Preparing for an A+ grade: the need for a clean audit

Pretty much everyone knows by now that audited financial statements are required for offerings under Tier 2 of Regulation A. While the SEC doesn’t require audited financials (or any kind of review by outside accountants) for Tier 1, some states do require audited financials in Tier 1 offerings.

But do you know what the audit letter is supposed to look like? That is important.

Without getting too much into the weeds, the SEC requires that audit reports meet the requirements of Regulation S-X. And that means those audit reports must be “clean.” There can’t be any reservations or qualifications or limitations on scope on the audit. Here’s an example of the sort of thing that may present problems: Freddie’s Ferret Foods has been in operation for three years and ships its premium ferret food to petstores around the country. They’ve never raised funds from outsiders before. In anticipation of making an offering under Regulation A, they hire Anita Accountants LLP to be their auditors. Anita’s auditors find the financial statements to be in excellent shape and say that Freddie’s financial accounting systems are great. However, there’s an issue with accounting for inventory. Auditors have to observe the inventory process (or apply other auditing procedures) and while Anita can do that for the date of the most recent balance sheet, they can’t go back in time and observe inventory at the beginning of the period audited. So now, even with excellent financial accounting controls and without anyone being at fault in any way, the audit opinion of Anita Accountants has to include a “disclaimer of opinion” with respect to inventory.

And that can’t be accepted by the SEC for the Tier 2 filing (and probably not by any state requiring audited financials in a Tier 1 offering). Conversations with the SEC accounting Staff indicate that the Staff is unlikely to give any waivers in these circumstances.

So, any company interested in a Regulation A offering should do this: Before you even start the process, make sure you know whether the independent auditors who will review your financial statements are able to give a “clean” audit opinion. Find out the answer to this before starting any “testing the waters” (TTW) activities, because Tier 1 TTW activities are subject to more limitations than Tier 2, and you need to know which Tier you are going to choose before you start TTW.

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