Observed Trends in the Jobs Act
The recently enacted JOBS Act is very much a work in progress; over half of the mandated rulemaking projects under the Act have not been finalized, and emerging growth companies (“EGCs”) are still finding their way with the new regulatory framework. Nevertheless, it is apparent that the JOBS Act is fulfilling its promise of making the capital raising process less burdensome for a sizable number of EGCs.
JOBS Act trends:
It has been one year since President Obama signed into law the Jumpstart Our Business Startups Act (the “JOBS Act”). The stated purpose of the JOBS Act is to encourage job creation by emerging growth companies (“EGCs”). The JOBS Act is intended to facilitate the creation of jobs by, among other means: (a) facilitating the capital raising process for EGC issuers (i) conducting traditional IPOs and (ii) seeking to raise funds pursuant to the ‘regulatory light’ structure of offerings under Regulation A of the Securities Act of 1933 (“Securities Act”); (b) exempting EGCs from certain aspects of the Sarbanes-Oxley Act (“SOX”); (c) delaying the time by which companies are required to become reporting companies under the federal securities laws; (d) relaxing marketing restrictions for certain private placements under Regulation D of the Securities Act; and (e) encouraging the raising of relatively small sums of capital (amounts not to exceed $1 million over any 12-month period) through “crowdfunding”.
Rather than give an overview of the JOBS Act, we will focus in this newsletter and in subsequent newsletters on certain developing trends1 since the enactment of the JOBS Act.
As noted, by creating the EGC status, Congress intended to help smaller, emerging companies raise capital by exempting them from some of the more onerous regulatory requirements associated with capital raising. The theory was that by loosening these restrictions, these younger companies could raise capital more easily and thus deploy that capital into new or expanding businesses thereby creating new jobs rather than utilizing the capital (or time to raise capital) by complying with certain regulations. To be considered an EGC and retain that status, an issuer must meet the following requirements:
- have less than $1 billion in annual revenues;
- have been publicly traded for less than five years;
- have a public float (the float of non-affiliates) of less than $700 million; and
- not have issued $1 billion in debt in the prior three-year period.
The high annual revenue threshold; up to five years of scaled compliance and disclosure burdens; the ability of EGCs to use pre-filing test-the-waters communications with qualified institutional buyers and institutional accredited investors; the ability to obtain confidential SEC review of an EGC’s registration statements; and the decrease in initial and ongoing costs of being a public company resulting from the JOBS Act are meant to encourage more companies to raise capital through an IPO and become publicly traded2.
Seeking to be classified as an EGC in a registration statement will prompt SEC staff comments requiring the issuer to describe:
- how and when it may lose EGC status;
- the various exemptions that are available to an EGC;
- its election under the JOBS Act:
- If the issuer has elected to opt out of the extended transition period for complying with new or revised accounting standards pursuant to Section 107(b) of the JOBS Act, include a statement that the election is irrevocable;
- If the issuer has elected to use the extended transition period for complying with new or revised accounting standards under Section 102(b)(2)(B) of the JOBS Act, provide a risk factor explaining that this election allows the issuer to delay the adoption of new or revised accounting standards that have different effective dates for public and private companies until those standards apply to private companies. In addition, the issuer must state in this risk factor that, as a result of this election, the issuer’s financial statements may not be comparable to companies that comply with public company effective dates. The issuer must include a similar statement in the company’s critical accounting policy disclosures in MD&A.
We have found that that the content and format of these disclosures have become standardized, and that once inserted in the registration statement, there is little back and forth with the SEC staff about these disclosures.
We have seen much use of the JOBS Act’s right to make confidential filings of registration statements, which form and content should be substantially the same as one that is publicly filed, except that the draft registration statement does not need the company's signatures or an auditor consent. In this regard, the interaction with the SEC staff appears to us to be the same as if there had been done in the context of a public submission of the registration statement via EDGAR. Nevertheless, issuers contemplating a confidential submission need to be mindful that the initial confidential submission and all amendments thereto will ultimately be required to be publicly filed with the SEC via EDGAR (a) no later than 21 days prior to the issuer’s commencement of a “road show”3, or (b) no later than 21 days prior to the anticipated date the registration statement will be declared effective by the Commission if there be no road show or similar marketing effort. On the other hand, comment and response letters exchanged between the staff and an EGC during the confidential submission process will be publicly released via EDGAR no earlier than 20 business days after the effectiveness of the related registration statement, as is standard for correspondence related to non-confidential submissions.
There is one notable area of tension with the staff - this concerns the public communications by the company in connection with such confidential filings. The SEC regulates what a company can say prior to and after the filing of a registration statement4. If a company violates any of these prescriptions, that company may be accused of committing a “Section 5 Violation” - the offer to buy or sell securities without an effective registration statement being in place5. The SEC might assert that a possible Section 5 Violation has occurred if, for example, a company that is migrating from the AIM Exchange to a US exchange has issued, as required by AIM, a press release announcing the confidential filing of the registration statement with the SEC. The staff has argued that the content of such press release is not consistent with its rules issued under the Securities Act and constituted an unauthorized offer to sell the company’s securities. In this regard, the staff, after giving the issuer an opportunity to explain its rationale for the distribution of such press release and argue that no offer to sell a security is present, may seek a delay in the effective date of the registration statement or require the issuer to include a risk factor in the registration statement alerting potential investors to the possibility of the assertion of a possible Section 5 Violation.
During the course of the past year since the JOBS Act was signed into law, we have seen several trends: smaller companies – startups by most standards – see the ability to raise money publicly as a more ideal way to raise early stage capital as opposed to venture funding or other historically traditional routes. While the so-called friends and family stage funding is still an integral component of early stage funding, the option of going public to raise a subsequent round appears to be a more desirable option to the historically traditional routes. We suspect that this trend is occurring for several reasons, among others, primarily because:
First and foremost, the JOBS Act is serving its purpose. By taking many of the more onerous aspects of regulatory compliance out of the process, the JOBS Act is encouraging more entrepreneurs to consider the public capital markets.
Second, venture capital financing, particularly for companies seeking to raise $1 million to $5 million and in industry segments not currently in vogue, is almost non-existent.
Third, an initial public offering (or an offering that takes a company public as a means to offering early stage investors liquidity) is an important capital raising device because post 2008, investors are demanding more liquidity not less.
Finally, there is a sense among EGC CEOs and CFOs that they have more control over the capital raising process in the JOBS Act/IPO scenario (whether their investors are individuals or institutions) vs. the stay private/VC funding paradigm.
As intimated above, the JOBS Act is very much a work in progress; over half of the mandated rulemaking projects under the Act have not been finalized, and EGCs are still finding their way with the new regulatory framework. Nevertheless, it is apparent that the JOBS Act is fulfilling its promise of making the capital raising process less burdensome for a sizable number of EGCs.
1 These trends are based on our practice, the experience of other practitioners, and industry observers.
2 In particular, the JOBS Act:
- permits EGCs to provide only two years of audited financial statements rather than three years in their IPO filings with the SEC and, in any other registration statement, provide selected financial data going back no earlier than the earliest audited period included in the IPO filing;
- excludes EGCs from the requirement under Section 404(b) of SOX to obtain an auditor attestation report on management's assessment of internal control over financial reporting;
- excludes EGCs from the "say-on-pay," "say-on-frequency" and "say-on-parachutes" advisory votes on executive compensation required of all companies under the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”);
- excludes EGCs from the Dodd-Frank Act requirement to provide disclosures comparing executive pay to performance and to median employee compensation (which will be required of other companies under pending SEC rulemaking);
- excludes EGCs from any new or revised financial accounting standards until private companies are required to comply with such requirements; and
- exempts EGCs from any audit firm rotation requirements that are adopted by the Public Company Accounting Oversight Board (PCAOB) and any other new PCAOB rules unless the SEC determines that such new rules are necessary or appropriate in the public interest.
According to USA Today (January 1, 2013) “[a]ll told, 128 companies managed to sell the shares to the public, up 2.4% from 2010. While that's more than quadruple the number of deals in the trough year of 2008, 2012 still couldn't keep up with the 154 IPOs in 2011. It was a year of smaller deals, as the median proceeds raised by IPOs fell 23%.” The JOBS Act to date does not seem to have had to the hoped for boost to the domestic IPO market.
3 A road show is a presentation by issuer’s management to a select group of investors and includes discussion of the issuer, its management, and the securities being offered.
4 This is called the “quiet period”, generally, the period commencing 30 days before the filing of the registration statement and ending 25 days after the registration statement has been declared effective.
5 Section 5 requires, in connection with any offer or sale of securities in interstate commerce or through the use of the mails, that a registration statement must be in effect and a prospectus meeting the prospectus requirements of Section 10 of the Securities Act must be delivered prior to sale.