The Jumpstart Our Business Startups Act (JOBS Act), signed into law on April 5, 2012, provides for certain changes to the initial public offering (IPO) process, as well as ongoing reporting requirements, for an issuer that qualifies as an emerging growth company (EGC). The amendments to the federal securities laws related to EGCs are intended to encourage qualifying companies to enter U.S. public capital markets by easing the costs and burdens related to going public and of being a public company for up to five years after an EGC’s IPO. The legislation’s proponents in the life sciences industry believe that the amendments should encourage life sciences companies to enter the public markets by allowing them up to five years to focus on critical research and product development before having to divert funds to costly compliance with regulations. However, some critics doubt that the JOBS Act will do much to attract additional investor interest in life sciences companies or increase the number of IPOs in the industry.
The JOBS Act defines an EGC as a company with less than $1 billion in annual revenue during its most recent fiscal year. An issuer that qualifies as an EGC will retain such status and the related reduced reporting requirements until the earliest of:
- The end of the fiscal year in which annual revenue exceeds $1 billion.
- The end of the fiscal year in which the fifth anniversary of the issuer’s IPO occurs.
- The date on which the issuer has, during the previous three-year period, publicly or privately issued more than $1 billion in non-convertible debt.
- The date on which the issuer qualifies as a “large accelerated filer.”1
An existing public company can qualify as an EGC if it completed its first registered sale of common equity after December 8, 2011, permitting such company to file its next periodic report under the Securities Exchange Act of 1934 (Exchange Act) using the scaled disclosure applicable to EGCs.
The JOBS Act amends certain provisions of the Securities Act of 1933 (Securities Act) to relax the IPO process for EGCs by:
- Requiring issuers to provide two rather than three years of audited financial statements (and the related Management’s Discussion & Analysis of Financial Condition and Results of Operations (MD&A) disclosure and selected financial data for such period) in their registration statements.
- Providing that issuers may comply with the more limited executive compensation disclosures of Item 402 of Regulation S-K applicable to smaller reporting companies in their registration statements.
- Lifting the restriction on communications to potential investors ahead of a public securities offering filing, provided such potential investors are qualified institutional buyers or institutional accredited investors (referred to as “testing the waters”).
- Permitting research analysts to publish research reports prior to or during the IPO process, even if the investment bank with which the research analyst is associated is an underwriter in the IPO.
- Permitting an EGC to submit its registration statement and any amendment to the SEC confidentially until 21 days before commencing the road show.
- Deferring compliance with new or revised accounting standards issued after the enactment of the JOBS Act until those standards are applicable to private companies.
- Exempting EGCs from compliance with Public Company Accounting Oversight Board (PCAOB) rules regarding expanded auditor reporting or audit firm rotation, or any new PCAOB rules issued after the enactment of the JOBS Act, unless the SEC determines compliance with such rules is necessary for investor protection.
The JOBS Act also amends certain provisions of the Exchange Act to ease the burden of ongoing public company reporting requirements by exempting EGCs from requirements to hold stockholder advisory votes on executive compensation and golden parachute compensation; disclose the relationship between executive compensation and the financial performance of the issuer, and the ratio of total CEO compensation to the median total compensation of the issuer’s employees; and comply with Section 404(b) of the Sarbanes Oxley-Act of 2002 (SOX) requiring auditor attestation on an issuer’s internal control over financial reporting. Also, in any subsequent registration statement or periodic report, EGCs are only required to comply with the executive compensation disclosures of Item 402 of Regulation S-K applicable to smaller reporting companies and provide selected financial data covering periods after the earliest audited period in their IPO registration statements (and the related MD&A disclosure and selected financial data for such periods). So long as an issuer maintains its status as an EGC, it will also be permitted to continue to defer compliance with new or revised accounting standards and will remain exempt from compliance with certain PCAOB rules, as discussed above.
While the JOBS Act is seen as the most significant relaxation of IPO and public company reporting requirements in recent times, some are skeptical as to its practical impact on the number of life sciences companies that will go public in 2012 and beyond. In 2011, only seven life sciences companies went public, down from just 13 in 2010.2 The changes to the IPO process may encourage small companies in the life sciences industry to enter the public markets by reducing expenses associated with preparation of offering materials, as well as decreasing the time it takes to go to market. The confidential filing process may also eliminate anxiety over disclosing sensitive business information while in registration and the potential embarrassment if the registration statement is subsequently withdrawn. Smaller companies in the industry may also be more willing to consider an IPO, given the ability to gauge investor interest in the offering prior to or during the registration process through pre-marketing, thereby avoiding the expense of an offering, which may be unsuccessful, and the possibility of having to withdraw a publicly filed registration statement. Underwriters may prefer not to engage in pre-marketing activities, however, as prospectus liability under Section 12(a)(2) of the Securities Act would still attach to any oral or written statements made.
While changes resulting from the JOBS Act may make going public more palatable for small companies in the industry, it is unclear how the appetite of investors will be affected. For an industry already losing interested investors to other types of technology and social media IPOs, investment banks may advise issuers that a decrease in the quality of disclosure could be detrimental to a successful offering. However, the cost savings associated with the scaled reporting requirements applicable to EGCs may attract some investors who previously were discouraged from investing in a company taking on the expense of being public with a product still in the early developmental stages. The two most significant cost savings associated with the scaled disclosure for EGCs are the elimination of the requirement to comply with Section 404(b) of SOX, which for a company with a public float of $250 million to $700 million is estimated to be more than $1.2 million per year,3 and certain of the executive compensation disclosures of Item 402 of Regulation S-K. 3
Approximately 55 percent of the life sciences companies that have gone public in the past five years were either non-accelerated filers or smaller reporting companies as of their first annual report for which an auditor attestation as to internal control over financial reporting would have been required, and were therefore exempt from such requirement pursuant to SOX.4 The elimination of the auditor attestation requirement would have represented a significant savings, however, for the approximately 36 percent of issuers during the same period that were required to include the report.5
In addition, less than 40 percent of those life sciences companies that have gone public in the last five years qualified as smaller reporting companies able to benefit from the existing scaled executive compensation disclosure requirements of Item 402 of Regulation S-K.6 The JOBS Act will allow more issuers in the industry to take advantage of the scaled executive compensation disclosure applicable to smaller reporting companies, which eliminates the costly and time consuming preparation of a Compensation Discussion & Analysis, reduces from five to three the number of executives for whom compensation disclosure must be provided and decreases from three to two the number of years for which such disclosure must be provided, in connection with an issuer’s annual report.
While, as of June 7, 2012, 19 companies in the industry that either went public after December 8, 2011 or were in the registration process when the JOBS Act was passed have made filings disclosing their status as EGCs, the JOBS Act provides issuers with the option to avail themselves of some or all of the scaled disclosure provisions (except that issuers may not selectively comply with new accounting standards). Many issuers may choose to or be advised by their investment bankers to include one or more items of disclosure EGCs are now permitted to exclude in order to enhance the marketability of their offerings. In particular, an April 2011 study by the SEC found that investors generally view the auditor’s attestation on internal control over financial reporting as beneficial.7 Underwriters and issuers may also be reluctant to take advantage of scaled disclosure in some instances, given the continued applicability of the general liability provisions of the federal securities laws. The SEC has suggested that the omission of financial information that shows a negative trend or that is related to a prior significant transaction, even if no longer required to be disclosed, may be material to an investor’s understanding of the business, and therefore should be included in the IPO registration statement. This is less likely to arise in the context of the IPO of a small life sciences company, however, given that most of these issuers have little or no product revenue prior to the offering.
Whether the amendments made by the JOBS Act to the federal securities laws will encourage more life sciences companies to enter the U.S. public markets remains unclear and, given the provision for confidential filing of registration statements, may take some time to assess. It is also unclear whether investment banks taking on underwriter liability in connection with a securities offering will be willing to change their existing disclosure standards and pre-deal marketing policies. Most importantly, it remains to be seen whether investors will be willing to sacrifice more extensive disclosure for the diversion of offering proceeds from regulatory compliance costs to a promising life sciences company’s developing product or technology.