On April 5, 2012, President Obama signed into law H.R. 3606, the Jumpstart Our Business Startups Act (the JOBS Act), which is intended to improve access to the public capital markets for a new category of issuer, the “emerging growth company” (an EGC). The JOBS Act also includes provisions that reduce restrictions on exempt offerings under Regulation D and Rule 144A under the Securities Act of 1933 (the Securities Act) and provide a new “crowdfunding” capital raising option.
Emerging Growth Companies / Access to Public Company Markets
The JOBS Act defines an emerging growth company as an issuer that had less than $1 billion in gross revenues in its last fiscal year. Any issuer that made its first registered sale of common equity securities (IPO) on or before Dec. 8, 2011, would not be eligible to be treated as an EGC. An issuer can remain an EGC for at most five years after its IPO (and will lose that status sooner if its revenues exceed $1 billion, it issues more than $1 billion in non-convertible debt in a three-year period or if it becomes a “large accelerated filer” [generally, issuers that have been public for at least a year and have an equity float of $700 million or more]).
Key benefits under the JOBS Act for the IPO process for EGCs include:
- Only two years of audited financial statements need to be included in the IPO registration statement. In addition, selected financial data need not be provided for any period prior to those two years of audited statements. This latter exemption is available not only for the registration statement, but also for all subsequent reports as well (such as the Annual Report on Form 10-K). Nor would any management’s discussion and analysis (MD&A) be required for a period prior to those two audited years.
- The auditor attestation under Section 404(b) of the Sarbanes-Oxley Act of 2002 (SOX) will not be required for so long as the issuer remains an emerging growth company. Previously, all “accelerated filers” and “large accelerated filers” were required to provide such attestations beginning with their second annual report on Form 10-K.
- The executive compensation disclosures in the IPO registration statement and subsequent proxy statements will be scaled back to those normally applicable only to “smaller reporting companies.” Benefits here include (a) not having to provide the compensation discussion and analysis (CD&A); (b) providing compensation information for just the top three, rather than five, executive officers; and (c) providing compensation information for only the most recent fiscal year instead of the prior three years. Also, the issuer will be temporarily exempt from the new “pay versus performance” and “pay ratio” disclosures (which the SEC has yet to implement) and will not be required to hold “say-on-pay,” “say-on-frequency” or “say-on-golden parachutes” shareholder votes until after it ceases to be an EGC.
- In addition to limiting the number of years for which audited financials are required in the IPO registration statement, the JOBS Act provides relief from a number of other accounting-related requirements. An EGC will not be required to comply with a new or revised financial accounting standard until the standard is also applicable to nonpublic companies. Any future rules adopted by the Public Company Accounting Oversight Board (PCAOB) requiring mandatory audit firm rotation or an “auditor discussion & analysis” will not apply. Further, any future audit rules adopted by the PCAOB will not apply to EGCs unless the SEC determines that such application is necessary or appropriate in the public interest.
- The JOBS Act liberalizes various rules limiting communications in connection with an IPO. For example, the issuer and its representatives can contact certain qualified investors prior to or after filing the registration statement to determine whether they might have an interest in a contemplated offering. Such investors must be “qualified institutional buyers” as defined in Rule 144A or institutions that are “accredited investors” as defined in Rule 501(a). In addition, brokers will be able to publish research reports about an EGC that is the subject of a proposed public offering of common equity at any time before or after the filing or effectiveness of the registration statement even if the brokers are or will be participants in the IPO. And the broker’s analysts will now be able to join in with its investment bankers in meetings with management.
- An issuer will have the option of submitting its registration statement for the IPO to the SEC on a confidential basis for a nonpublic staff review, allowing the issuer to explore an IPO without making competitive information available to the public (confidential processing was previously available only to certain foreign issuers). However, the initial submission and all subsequent confidential amendments must be filed with the SEC at least 21 days prior to starting the roadshow. Registration fees are due at the time of the public filing.
An EGC is generally free to rely upon or forego any of the exemptions described above with one exception. If an EGC chooses to forego the extension on the application of new or revised financial accounting standards, (i) it must make that election with its first filing with the SEC; (ii) the election will apply to all new or revised standards; and (iii) the election must continue for so long as the company remains an EGC.
The above IPO-related provisions of the JOBS Act took effect immediately upon the Act becoming law and are not dependent on any SEC rulemaking. Nonetheless, the SEC will need to adopt revisions to some of its rules to conform to the new statutory provisions.
The Act also requires the SEC to undertake a comprehensive review of the registration requirements under Regulation S-K and to report back to Congress within 180 days regarding how the registration process can be further streamlined and simplified for EGCs.
Increase in Threshold for Public Company Reporting
The JOBS Act amends the thresholds that trigger registration of securities and the reporting obligations under the Securities Exchange Act of 1934 (the Exchange Act). Previously, companies with 500 or more shareholders of record and $10 million in total assets would have to comply with SEC public disclosure rules such as filing periodic and other reports. The threshold for registering securities with the SEC has been increased to:
- $10 million in total assets and a class of equity security held “of record” by either 2,000 persons or 500 or more shareholders who are not “accredited investors”;
- For banks and bank holding companies the 2,000 shareholders trigger does not include a limit on shareholders who are not accredited investors; and
- For the purposes of calculating the number of shareholders “of record,” the JOBS Act excludes shareholders who received securities under an employee compensation plan in transactions exempted from Securities Act registration.
Expansion of Regulation A – Small Company Capital Formation
The JOBS Act requires the SEC to amend the registration exemption contained in Regulation A under the Securities Act to increase the amount of securities that can be issued over a 12-month period under such exemption from $5 million to $50 million. The issuer may solicit interest in the offering prior to filing any offering statement, but must file audited financial statements with the SEC annually.
Removal of General Solicitation Prohibition under Regulation D and Rule 144A
The JOBS Act directs the SEC to revise Rule 506 of Regulation D and Rule 144A to eliminate the prohibition against general solicitation or general advertising as applied to offers and sales of securities under Rule 506 and Rule 144A, provided that all purchasers are “accredited investors,” or “qualified institutional buyers,” respectively. All issuers may take advantage of this change; however, the SEC has 90 days to revise Rule 506 and Rule 144A and the current rules will remain in effect until revised.
Fundraising Modifications (“Crowdfunding”)
Crowdfunding refers to the solicitation of pledges of smaller amounts of money from a large number of investors. The JOBS Act adds a new Section 4A to the Securities Act of 1933, which details the requirements for crowdfunding:
- The exemption would be limited to the offer and sale of up to $1 million of securities of the issuer over any 12-month period.
- The aggregate amount sold to any single investor over a 12-month period would be capped at: the greater of $2,000 or 5 percent of the annual income or net worth of an investor whose net worth is less than $100,000 or 10 percent of an investor’s annual income or net worth (but no more than $100,000) if such investor’s annual income or net worth is greater than $100,000.
- the greater of $2,000 or 5 percent of the annual income or net worth of an investor whose net worth is less than $100,000 or
- 10 percent of an investor’s annual income or net worth (but no more than $100,000) if such investor’s annual income or net worth is greater than $100,000.
- Crowdfunding offerings must be conducted through either a registered broker or a funding portal that is registered with the SEC.
- An issuer engaging in a crowdfunding offering must provide investors with: information about the issuer, its officers, directors and 20 percent shareholders; a description of the issuer’s business and anticipated business plan; certain required financial information depending on the size of the offering:
- information about the issuer, its officers, directors and 20 percent shareholders;
- a description of the issuer’s business and anticipated business plan;
- certain required financial information depending on the size of the offering:
- for an offering of less than $100,000, an issuer must provide income tax returns and financial statements that are certified by its CEO;
- for an offering of between $100,000 and $500,000, an issuer must provide financial statements that have been reviewed by an independent public accountant; and
- for offerings of $500,000 or more, an issuer must provide audited financial statements.
The implementation of the crowdfunding offering exemption will require SEC rulemaking on certain issues in order to become effective.