On April 5, President Obama signed the Jump-Start Our Business Startups Act (JOBS Act) into law, which the U.S. House of Representatives and U.S. Senate had passed by wide margins on March 27 and March 24, respectively. The JOBS Act makes it easier for small, early-stage companies to access sources of capital by exempting these companies from certain of the more burdensome regulatory requirements. Among the more significant changes, the JOBS Act:
- Creates a new category of issuer called an “emerging growth company” that is subject to scaled-back Securities and Exchange Commission (SEC) regulation while streamlining the initial public offering (IPO) process for emerging growth companies;
- Eases restrictions on using advertising materials to solicit investors in certain private placement transactions;
- Allows the use of internet-based platforms to obtain relatively small investments from a large pool of investors (also known as “crowdfunding”);
- Increases the limit for offerings by private companies from $5 million to $50 million pursuant to Regulation A; and
- Raises the minimum number of shareholders a company is allowed to have before the company must register under the Securities Exchange Act of 1934 (’34 Act).
IPO On-Ramp for Emerging Growth Companies
The JOBS Act defines an emerging growth company (EGC) as an issuer with less than $1 billion in annual revenue. Such a company will qualify as an EGC until the earliest of: (1) the EGC’s annual revenues exceed $1 billion; (2) the fifth anniversary of the EGC’s IPO; (3) the EGC issues more than $1 billion in non-convertible debt during a three year period; or (4) the EGC meets the definition of a “large accelerated filer” (i.e., a seasoned issuer with a public float greater than $700 million).
The JOBS Act significantly streamlines the IPO process for an EGC by introducing the following changes:
- Two Years of Historical Financial Information. The JOBS Act limits to two years the audited financial statements and selected financial data an EGC is required to provide in its registration statement, as well as allows an abbreviated form of management discussion and analysis. In addition, an EGC’s subsequent ’34 Act filings do not need to include historical financial information prior to the two years provided in the registration statement.
- Scaled-Back Compensation and Accounting Rules. An EGC is exempted from executive compensation disclosure requirements such as “say-on-pay” and “say-on-golden parachutes,” and can provide scaled-back executive compensation disclosure consistent with the disclosure currently required of smaller reporting companies. An EGC is also exempted from newly promulgated or revised accounting standards (unless the new standards are deemed to apply to companies that are not "issuers" as defined in the Sarbanes-Oxley Act of 2002). In addition, an EGC is not required to submit attestations by an independent public audit firm regarding internal controls over financial reporting or be subject to mandatory audit firm rotation.
- Communications with Investors. An EGC is allowed to communicate (orally or in writing) with potential investors that are qualified institutional buyers or institutional accredited investors before or after filing a registration statement.
- Confidential SEC Review. An EGC has the opportunity to submit draft registration statements to the SEC’s staff for confidential review (although the EGC must file the initial registration statement and all amendments at least 21 days prior to the start of a roadshow).
- Analyst Reports. The JOBS Act eases restrictions governing the publication of reports by securities analysts with respect to an EGC that is the subject of a proposed IPO by allowing a broker or dealer to publish or distribute research reports before or after an EGC’s registration statement has been filed. Such a research report will not be considered an offer for sale even if the broker or dealer participates in the offering. In addition, analysts are allowed to participate in communications with an EGC’s management alongside other representatives of a broker or dealer, including investment bankers participating in an EGC's IPO.
Other Provisions to Promote Access to Capital
In addition to the IPO on-ramp provisions summarized above, the JOBS Act includes the following significant regulatory reforms which facilitate access to sources of capital for issuers in small public offerings by exempting the issuers from certain SEC registration requirements:
- Advertising. The JOBS Act extends the “safe harbor” for private placement transactions under Section 4(2) of the Securities Act of 1933 (‘33 Act) to an issuer even if securities are marketed through a general solicitation, so long as the purchasers of the securities are “accredited investors.” The JOBS Act introduces a parallel change for offerings made to “qualified institutional buyers” under Rule 144A. In order to rely on this safe harbor, an issuer needs to take reasonable steps to verify the accredited investor or qualified institutional buyer status of the investors participating in the offering.
- Crowdfunding. Securities offered through certain funding platforms are exempt from registration under federal or state securities laws pursuant to a new exemption that the JOBS Act created. Pursuant to this new exemption, an issuer is able to offer up to $1 million worth of securities in any 12 month period through crowdfunding. Each investment cannot exceed either (i) the greater of $2,000 or 5 percent of an investor’s annual income or net worth for investors with annual income or net worth below $100,000, or (ii) 10 percent of the annual income or net worth, not to exceed $10,000, of an investor for investors with annual income or net worth equal to or greater than $100,000. Issuers are required to make a filing with the SEC and provide information to investors including a business plan, an overview of the issuer’s financial condition and capitalization, and a description of the intended use of proceeds from the offering. In addition, issuers are required to use either a broker or "funding portal," which must register with the SEC, conduct background checks on the officers, directors and 20 percent equityholders of the issuer, and ensure that the investors understand the risks of the investment.
- Increase in Regulation A Ceiling. The threshold for exemption from federal and state securities laws for small issues of securities pursuant to Regulation A has increased from $5 million to $50 million in any 12 month period. An issuer relying on this exemption must file an offering memorandum and annual audited financial statements. Securities sold pursuant to this Regulation A exemption are not considered "restricted securities" for purposes of the federal securities laws.
- Registration Thresholds. Previously, a company with more than 500 shareholders of record and $10 million in assets had to register under the ’34 Act. The JOBS Act raises the minimum shareholder threshold from 500 to either 2,000 persons or 500 persons who are not “accredited investors” (or 2,000 persons in the case of banks and bank holding companies). The Act excludes securities received by employees pursuant to employee stock incentive plans for purposes of calculating the shareholder threshold. The SEC is also required to exempt securities acquired through crowdfunding transactions within 270 days of the JOBS Act’s enactment from the calculation of the minimum shareholder threshold for ‘34 Act purposes.