a disclosure document (on Form 1-A) and qualify it with the appropriate federal and state authorities.”

Nick Bhargava, co-founder of Groundfloor, told Growth Capital Investor in an interview, “We knew our risk and decided to roll to the dice because we believe we need the states’ approval in the offering process to get our business model growing nationally.” Bharagava thinks changes to the Reg A process will allow thousands of more start-up companies access to affordable capital. Contrary to many other issuers though he firmly believes the market needs the states’ buy-in so the securities issued will amount to enough volume to create a robust secondary market and offer easier investor liquidity. Bharagava, who started his career working for a broker-dealer after graduating from Harvard, has also worked for FINRA.

Bhargava says getting the proper accounting controls in place for the company to pass an audit took the most time, along with working with Smith Anderson to prepare over 150 pages of disclosures needed for a successful approval of its Form 1-A. Groundfloor estimated their total cost to go through the NASAA review and SEC filings would be $200,000. Bhargava said that so far the offering costs have been less than estimated.

NASAA assigned Washington State as the lead state to run the examination. Washington was also chosen as the state for the disclosure review, while Maryland was chosen as the merit review state.

“The guidelines NASAA laid out were followed to a T, and the timelines the states committed to were honored,” said Bhargava. Of course this was the only issuer to submit an offering to the coordinated review process so far. Smith Anderson’s Jones said, “If the SEC decides preemption is not an option, NASAA is creating a process that is at least better than the current alternative. Fundamentally NASAA has been very accommodating and eager to provide a path that could work for issuers using Reg A or Reg A+.”

Groundfloor had to change its tech platform during the review process and made a significant change to its business model. Originally investors had to make a minimum $100 investment. As a result of the review process, the minimum was changed to a $10 minimum investment.

Loans to the company from insiders were also allowed by state regulators. Co-founder Brian Daily had made a $30,000 loan at 5% interest to cover some of the company’s operating costs. Additionally the original seed investments (made by company outsiders) of $1.5 million were turned into equity via discounted stock warrants exercised during the review process.

Real Estate investors in Groundfloor’s Reg A offering do not have their interests secured by collateral. If there is a foreclosure Groundfloor would have to do legal work to recover any investment. One of the worries of crowdfunding has been increasing the number of diverse parties if investments go wrong and litigation is needed, Bhargava said state regulators liked this part of their business model because it meant less people who crowdfunded a real estate investment would be involved in any litigation

Groundfloor’s executives told Growth Capital Investor they would go through the NASAA coordinated review process again if needed after their $5 million offering is completed.