On March 8, 2012, the U.S. House of Representatives passed the Jumpstart Our Business Startups Act, or "JOBS Act." The JOBS Act, which combines several bills that were introduced in the House last year, aims to reduce the costs of going public for private companies and facilitate increased capital formation.

The JOBS Act must still be approved by the Senate and the White House, but both have expressed support for the reforms generally and indicated they will act quickly. Comparable legislation has been introduced in the Senate and has been the subject of various hearings, and discussions with contacts on Capitol Hill suggest it is moving forward in the Senate. A number of industry groups and organizations have voiced both support and concerns as the JOBS Act makes its way to the Senate. While the North American Securities Administrators Association opposes the relaxed regulations in the JOBS Act, both the National Venture Capital Association as well as several hundred entrepreneurs have urged legislators to approve the bill.

The JOBS Act may undergo changes before becoming law, but as currently passed by the House it encompasses reforms in two general areas: (1) making the IPO process less burdensome for smaller companies with the benefit of an "on ramp" regulatory regime characterized by reduced regulation, and (2) easing regulatory restrictions on private capital formation that has been substantially curtailed under an existing regulatory regime that is outmoded and does not reflect current communications technology and recent innovation in social media.

Reforms in the IPO Process

The current regulatory requirements for an IPO are generally the same regardless of the size of the company, which many believe has contributed to a decrease in the number of IPOs by smaller companies. The JOBS Act would create a new class of public companies called "Emerging Growth Companies," defined as those that had less than $1 billion in annual gross revenues during their most recently completed fiscal year.

For Emerging Growth Companies, provisions in the JOBS Act would ease the burdens associated with going public, both in connection with the IPO itself, as well as in the early years as a public company. Emerging Growth Companies could take advantage of the lighter rules until the earliest of:

  • the last day of the fiscal year during which the company's annual gross revenues exceeded $1 billion;
  • the last day of the fiscal year following the fifth anniversary of its IPO;
  • the date on which the company has, during the previous three-year period, issued more than $1 billion in non-convertible debt; or
  • the date on which the company is deemed to be a "large accelerated filer" (that is, a company with an unaffiliated public equity float of at least $700 million that has been filing reports with the Securities and Exchange Commission for at least one year).

IPO On-Ramp

Under the JOBS Act, an Emerging Growth Company would be able to take advantage of reforms aimed at making the IPO process more attractive to smaller companies – a so-called "IPO on-ramp." The IPO on-ramp would allow Emerging Growth Companies to do the following:

  • Confidentially submit a draft registration statement to the SEC for confidential nonpublic review prior to filing, provided that the initial submission and all amendments thereto are publicly filed at least 21 days prior to conducting a road show. This option is intended to facilitate increased dialogue between Emerging Growth Companies and the SEC, and would allow those companies to consider an IPO without first publicly releasing sensitive information.
  • Communicate both pre- and post-filing with qualified institutional buyers and accredited investors to determine whether such investors would have an interest in the contemplated offering. This option would allow Emerging Growth Companies to test the waters for a contemplated IPO without being subject to current quiet period, gun jumping restrictions on pre-offering communications.
  • Limit the information required in the IPO registration statement to two years of audited financial statements (instead of three) and selected financial data for only the period presented in the IPO registration statement (rather than for the previous five years), and reduce in scale the executive compensation disclosure. These accommodations could reduce the audit costs associated with an IPO substantially.

In addition, the JOBS Act would ease restrictions on research published by investment banks around the time of a company's IPO. Such accommodations would address a perceived lack of research coverage for emerging companies by permitting broker-dealers – including participating underwriters – to publish reports about an Emerging Growth Company, even in the period immediately following the IPO, which current rules limit. The JOBS Act would also remove certain restrictions regarding communications between securities analysts and potential investors, which will allow this important source of information to be made available to investors as part of the offering process.

Early Post-IPO Years

Beyond simplifying the IPO process for Emerging Growth Companies, the JOBS Act would ease regulatory restrictions for these companies in the early years post-IPO. For as long as a company maintains its status as an Emerging Growth Company, it would be permitted to adhere to the following, less rigorous requirements:

  • For reports filed with the SEC and any post-IPO registration statements, Emerging Growth Companies could include reduced in scale the executive compensation disclosure (applicable to smaller reporting companies) and limit selected financial data to the period presented in the IPO registration statement.
  • Emerging Growth Companies would be exempt from:
    • the auditor attestation requirements regarding internal control over financial reporting of Section 404(b) of the Sarbanes-Oxley Act of 2002;
    • holding say-on-pay votes and disclosing certain executive compensation information (such as pay versus performance ratios);
    • compliance with any new or revised U.S. GAAP accounting standards, until such standards are also applicable to private companies; and
    • compliance with any new PCAOB rules requiring mandatory audit firm rotation or a supplement to the auditor's report.

Reforms in Private Capital Formation

In addition to reforms in the IPO process, the JOBS Act includes measures that aim to facilitate capital formation through private offerings. The legislation would implement regulatory reform that has been recommended to the SEC for almost a decade.

Elimination of Solicitation Prohibitions

General solicitation and advertising are currently prohibited for private placements of securities, including Rule 144A offerings. The JOBS Act would require the SEC to amend Regulation D and Rule 144A to allow general solicitation and advertising, even to non-accredited investors, so long as the issuing company takes reasonable steps to ensure that any actual sales of securities are made to, as applicable, accredited investors or qualified institutional buyers.

While companies may face added steps to ascertain the identity and qualifications of any purchasers, allowing general solicitation would open the door for companies to solicit a much broader base of potential investors through modern day online and social media communication portals.

Expansion of Regulation A

Regulation A currently offers an exemption from certain registration requirements for public offerings of securities of $5 million or less that are sold over a 12-month period. Regulation A requires the filing with the SEC of an offering statement containing an offering circular, the form and content of which is less burdensome to prepare when compared to the content of an IPO prospectuses for a registered public offerings. Under the JOBS Act, Regulation A would be amended to increase the cap on offering size to $50 million in a 12-month period, thus significantly broadening the appeal of a Regulation A offering.

In addition to the increased cap, the JOBS Act would mandate a study on the impact of Blue Sky securities laws on offerings made under Regulation A. An earlier version of the legislation would have preempted the application Blue Sky laws to Regulation A offerings intermediated by SEC registered broker-dealers, but this element was removed under pressure from state Blue Sky authorities. Depending on the outcome of the study, additional reforms may be made, such as preempting the application of Blue Sky laws to Regulation A offerings.

Crowdfunding

Crowdfunding is a relatively new method of fundraising in which groups of small investors pool their resources to fund companies seeking capital. In practice, crowdfunding tends to apply primarily to early stage companies. The JOBS Act would amend Section 4 of the Securities Act to provide a new exemption from registration requirements targeted at facilitating crowdfunding. The proposed exemption would apply to private companies selling up to $1 million of securities over a 12-month period (or up to $2 million if the company provides investors certain financial information). The investment by any single investor in such an offering could not exceed the lesser of $10,000 or 10% of such investor's annual income. The legislation would also allow portals through which crowdfunding capital is raised to operate without a need to register as broker-dealers with the SEC, provided certain recordkeeping and operational requirements are satisfied.

The JOBS Act would also require a company (or, if applicable, its intermediary) taking advantage of the crowdfunding exemption to take certain steps intended to inform a potentially unsophisticated shareholder base, including warning investors of the risks associated with such an investment, taking certain measures to reduce the risk of fraud, and providing investors ongoing access to issuer information.

Increase in Public Company Reporting Thresholds

Currently, Section 12(g) of the Securities Exchange Act mandates that private companies with 500 or more shareholders of record and more than $10 million in assets as of the last day of their most recent fiscal year comply with public company reporting requirements. The 500 shareholder threshold has been a burden on many private companies, as they have issued shares to an increasing number of employees and simultaneously seen an increase in the liquidity of private company shares in developing secondary markets. The JOBS Act would not only raise the shareholder threshold triggering reporting requirements to 2,000, but it would also exclude from the threshold calculation any employees holding only shares issued under equity compensation plans.

Similarly, the JOBS Act would permit banks and bank holding companies to reach $10 million in assets and 2,000 shareholders before triggering public company reporting requirements (as opposed to the current threshold of $1 million in assets and 500 shareholders).

Final Thoughts on Potential Impact of the JOBS Act

At this stage, the JOBS Act still faces the hurdles of approval in both the Senate and the White House, and even if approved, it is likely that it will be modified to some extent. However, given the framing of the bill as a job-creating measure, the fact that it enjoyed bi-partisan support in the House, and general support so far voiced by both the Senate and the White House, it appears likely that the JOBS Act or similar legislation may very well become law. If that happens, the measures proposed in the JOBS Act are poised to pave the way for an increased number of smaller company IPOs and have a significant effect on the way private offerings are structured.

The content of this article does not constitute legal advice and should not be relied on in that way. Specific advice should be sought about your specific circumstances.