The SEC's expanded role in small business capital formation.

Recent changes should make it easier and less expensive for small businesses to raise capital.

Although the Securities and Exchange Commission's role in large public companies' capital formation receives frequent publicity, the SEC also is active in promoting small businesses' capital formation. Consistent with these efforts, last year the SEC undertook major new initiatives to address the capital needs of small businesses, which culminated in final rules adopted in July 1992 and April 1993 (see Securities Act Releases nos. 33-6949 [57 FR 36442] and 33-6996 [58 FR 26509]) that provide new and broadened opportunities for small enterprises to raise the capital needed to start and expand their businesses.

RULE CHANGES

Capital formation costs through public securities offerings are significant. To reduce these costs, the SEC adopted rules and forms to provide a series of simplified capital formation opportunities for small businesses. These are the most significant rule changes:

* Rule 504 (which applies to certain exempt private offerings) was amended to allow issuers, other than certain development-stage companies, to raise up to $1 million in any 12-month period in a general solicitation without registering under the Securities Act of 1933.

* Regulation A, which provides a registration exemption for certain small securities offerings, was amended to raise the ceiling on an exempt small offering from $1.5 million to $5 million and to allow issuers to test the waters by soliciting indications of possible investor interest before incurring an offering circular's preparation costs.

* The safe-harbor provisions for prospective information on trends and events that may affect future operating results or financial condition were revised to apply to statements made in a regulation A offering statement.

* An integrated small business disclosure system, grounded in new regulation S-B, was adopted to replace regulations S-K and S-X for small businesses. The new disclosure system is optional and includes Securities Act of 1933 registration forms SB-1 and SB-2 as well as adaptations of forms S-2, S-4 and S-8. Under the new small business initiatives, an issuer can raise capital by using abbreviated disclosure documents and fulfill its Securities Exchange Act of 1934 registration and periodic reporting requirements by using forms 10-SB, 10-QSB and 10-KSB and special small business instructions to form 8-K.

Under the new disclosure system, a small business issuer is characterized as a U.S. or Canadian entity other than an investment company that meets, for each of its last two fiscal years, all of the following tests:

* The entity has annual revenues of less than $25 million.

* The aggregate market value of the entity's voting stock held by nonaffiliates (referred to as the public float) is less than $25 million.

* The entity is not a subsidiary of another company that does not qualify as a small business issuer.

Based on SEC staff data, 3,000 reporting public companies fall within the definition of a small business issuer.

* Of these recent small business initiatives, regulation S-B and the related integrated disclosure system are likely to have the greatest impact on small business capital formation. Before regulation S-B was adopted, registrants could make an initial public offering limited to $7.5 million using form S-18, which required two years of audited financial statements (other public offerings required three years). Financial statement requirements under regulation S-B are similar to those under the old form S-18 in that the financial statements can be prepared in accordance with generally accepted accounting principles and are not required to comply with regulation S-X, which governs the form and content of financial statements otherwise filed with the SEC.

Among other requirements exceeding those under GAAP, regulation S-X requires supplemental financial statement schedules that provide details on investments, valuation accounts, short-term borrowings, property and depreciation schedules. Exemption from these regulation S-X requirements reduces the cost of financial statement preparation and auditing. To provide a complete, stand-alone regulatory package for small businesses, the small business financial statement requirements, modeled after the form S-18 financial statement requirements, are included in item 310 of regulation S-B (see 17 CFR 228.310).

In adopting the release, the SEC said small business issuers engaged in operations involving real estate, mining, insurance, banking, utilities and oil and gas should refer to applicable industry guides to consider the need for such disclosures. In addition, certain transactions involving an exchange of real estate interests are required to include disclosures required by subpart 900 of regulation S-K.

SIMPLIFIED DISCLOSURE

REQUIREMENTS

Included in the April 1993 changes were rules and forms to facilitate a small business issuer's transition to reporting status and to simplify disclosure requirements for small issuers that engage in exempt offerings. Under the transitional filer rules, a small business issuer may enter the reporting system using the level of disclosure required in a regulation A offering and two years of audited financial statements. The new form SB-1 transitional issuer registration statement may be used for public offerings of up to $10 million in any continuous 12-month period. Transitional issuers can meet subsequent reporting requirements under the 1934 act using the regulation A model of disclosure until they either

* Register more than $10 million in any continuous 12-month period.

* Elect to graduate to another disclosure system.

* Are no longer small business issuers.

One refinement to the financial statement requirements for small business issuers adopted in April 1993 that received significant public support provides an automatic waiver of the requirements for one year of a significant acquired business's audited financial statements if they are not otherwise available and the significance of the acquisition does not exceed 40%. However, if an issuer has the acquiree's unaudited financial statements or other financial information, the data must be provided.

FAVORABLE RESPONSE

Although these new provisions have been effective for a very short period, early returns indicate the new capital formation opportunities are being well received. From August 1992 through April 1993, the value of securities qualifying under regulation A was approximately twice that for all of calendar year 1991. Since the first form SB-2 was filed in September 1992, 33 issuers using these forms raised an aggregate of more than $375 million. The favorable response to these new rules and continued feedback on the use of the forms will further efforts to foster small business capital formation.

* THE SECURITIES AND EXCHANGE Commission adopted new rules to make it easier and less expensive for small businesses to raise capital through public stock offerings.

* ISSUERS CAN NOW RAISE up to $1 million in any 12-month period in a general solicitation without registering under the Securities Act of 1933. Other amendments raised the ceiling on exempt small offerings to $5 million.

* CERTAIN ISSUERS CAN NOW USE abbreviated disclosure documents to fulfill Securities Exchange Act of 1934 registration and periodic reporting requirements.

* IN THE SHORT TIME THE NEW capital formation rules have been effective, early returns show the value of securities qualifying under regulation A has been approximately twice that for all of calendar year 1991.

TERESA E. IANNACONI is associate director - accounting operations in the Division of Corporation Finance of the Securities and Exchange Commission in Washington, D.C.

Ms. Iannaconi is an employee of the Securities and Exchange Commission. The views expressed in this article are the author's and do not necessarily represent the views of the SEC or the authors' colleagues.