On April 5, 2012, the President signed into law the Jumpstart Our Business Startups Act (the “JOBS Act”), a significant piece of legislation likely to make immediate changes to the way entrepreneurs and emerging growth companies raise capital.
Rule 506 and Rule 144A: Elimination of Prohibition on General Solicitations and Advertising
The JOBS Act directs the SEC to modify existing regulations to eliminate the prohibition on “general solicitation and general advertising” in connection with offers and sales of securities made to accredited investors (in the case of Rule 506) and persons reasonably believed to be qualified institutional buyers (in the case of Rule 144A). Because Rule 506 is the most common exemption from the registration requirements of the Securities Act used by emerging growth companies, we expect this change to have a significant and beneficial impact on their ability to raise capital. The SEC has 90 days from enactment to make the necessary changes to its regulations.
Private companies will be permitted to raise limited amounts of capital from small investors without registration under federal or state securities laws by using an SEC-registered broker or a newly created class of SEC-registered funding portals to “crowdfund.” A private company may raise up to $1 million in any 12-month period by issuing restricted securities. The aggregate amount an individual may invest in crowdfunded securities (regardless of issuer) will be capped, depending on each investor’s annual income and net worth, at amounts ranging from $2,000 to $100,000. The issuer and the securities’ intermediary will need to meet a number of one-time and ongoing requirements, such as providing certain information to investors, in order to rely upon this exemption. Additionally, issuers (which includes directors and executive officers) will be liable to the purchasers of these securities, who may sue for damages or a rescission of their investment in the event of any material misstatements or omissions. The value of this exemption will be determined by the ease with which issuers can comply with the forthcoming regulations.
Expansion of Regulation A
The JOBS Act amends the threshold for offerings under Section 3(b) of the Securities Act, thereby modifying Regulation A (conditional small issues exemption) to permit offerings of up to $50 million in aggregate offering amount in any 12-month period (as compared to the current $5 million limitation). Changes to Regulation A will require SEC rulemaking, but no time limit is set by the JOBS Act. As with the crowdfunding exemption, the value of this exemption will depend in large part on the regulations adopted by the SEC.
Changes to SEC Registration Thresholds
Under current law, a company is required to register with the SEC under Section 12(g) of the Securities Exchange Act if it has total assets exceeding $10 million and more than 500 record holders of a class of its equity securities, even if it has never conducted a public offering. The JOBS Act raises this threshold to cover only companies that have total assets exceeding $10 million and at least 2,000 record holders of a class of its equity securities or 500 record holders that are not accredited investors. For banks and bank holding companies, the threshold is 2,000 persons (whether or not all are accredited investors). Registered banks and bank holding companies will also be permitted to deregister once they have less 1,200 holders of record (rather than the 300 applicable other issuers). Additionally, the definition of “held of record” has been modified to exclude persons who received securities pursuant to an employee compensation plan in transactions exempt from registration and purchasers of securities under the crowdfunding exemption.
Improvements to the IPO Process and Reporting Requirements for Emerging Growth Companies
Title I of the JOBS Act amends the Securities Act and the Exchange Act to create the emerging growth company (“EGC”) as a new category of issuer. An EGC includes any issuer that had total annual gross revenues of less than $1 billion (indexed for inflation) during its most recently completed fiscal year, other than an issuer that completed an initial public offering on or prior to December 8, 2011. All EGCs will be granted the option to pursue a streamlined IPO process and, following completion of the IPO, will have up to five years to achieve full compliance with certain disclosure regulations and accounting and auditing standards that are currently applicable to all U.S. public companies.
During this “IPO on-ramp” period, an EGC will be permitted the following exemptions from, or modifications of, currently-required disclosures and accounting and auditing standards.
- Audited Financial Statements and MD&A – An EGC will be required to provide only two years of audited financial statements in its IPO registration statement rather than the three years currently required (and the management’s discussion and analysis of financial condition and results of operations need only cover two years). Additionally, an EGC will not need to present selected financial data for any period prior to the earliest audited period presented in its IPO registration statement.
- Application of New Accounting Standards – EGCs will not be subject to any newly adopted or revised accounting standards until such standards are deemed to apply to companies that are not “issuers” within the meaning of the Sarbanes-Oxley Act of 2002.
- Internal Controls Audit Attestation – EGCs will be exempt from the requirement that an independent registered public accounting firm attest to an issuer’s internal controls over financial reporting.
- Audit Firm Rotation – EGCs will be exempt from any future mandatory audit firm rotation requirement and any rules requiring that auditors provide additional information about the audit or financial statements of the issuer that the Public Company Accounting Oversight Board may adopt.
- Executive Compensation – EGCs will have the option of complying with disclosure requirements applicable to smaller reporting companies with respect to executive compensation.
- Say-on-Pay; Frequency of Say-on-Pay; Golden Parachute Exemption – EGCs will be exempt from the requirement that issuers seek shareholder approval of an advisory vote on executive compensation arrangements, including golden parachute compensation.
- Investor and Analyst Communications – EGCs will have a greater ability to communicate with certain potential investors (qualified institutional buyers or institutional accredited investors) with respect to offerings of securities. Analysts will also have an increased ability to communicate with management, including attending meetings with management in certain instances.
- Confidential Registration Statements – EGCs will be permitted to submit IPO registration statements and subsequent registration statements for SEC review on a confidential basis, so long as a public filing is made at least 21 days prior to the roadshow for the public offering.
An EGC would retain its status as such until the earliest of (a) the first fiscal year after its annual revenue exceeds $1 billion, (b) the first fiscal year following the fifth anniversary of its IPO, (c) the date when the company has issued more than $1 billion in non-convertible debt securities (over the previous three-year period), and (d) the first fiscal year in which the company becomes a large accelerated filer.
A company may choose to forgo any of the exemptions provided to EGCs under the JOBS Act and instead comply with the requirements applicable to non-EGCs. However, if an EGC elects to comply with the timing requirements that apply to non-EGCs with respect to new and revised accounting standards, it must make such election at the time the company is first required to file a registration statement or report with the SEC and must continue to comply with such standards for as long as the company remains an emerging growth company.
Please contact the authors of this alert, Jim Stewart (205/521-8087) and Charlie Roberts (205/521-8122), or another member of Bradley Arant Boult Cummings LLP’s Venture Capital and Private Equity Team if you have any questions about the JOBS Act.
BABC Attorneys Involved in Legislation
During the drafting of the JOBS Act, members of BABC’s Corporate and Government Affairs practice groups met with staff for the House Financial Services Committee to discuss certain aspects of the Act. BABC attorneys provided their input on ways to generate additional capital investment and other aspects of the legislation. The members of the BABC Government Affairs practice group provide advocacy services at the federal, state, and local levels. Our members routinely work on legislation, such as the JOBS Act, and regulations for our clients. If you have questions about our Government Affairs Practice Group, please contact David Stewart (205-521-8368) or firstname.lastname@example.org.