On April 5, 2012, President Obama signed the Jumpstart Our Business Startups Act (the “JOBS Act”), significantly improving access to the U.S. capital markets for emerging companies and relaxing other restrictions viewed as an impediment to capital raising in an effort to create jobs and spur economic growth. The JOBS Act will enable certain issuers to immediately take advantage of a streamlined and less burdensome IPO process. Other provisions of the JOBS Act are expected to become effective later this year after the Securities and Exchange Commission (the “SEC”) promulgates rules, which will, among other things: (1) repeal the ban on general solicitation and general advertising in private placements, (2) create a new exemption under the Securities Act of 1933 (the “Securities Act”) to allow issuers to raise up to $1,000,000 in twelve months without registration and (3) increase the limits on the number of stockholders permitted before triggering mandatory registration under Section 12(g) of the Securities Exchange Act of 1934 (the “Exchange Act”).
Streamlining the IPO Process for Emerging Growth Companies
Effective immediately, the JOBS Act creates a new category of issuers called Emerging Growth Companies (“EGCs”) and provides regulatory relief aimed at encouraging these EGCs to consummate an initial public offering of their equity securities. This so-called “IPO On-Ramp” is designed to reduce the costs of accessing public capital by giving EGCs up to five years from the date of their IPOs to scale up to compliance with certain reporting requirements. Under the JOBS Act, an EGC is an issuer with total annual gross revenues of less than $1 billion dollars during its most recently completed fiscal year. An EGC may continue to take advantage of the IPO On-Ramp until the earliest of: (1) five years from the date of its IPO, (2) the date an EGC has $1 billion in annual gross revenue, or (3) the date an EGC becomes a “large accelerated filer,” an SEC designation for a company with a public float of $700 million or more. It is estimated that 11%-15% of public companies, representing 3% of total market capitalization, will qualify as EGCs at any given time.
Qualified issuers choosing to take advantage of the benefits afforded to EGCs will be entitled to the following:
- Ability to Confidentially Submit Draft Registration Statements: The JOBS Act allows EGCs to submit draft registration statements to the SEC prior to public filing on a confidential basis, as is currently permitted for non-U.S. companies, enabling them to keep sensitive information confidential while exploring the IPO process.
- Reduced Disclosure Requirements: The JOBS Act allows EGCs to take advantage of certain reduced disclosure requirements such as exemption from the requirement for separate shareholder approval of executive compensation, including golden parachute compensation and the other scaled disclosure available to smaller reporting companies regarding executive compensation; and EGCs may provide two years of audited financials (rather than three as was previously required) along with their registration statement and limit their Management’s Discussion and Analysis to the years covered by those financial statements.
- Relaxed Accounting Rules: The JOBS Act permits EGCs to adopt new accounting standards under the same extended compliance period as private companies, permits EGCs to defer compliance with Section 404(b) until the conclusion of the IPO On-Ramp period and provides that EGCs are exempt from the auditing standards proposed by the Public Company Accounting Oversight Board (PCAOB).
- Improvements to the Availability of Information About EGCs: The JOBS Act permits (i) the publication or distribution by a broker or dealer of a research report about an EGC that is the subject of a proposed public offering, even if the broker or dealer is participating or will participate in the offering; (ii) members of the investment banking team of a broker or dealer participating in an offering to arrange for communications between securities analysts and potential investors; and (iii) research analysts to participate in communications with management of the issuer in which other members of the broker or dealer also participate.
- Ability to “Test the Waters” Pre-IPO: The JOBS Act allows EGCs to “test the waters” of the market by expanding the range of permissible pre-filing communications to sophisticated institutional investors and permits the publication and distribution of research reports about EGCs during post-IPO quiet periods and lock-up periods.
Relaxed Restrictions on Private Placements
Repeal of Ban on General Solicitation and General Advertising
Subject to the enactment of rules and regulations by the SEC, the JOBS Act repeals the ban on general solicitation and general advertising in connection with private offerings. The JOBS Act directs the SEC to modify Regulation D within 90 days of the Act’s passage in order to allow general advertising and solicitation as long as the sales are only made to accredited investors under Rule 506. Similarly, the SEC must revise Rule 144A to allow general advertising and solicitation as long as the sales are only made to qualified institutional buyers. In connection with both of these changes, the issuers must take reasonable steps to verify that they are only issuing to investors with the applicable status.
The JOBS Act directs the SEC to create a new exemption under the Securities Act that will allow issuers to offer and sell securities to non-accredited investors without registering the offering with the SEC and without meeting the requirements of state securities laws. Within 270 days of enactment, the SEC must create an exemption under Section 4 of the Securities Act that will allow issuers to sell up to $1,000,000 of securities without registration under the Securities Act, provided the transaction meets the following criteria:
- Individual investments may not exceed (i) $2,000 or 5% of annual income or net worth for investors with annual income or net worth of less than $100,000 or (ii) 10% of annual income or net worth, up to a maximum of $100,000, for investors with annual income or net worth of at least $100,000.
- The issuer must use a “funding portal” for the transaction, which is an intermediary that is registered with the SEC and applicable self-regulatory associations. The funding portal will ensure that investors understand and are able to bear the risk of investment, conduct a background check and ensure compliance with SEC regulations.
- The issuer must meet certain disclosure obligations, including the target amount of the offering and deadline for reaching the target, as well as file ongoing reports with the SEC to be determined by the SEC in its rulemaking process.
- For one year following issuance, transfer of the securities will be restricted, other than to the issuer, accredited investors, as part of an SEC-registered offering, to family members or in connection with death or divorce.
Under the JOBS Act, Section 12(g) of the Exchange Act will be amended to increase the thresholds at which an issuer must register its securities with the SEC. The new thresholds are either 2,000 persons or 500 persons who are not accredited investors.
Further, the JOBS Act makes amendments to Regulation A to ease the use of the exemption for small businesses to go public.
These changes represent the most significant changes enacted to an issuer’s ability to access capital through U.S. markets in decades and will spawn an entirely new industry of funding portals. Brown Rudnick will monitor developments as the SEC issues guidance regarding the JOBS Act and promulgates rules thereunder.