Privately-held companies have long encountered a litany of regulatory challenges in raising capital in the United States, both in the private markets and through an initial public offering (IPO). These regulatory challenges arise primarily from the provisions of the Securities Act of 1933 (the Securities Act), which generally regulates public and private offerings, and the Securities Exchange Act of 1934 (the Exchange Act), which in large part deals with the ongoing reporting and proxy solicitation obligations of public companies. On April 5, 2012, President Obama signed into law the Jumpstart Our Business Startups Act (the JOBS Act), bipartisan legislation aimed at easing regulatory burdens on small companies and facilitating capital formation. As we discussed in our E-Alert dated April 5, 2012, the JOBS Act makes sweeping changes to the U.S. federal securities laws by (i) streamlining the IPO process and relaxing post-IPO reporting obligations and (ii) easing regulatory restrictions on private capital formation. This E-Alert deals with that part of the JOBS Act (Title 1) that makes the IPO process less burdensome for certain smaller companies and creates an “on-ramp” of post-IPO regulation for these same companies.
Regulatory Reform for EGCs
The JOBS Act creates a new class of IPO issuer: the emerging growth company (EGC). An EGC is an issuer that had total annual gross revenues of less than $1 billion during its most recently-completed fiscal year. However, a company that has already sold, under an effective Securities Act registration statement, common equity securities on or before December 8, 2011 cannot qualify as an EGC.
The JOBS Act simplifies the IPO process for EGCs and creates a transitional “on-ramp” for EGCs that phases in compliance measures over time following their IPOs.
IPO by EGCs
EGCs benefit from the following relaxed regulatory requirements in the IPO process:
Financial Statement Disclosure. EGCs are permitted to present only two years of audited financial statements (and two years of the related management’s discussion and analysis of financial condition and results of operations) in its IPO registration statement rather than the three years required of other issuers. For selected financial data, EGCs will only need to include the past two fiscal years (as opposed to the standard five-year requirement).
Financial Data Disclosure. EGCs are exempt from providing selected financial data for any period prior to the earliest audited period presented in its IPO registration statement (currently, selected financial data must be provided for the previous five years).
Executive Compensation Disclosure. EGCs have the option of complying with disclosure requirements applicable to smaller reporting companies, as defined under the Exchange Act, with respect to executive compensation disclosure.
Confidential Registration Statement Submissions. EGCs are permitted to submit a draft of their IPO registration statement for Securities and Exchange Commission (“SEC”) review on a confidential basis, provided a public filing of the initial draft submission and all of the amendments to such submission is made at least 21 days prior to the roadshow for the applicable public offering.
Research Reports. Investment banks are permitted to publish research related to an EGC even while such EGC is conducting an IPO or other offering. Such research report will not be deemed an “offer” under the Securities Act, even if the investment bank publishing the research is participating in the offering. Research analysts would also be permitted to participate in meetings with an EGC together with investment banking staff.
Gauging IPO Interest. EGCs are permitted to “test the waters” for an IPO with institutional investors. EGCs will be able to communicate in writing or orally with certain institutional investors (such as qualified institutional buyers (called “QIBs”) or institutional accredited investors), both prior to and following the first filing of its IPO registration statement, to determine the level of interest that may exist for securities to be offered by the EGC in its IPO.
Ongoing Disclosures/Governance Requirements
In addition, the JOBS Act eases many ongoing disclosure and regulatory compliance requirements for EGCs to which they would otherwise be fully subject as public companies. After going public, EGCs continue to benefit from the following relief:
No SOX 404 Auditor's Attestation. EGCs will not be required to provide with their annual reports an auditor's attestation report on internal control over financial reporting, as otherwise mandated by Section 404(b) of the Sarbanes-Oxley Act (SOX). The requirement for an auditor attestation report on internal control over financial reporting imposes a significant financial burden on companies and has been cited as one of the reasons why fewer private companies go public in the United States. The EGC will still be subject to the requirements that (i) management establish, maintain, and assess internal control over financial reporting, and (ii) the CEO and CFO sign SOX-compliant certifications (SOX 302 and 906) and include the certifications as exhibits to the ECG’s annual, semi-annual and quarterly reports.
No Audit Firm Rotation. EGCs will not be required to comply with future PCAOB rules that may mandate audit firm rotation and the provision of supplementary information by the auditors in their report on the financial statements. An EGC will be subject to a transition period for any required PCAOB mandatory audit firm rotation.
Delayed Application of New Accounting Standards. An EGC will not be required to comply with any new or revised financial accounting standard until the date that such accounting standard becomes broadly applicable to private companies.
Relaxed "Say-on Pay" and Other Rules Addressing Executive Compensation. EGCs will not be required to conduct shareholder advisory votes on executive compensation or golden parachutes as mandated by the Dodd-Frank Act, and will benefit from less stringent disclosure requirements concerning executive compensation matters. An issuer that was previously an EGC will be required to comply with the say-on-pay requirement as follows: (i) in the case of an issuer that was an EGC for less than two years, by the end of the three-year period following its IPO, and (ii) for any other issuer, within one year of having lost its EGC status.
Phase-out of EGC Status
A company retains its status as an EGC until the earliest of:
- the first fiscal year after its annual gross revenue exceeds $1 billion;
- the first fiscal year following the fifth anniversary of the date of the first sale of common equity securities of the issuer pursuant to an effective registration statement under the Securities Act;
- the date when the company has issued more than $1 billion in non-convertible debt securities over the previous three-year period; or
- the first fiscal year in which the company becomes a large accelerated filer (i.e., Exchange Act reporting for at least one year with $700 million of aggregate worldwide public equity float held by non-affiliates).
While many of the provisions of the JOBS Act will not be fully effective until the SEC completes required rule making, that portion of the JOBS Act dealing with EGCs is effective immediately. Indeed, an SEC staff member recently stated that by April 11, 2012, two issuers had already submitted confidential draft registration statements to the SEC.
Impact of the JOBS Act for EGCs
For a broad universe of companies, small, medium and relatively large, the accommodations for EGCs contained in the JOBS Act provides an attractive capital formation alternative, an IPO, which heretofore may have been viewed as impractical.