The JOBS Act: Improving Access to Capital

[authors: Brian J. Burt, Joseph M. Miller and Nicholas Varela]

On April 5, 2012, the Jumpstart Our Business Startups Act (JOBS Act) was signed into law, bringing sweeping changes to the Securities Act of 1933 and the Securities Exchange Act of 1934. The JOBS Act is designed to make it significantly easier for startup and emerging growth companies to raise capital by eliminating or reducing certain regulatory burdens.

The JOBS Act is comprised of six sections:

• Title I creates an initial public offering (IPO) “on-ramp” for a new category of issuer known as “emerging growth companies.”

• Title II requires the Securities and Exchange Commission (SEC) to revise Regulation D and Rule 144A to permit general advertising and solicitation under certain circumstances.

• Title III creates a new private offering exemption for “crowdfunding.”

• Title IV raises the offering limit under Regulation A to $50 million in a 12-month period.

• Titles V and VI raise the shareholder thresholds triggering a company’s obligation to register as a public reporting company with the SEC.

The JOBS Act became effective only in part upon enactment. The provisions governing the IPO “on-ramp” and the new registration/deregistration standards generally became effective immediately, while the other provisions will require SEC rulemaking. The following table provides the deadlines by which the SEC is to complete its rulemaking under the JOBS Act

I. Title I: IPO “On-Ramp” for Emerging Growth Companies.  

This title creates a new category of issuer known as “emerging growth companies” (EGCs), and provides for reduced offering, disclosure and compliance requirements for EGCs both during and after their initial public offering.

A. What is an Emerging Growth Company?   

An EGC is a company that completed an IPO after December 8, 2011, and had less than $1 billion in revenue during its most recent fiscal year. An EGC will retain that status until the earliest of the following:

• the end of the fiscal year in which its annual revenues exceed $1 billion;
• the end of the fiscal year following the fifth anniversary of its IPO;
• the date on which it has issued more than $1 billion in non-convertible debt in a three-year period; or
• the date on which it becomes a large accelerated filer.

B. How Has the IPO Process Been Changed for EGCs? 

• Financial Information – an EGC will only need to provide two years of audited financial statements (instead of three) and two years of selected financial data (instead of five) in its IPO registration statement.
• Management Discussion and Analysis (MD&A) – an EGC will only need to provide management’s discussion and analysis of two years of financial information (instead of three) in its IPO registration statement.
• Executive Compensation – in its IPO registration statement, an EGC will only need to comply with Item 402 of Regulation S-K under the smaller reporting company standards, meaning (i) no compensation discussion and analysis, qualification of termination and change of control benefits, or internal pay comparison is required, (ii) disclosure is required only for the CEO and two other most highly paid executives (instead of CEO, CFO and three other most highly paid executives), and (iii) only the summary compensation table and outstanding equity awards table are required.
• Pre-filing Communications – an EGC can now “test the waters” with qualified institutional buyers (QIBs) and institutional accredited investors (IAIs) to gauge investor interest prior to filing its registration statement.
• Confidentiality – an EGC can submit draft registration statements for confidential review by the SEC.

C. How Are the Post-IPO Requirements Different for EGCs?

Until a company no longer qualifies as an EGC:

• Say on Pay – it is not required to hold shareholder advisory votes on executive compensation and golden parachutes until the first year after it loses EGC status (or if the loss of its EGC status occurs less than two years after its IPO, then two years after the loss of such status).
• Executive Compensation – it is not required to provide (i) a comparison of executive compensation to the company performance or (ii) the ratio of CEO to median worker pay (i.e., the pay disparity ratio). An EGC also only needs to comply with Item 402 of Regulation S-K under the smaller reporting company standards.
• Historic Financial Information – it is not required to provide, in any later registration statements or periodic reports, selected financial data for any period before the earliest audited period presented in its IPO registration statement(s).
• Accounting Standards – it is not required to comply with any new or revised accounting standards until such standard is made generally applicable to private companies.
• Internal Control – it is not required to provide the auditor attestation on internal control over financial reporting.
• Audit Firm Rotation – it is not subject to mandatory audit firm rotation and auditor discussion and analysis requirements if they are adopted by the Public Company Accounting Oversight Board (PCAOB).
• Future PCAOB Rules – it will only be subject to future rules promulgated by the PCAOB if the SEC determines that such rules are necessary for protection of the public.

Finally, the SEC is required to review and revise Regulation S-K to simplify registration and compliance requirements for EGCs.

D. What Is Different for Research Analysts? 

Broker and dealers can now publish research reports relating to an EGC at any time before, during or after the EGCs IPO or any other offering, even if the broker or dealer expects to participate in the IPO. 

II. Title II: General Solicitation under Regulation D and Rule 144A.

The JOBS Act requires the SEC to amend Rule 506 under Regulation D and Rule 144A to allow for offers and sales of securities through general solicitation or advertising, provided that all purchasers are accredited investors (for Rule 506 offerings) or qualified institutional buyers or QIBs (for Rule 144A offerings).

By lifting the general solicitation ban, the JOBS Act dramatically increases the pool of potential investors available to companies that use Rule 506 to raise capital.

III. Title III: Crowdfunding.   

The JOBS Act created a new transactional exemption under the Securities Act that serves to legalize equity crowdfunding. Crowdfunding refers to the use of a broker or SEC-registered “funding portal” to raise capital through small investments from a relatively large pool of individual investors (who do not need to be accredited). It is anticipated that the Internet will provide the platform to facilitate most crowdfunding offerings. Some of the key provisions governing crowdfunding are set forth below:

• Investment Limits
  • A company will be able raise up to $1 million every 12 months through crowdfunding (although such amount includes the value of all securities sold to investors, whether through crowdfunding or another exemption).
  • Within a 12-month period, individuals will be able to invest:
    • if their annual income or net worth is less than $100,000, the greater of (i) $2,000 or (ii) 5 percent of annual income or net worth; or
    • if their annual income or net worth is equal to or greater than $100,000, the greater of (i) 10 percent of annual income or (ii) 10 percent of net worth, not to exceed $100,000.
       
• Disclosure Requirements – the issuer will be required to file with the SEC and deliver to investors, brokers and the funding portal certain disclosures, both at the time of the offering and on an annual basis thereafter. 

• Advertising Restrictions – issuers may not advertise the terms of offerings, except for notices directing investors to the broker or funding portal facilitating the offering.

• Intermediaries – those who want to serve as crowdfunding intermediaries must:
  • register as a broker or a funding portal with the SEC;
  • become a member of a national securities association that is registered with the SEC (the only one in existence today is the Financial Industry Regulatory Authority (FINRA));
  • provide certain disclosures as required by SEC;
  • take measures to reduce the risk of fraud;
  • comply with privacy rules adopted by the SEC; and
  • satisfy certain additional requirements.
     
• Transfer Restrictions – shares purchased through crowdfunding are subject to a one-year holding period, subject to limited exceptions.

• Preemption of State Law – the new crowdfunding exemption will preempt state “blue sky” law, although states will be able to enforce their anti-fraud rules against issuers, brokers and funding portals.

IV. Title IV: Regulation A+. 

The JOBS Act requires the SEC to amend Regulation A so as to increase the aggregate amount of securities that may be offered and sold within any 12-month period from $5 million to $50 million. Such securities can be offered and sold publicly in compliance with SEC rules and will not be restricted securities in the hands of the purchasers. Historically, Regulation A has not been frequently used to raise capital. It remains to be seen whether this change will reinvigorate this snubbed regulation.

V. Titles V and VI: Thresholds for Company Registration.

Prior to the JOBS Act, an issuer was required to register with the SEC and become subject to the reporting requirements under the Exchange Act, when it had total assets in excess of $10 million and a class of securities held of record by 500 or more persons. 

The JOBS Act significantly increases that shareholder threshold, so that a company will not be required to register until its total assets exceed $10 million and it has a class of securities held of record by either (i) 2,000 or more persons or (ii) 500 or more persons who are not accredited investors. In addition, persons who received their shares through employee compensation plans or crowdfunding offerings will not count toward these shareholder limits.