On March 27, 2012, Congress passed the Jumpstart Our Business Startups (JOBS) Act in an attempt to "increase American job creation and economic growth by improving access to public capital markets for emerging growth companies." The JOBS Act seeks to accomplish this goal in part through reducing the regulatory restrictions placed on certain companies seeking to pursue an initial public offering (IPO) and phasing in certain requirements on certain newly public companies.

The JOBS Act has been sent to the White House for enactment, and it is likely that it will become law in the near term. Some of the provisions of the JOBS Act will require implementation by regulatory authorities, including review and rule-making procedures by the U.S. Securities and Exchange Commission (SEC). Other provisions of the JOBS Act (specifically those relating to IPOs of emerging growth companies) are direct amendments to the Securities Act of 1933 (Securities Act) and the Securities Exchange Act of 1934 (Exchange Act) and will become effective immediately.

The following outlines the major provisions of the JOBS Act that will affect certain companies seeking to conduct an IPO.

Application of the JOBS Act

The portions of the JOBS Act that will impact the IPO registration process relate to a new category of issuers called "emerging growth companies." An "emerging growth company" is defined as a company that had gross revenues of less than $1.0 billion during its most recently completed fiscal year. This threshold applies solely to the most recently completed fiscal year and not to prior years, allowing companies with revenues in excess of such amount in past periods to avail themselves to the benefits of the Act so long as revenues were below the threshold for the most recently completed year.

Once an emerging growth company has completed an IPO, it will continue to be considered an emerging growth company until the earliest of:

  • The last day of the fiscal year during which the company generates revenues of $1.0 billion or more;
  • The last day of the fiscal year following the fifth anniversary of the date of the first sale of common equity securities by the company pursuant to its IPO registration statement;
  • The date on which the company has, during the previous three-year period, issued more than $1.0 billion in non-convertible debt; or
  • The date on which the issuer is deemed to be a "large accelerated filer," meaning a company with an equity public float in excess of $700 million that has been a reporting company for at least one year.

A company that has commenced, but not yet completed, the IPO registration process would be able to take advantage of the JOBS Act if it qualifies as an emerging growth company. However, any company that has completed a registered sale of its common equity under the Securities Act on or prior to December 8, 2011, is not eligible to be considered an emerging growth company.

While the following focuses on the impact of the JOBS Act on emerging growth companies that are considering an IPO, all emerging growth companies will be afforded significant benefits for a period of one to five years, including delayed application of auditor attestation compliance, delayed application of provisions of the Dodd-Frank Act relating to say-on-pay rules, reduced financial information disclosure, delayed compliance with new accounting standards, and exemption from certain proposed rules promulgated by the Public Company Accounting Oversight Board (PCAOB) relating to the audit process. SEC reporting companies that qualify for emerging growth company treatment should consult with their counsel prior to availing themselves of any of these benefits.

Benefits of the JOBS Act Related to IPOs

The JOBS Act incorporates several significant deviations from traditional SEC rules and restrictions relating to the IPO registration process that would benefit emerging growth companies, including the following:

More Lenient Financial Information Requirements. Under the Act, emerging growth companies are allowed to pursue an IPO with a registration statement that includes only two years of audited financial statements and two years of selected financial data. Historically, these companies would have been required to have three years of audited financial statements and five years of selected financial data in their IPO registration statement. While this change is expected to increase the pool of potential IPO candidates, companies should be cognizant that this change will require additional analysis from underwriters and counsel on the viability of an IPO with limited financial disclosures. It is not known how potential investors might attribute risk to a security of a company providing reduced financial statement disclosure. As such, emerging growth companies contemplating pursuing an IPO with reduced financial statement disclosures should consider consulting with their lead underwriter(s) early in the process to discuss any market impact the reduced presentation might have. In addition, these companies should consider including the balance of the underwriters in conversations at an earlier stage than in a traditional IPO in order to ensure that committee approvals do not impede the establishment of a full underwriting syndicate. Despite these issues, we believe that these reduced financial disclosure requirements will have less of an impact on investors and underwriters with respect to (i) companies considering an IPO as a master limited partnership or royalty trust, where valuation keys more heavily off of projected cash distributions than past performance, and (ii) exploration and production companies, where valuation principally relates to estimated reserves, and therefore represent a more viable avenue for an IPO with reduced financial disclosures than in other structures and industries.

Confidential Review of Draft Registration Statements. The Act allows emerging growth companies the option to receive confidential review of an IPO registration statement by the SEC, meaning preliminary draft registration statements (as well as SEC comments thereto) generally will not appear on the SEC's EDGAR website while the company is preparing for its IPO. While a company must publicly file its initial IPO registration statement (and any amendments thereto) at least 21 days prior to its anticipated "road show," the confidential review process will allow for a company to time its entry into the public domain so as to minimize the risk of potential delays associated with volatile equity markets or business or other operational or strategic considerations.

Scaled Executive Compensation Disclosure. The JOBS Act permits reduced executive compensation disclosure in the IPO registration statement of an emerging growth company. An emerging growth company will be permitted to provide (i) executive compensation disclosure for three named executive officers (specifically including the principal executive officer, but not the principal financial officer) rather than five officers; (ii) Summary Compensation Table disclosure for two years rather than three years; (iii) two of the other six tables typically required; and (iv) an alternative narrative disclosure.

Testing the Waters. Under the Act, emerging growth companies are allowed to communicate with institutional accredited investors and qualified institutional buyers to gauge interest in IPO securities without being subject to the traditional prohibitions on pre-IPO publicity. These types of communications would allow emerging growth companies to weigh institutional investor interest during the IPO registration process even prior to the time of the initial filing of a registration statement, thereby providing management with greater insight into the likely success of an IPO prior to incurring the expense and time allocation associated therewith, all without expectations being set in the public domain if confidential review is requested.

Reduced Research Analyst Restrictions. Under the Act, research analysts of investment banking firms that are a part of the underwriting syndicate of an emerging growth company would not be prohibited from publishing research related to the company around the company's IPO. In addition, research analysts would be allowed to participate in meetings with the company in the presence of members of its investment banking team.

Companies qualifying as emerging growth companies are expected to be able to take advantage of these provisions immediately upon enactment of the JOBS Act.

Other Considerations Relating to an IPO Following JOBS Act Enactment

For companies considering an IPO in the foreseeable future, the JOBS Act may significantly impact the timing of their access to the public markets. However, companies should consult with their legal counsel, accountants, and investment bankers as to the application of the JOBS Act to their particular capital-raising plans. In addition, the following items should be considered.

  • Emerging Growth Company Status is Temporary. Many issuers who conduct IPOs become "large accelerated filers" within the first couple of years following the IPO. Accordingly, companies should be mindful of the more stringent requirements that become applicable upon ceasing to qualify as an emerging growth company, and be aware that such requirements may apply sooner than expected.
  • SEC Implementation Timeline. The SEC is required to review and propose changes to certain of its prescribed disclosure rules (e.g., Regulation S-K) within 180 days following enactment of the JOBS Act in order to reduce disclosure burdens for emerging growth companies. Given the SEC's publicly stated concerns with the JOBS Act, it is not known to what extent the disclosure rules will be amended or when such amended rules will become effective.
  • Impact of Implementation on Ancillary SEC Rules and Regulations. Other SEC rule making will be required to reconcile the amendments to the Securities Act and the Exchange Act with current SEC rules and regulations. These rules will need to be amended to provide relief for emerging growth companies consistent with the intent of the Act.

Increased Flexibility in Conducting Certain Private Offerings

In addition to changes in the IPO requirements for emerging growth companies, the JOBS Act also increases flexibility for all companies (as opposed to only emerging growth companies) seeking to raise capital in certain private offerings, including transactions pursuant to Rule 506 and Rule 144A under the Securities Act. Specifically, whereas in the past these rules established a prohibition on general solicitations or advertising of offers to purchase securities, the JOBS Act directs the SEC to adopt amendments within 90 days of enactment to eliminate these restrictions in certain instances. Pursuant to this directive, the SEC will be required to create an exemption to the general solicitation prohibition for Rule 506 transactions in which securities are only sold to "accredited investors" and for Rule 144A in which securities are only sold to "qualified institutional buyers," regardless of whether offers are made to non-accredited investors or non-qualified institutional buyers, respectively. While SEC implementation will dictate the procedures that must be followed in order for a company to avail itself to these safe harbors — and while these provisions of the JOBS Act will not be in effect until SEC implementation — the intent of Congress is to allow companies seeking to raise capital in these non-public settings to cast a wider net for potential investors without running afoul of traditional general solicitation restrictions.

Conclusion

While its benefits will in part be dictated by the manner in which it is implemented and interpreted by the SEC, the JOBS Act is likely to have a far-reaching impact on the ability of companies to raise capital both in IPOs and private placements. Companies considering capital raises in the near term should look beyond the changes to the letter of the law and consider the practical implications of these laws before seeking to avail themselves of these benefits. While more clarity will arise with the passage of time, in certain instances companies may benefit from proactively taking advantage of these changes in the securities laws in the near term.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.