THE JOBS ACT: "TWILIGHT COMPANIES?"
EDITOR'S NOTE: INCREASE IN REGISTERED HOLDERS THRESHOLD BOON FOR COMMUNITY BANKS
By Bradley A. Robinson
May 11, 2012
The Jumpstart Our Business Startups Act (the "JOBS Act"), was signed into law on April 5, 2012. The law is aimed at increasing the ability of smaller companies, both private and recently public, to raise funds from the general public without subjecting them to some of the more onerous requirements (financial, accounting, disclosure, etc.) that had been in effect prior to the law's enactment. The law is intended to address what many in the business community have called the "chilling effect" that current requirements cause due to the high bar of entry into the public sphere. With the introduction of the bill, US law will now see a significant reduction of restrictions in public company reporting. While the majority of the relaxed restrictions will affect IPOs, it should be noted that a significant portion of private companies and their access to capital will also be affected.
The JOBS Act will have the greatest impact on companies with annual gross revenues of less than $1 billion (indexed for inflation), with additional provisions that will benefit a broader range of private companies.
Title I of the JOBS Act creates a new category of issuer, an emerging growth company ("EGC"). The law defines an EGC as "any issuer that had total annual gross revenues of less than $1 billion (indexed for inflation) during its most recently completed fiscal year", excluding issuers that completed an initial public offering on or prior to December 8, 2011. We note that it has been estimated that over 90% of IPOs that have been filed since December 2011 would qualify under the rules. Qualifying IPOs will also have up to five years to achieve full regulatory compliance that would have been initially required upon public filing prior to the rules. Companies may forgo the reduced reporting standards, however, companies must choose which set of reporting rules they will follow at the time they register with the SEC. These reduced disclosure and compliance barriers include accounting, disclosure, and audit standards. They are as follows:
Financial Statements and MD&A - Only two years of audited financial statements will be required in IPO registration statements. Prior standard had been three years. Additionally, an EGC does not need to present financial data for any period prior to the earliest audited period presented in its IPO registration statement.
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.
Audit Related Internal Controls - Under the new law, EGCs will be exempt from the requirement that an independent registered public accounting firm attest to an issuer's internal control over financial reporting.
Audit Firm Rotation - EGCs will also be exempt from 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 have the option of complying with disclosure requirements applicable to smaller reporting companies with respect to executive compensation. As such, many of the newer rules on executive compensation disclosures, including the length of time that these disclosures must cover, will no longer apply to new companies qualifying as EGCs.
- Additionally, Say-on-Pay; Frequency of Say-on-Pay; Golden Parachute requirements will be abated. EGCs are exempt from the requirement that issuers seek shareholder approval of an advisory vote on executive compensation arrangements, until the company no longer qualifies under the EGC guidelines ($1B or 5 years).
Outside Communications - Certain laws affecting communication with potential outside investors will also be relaxed. These relaxed requirements will also apply to communications to the company by outsiders. Qualifying companies will be allowed increased communications with institutional investors for prospective securities offerings, ideally reducing or eliminating many of the more time and money intensive efforts that a company must meet in order to reach out to these investors. Analysts will also be able to communicate more directly with management, with the goal of reducing the time and cost barriers that may prevent many issuers from being covered by analysts.
Registration Statements - EGCs are now permitted to submit IPO registration statements and subsequent registration statements for SEC review on a confidential basis. A company will be able to submit a confidential registration statement any time up to 21 days before the roadshow (a tour during which the company pitches its business plan to potential investors) for the public offering.
Private Company Capital
The JOBS Act will also directly affect qualifying private companies as well. The Act directs the SEC to modify its rules to eliminate the prohibition on "general solicitation and general advertising" as it applies to offers and sales of securities. The rules will be modified in such a way that the prohibition would not apply so long as all purchasers are accredited investors or if the securities are sold only to persons reasonably believed to be qualified institutional buyers. The SEC is required to make some of these changes within 90 days. Further details of reduction of rules relating to raising capital include:
An Increased Threshold for Registration - Companies are now required to register only when they have (a) more than $10 million in assets and (b) a class of equity securities held of record by (i) 2,000 persons or (ii) 500 persons who are not accredited investors. Notably, banks will have a lower threshold (2,000 persons whether or not all are accredited investors). In addition, the threshold that permits deregistration for bank and bank-holding companies changed from 300 persons to 1,200 persons. Additionally, the definition of "held of record" will be modified to exclude employee compensation plans and purchasers of securities under the "crowdfunding" provisions.
Higher Monetary Threshold Under Regulation A - The JOBS Act permits offerings of up to $50 million in aggregate offering amount in any 12-month period (as compared to the current $5 million threshold).
Crowdfunding - Crowdfunding will allow private companies to raise capital from any investor (accredited, qualified, and neither) without registration, by using an SEC-registered broker or an SEC-registered funding portal to "crowdfund." Under the new rules, a private company may now 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 SEC has been clear, however, that these rules are not yet in effect. The SEC has given themselves up to 270 days after the signing of the bill before issuing rules regarding the specifics on enacting this rule. As such, investors should be clear that the rules regarding crowdfunding are not yet in effect.
It should be noted that none of the rule changes promulgated by the act are yet in effect. As such, potential investors and companies that are expected to be most affected by the act should remain wary of relying on all aspects of the initial rules from being implemented. As it is not in effect yet, it will be interesting to see how the new rules are implemented and the effect they will have on these twilight companies, somewhere between fully public and fully private, staked out by the parameters of ECGs as defined by the JOBS Act.
Editors Note: Registered Holders Change Boon for Community Banks
Increasing the registration threshold from 500 to 2,000 shareholders for community banks may enable some of these institutions to raise capital or to consider merger opportunities. Keeping the number of registered shareholders below the limit that would require registration may have restrained some financial institutions from proceeding with merger or secondary offerings to improve capital levels. With the increase in the threshold, these companies may now, or in the coming months, be able to address strategic plans with less of an eye towards avoiding the costly registration requirements.