Emerging Growth Companies—Election Year Winner?
Congress has passed, and President Obama has signed, legislation entitled the Jumpstart Our Business Startups Act (JOBS Act).
This legislation includes a number of separate but related initiatives designed to assist small businesses to raise capital, including the removal of some perceived obstacles to becoming publicly-held through an initial public offering (IPO). (Please view Ice Miller's previous article on access to capital
.) Members of Congress and the Obama Administration, by stressing the benefits to small businesses, were able to overcome objections from many who remain concerned that this deregulation effort goes too far and exposes investors to unreasonable risk. Even the U.S. Securities and Exchange Commission (SEC) raised serious concerns with some aspects of the JOBS Act. We shall see.
To follow are some highlights of the JOBS Act.
Emerging Growth Company Definition
Companies that have revenues less than $1.0 billion during their latest fiscal year qualify. These companies would continue to qualify until the earliest of:
the last day of the fiscal year for which their revenues exceed $1.0 billion;
the end of the fiscal year which includes the fifth anniversary of the company's first registered public offering of equity securities;
the company issues more than $1 billion in non-convertible debt during a three year period; and
the company becomes a large accelerated filer under SEC rules.
The $1 billion revenue threshold is to be adjusted for inflation every five years.
Importantly, companies that would qualify but that have completed their IPO on or before Dec. 8, 2011, are excluded from the emerging growth company definition. Companies that completed their IPOs after Dec. 8, 2011, and that otherwise meet the definition would qualify.
Benefits for Private Companies
Within 90 days of enactment, the SEC is directed to amend its rules to remove the long-standing prohibition on general advertising or solicitation in private offerings so long as only accredited investors or qualified institutional buyers (QIBs) under Rule 144A purchase in the offering. The JOBS Act includes specific language that offers and sales made under the revised private placement rules would not be public offerings notwithstanding any general advertising or solicitation.
The ability to raise small amounts of capital from a large number of investors, also known as crowdfunding, over the Internet and otherwise is now expressly authorized but with some additional investor safeguards. First, the total amount sold to all investors in any 12 month period cannot exceed $1 million. Second, the amount sold to any single investor during a 12 month period cannot exceed (i) the greater of $2,000 or five percent of the annual income or net worth of the investor if the investor has a net worth less than $100,000, and (ii) 10 percent of the annual income or net worth of the investor if the investor's net worth is at least $100,000 and the amount sold does not exceed $100,000. Third, the offering must be conducted through a broker or funding portal that meets certain requirements. Finally, the issuing company must comply with disclosure requirements including reviewed or audited financial statements depending on the offering size. There will also be restrictions on transfer and resale during the one year period following purchase by the investor. The SEC will also be required to develop specific rules, including disqualification provisions, within 270 days after enactment.
The existing 500 shareholder rule that has concerned some private companies has been increased to 2,000. This will provide some additional runway to companies, for example, that have a large number of shareholders and/or option holders and want to avoid becoming subject to public company reporting and other regulations simply because of the number of shareholders. Also note that employees who receive stock through employee equity plans would not be counted against the 2,000 threshold.
Impact on Public Companies (or those considering an IPO)
For emerging growth companies, there will be more relaxed rules in several areas. Of particular note:
only two years of audited financial statements will be required (instead of the current three) in a registered offering;
for the first five years following an IPO, an auditor's attestation on internal controls under Rule 404 would not be required;
the fairly new "say on pay" or the shareholder advisory vote rules on executive compensation would not apply (again for five years);
the emerging growth company could file its IPO registration statement for review by the SEC on a confidential basis; and
emerging growth companies could have "test the waters" discussions with potential institutional investors prior to any IPO filing (and thus an exception to the typical quiet period or gun-jumping rules).
These new rules should provide very tangible assistance and cost reduction to companies seeking to access the public markets and to smaller public companies.
Finally, the JOBS Act includes some changes to the rules which restrict the rules by which public companies can communicate with members of the financial community, including financial analysts issuing research reports. Currently, in addition to rules that require separation of the investment banking and financial analyst functions, research reports may not be issued by analysts affiliated with investment banks involved in the offering until 40 days after the offering. These rules have been put in place to deal with conflict of interest concerns and concerns about analyst objectivity.
The JOBS Act would in general terms:
require Financial Industry Regulatory Authority (FINRA) to rescind its rules prohibiting both investment bankers and financial analysts from meeting with emerging growth company representatives;
also require FINRA to rescind its rules restricting the issuance of research reports during the post-IPO quiet period (and around lock-up expirations); and
permit research reports related to an emerging growth company in advance of an IPO.
We also expect the New York Stock Exchange to amend its Rule 472 that imposes similar restrictions on research reports, etc. to line up with the to-be-revised FINRA rules.
Given the very public abuses in this area in the past and the continuing financial exposure to companies and investment banks involved in public offerings, it remains to be seen how these new rules will actually affect both pre- and post-IPO communications and research reports by financial analysts affiliated with investment banking institutions.
It also remains to be seen how many jobs the JOBS Act helps to create, especially before the elections in November!
POSTED: March 29, 2012
UPDATED: April 5, 2012
This publication is intended for general information purposes only and does not and is not intended to constitute legal advice. The reader should consult with legal counsel to determine how laws or decisions discussed herein apply to the reader's specific circumstances.