Signed into law on April 5, 2012, the “Jumpstart Our Business Startups” Act (“JOBS Act” or “the Act”), was designed to spur economic growth by relaxing the regulatory requirements for small or new companies seeking access to capital from the public markets. The JOBS Act created what has been termed the IPO On-Ramp—a transition period of relaxed or phased requirement for companies as they go through the IPO registration process and in the five years directly thereafter. This article will explain the major provisions of the JOBS Act to help you understand what is required of your company as you prepare for an IPO.
Emerging Growth Company
The JOBS Act created a new category of company with special regulatory requirements called an Emerging Growth Company (EGC). As the name suggests, EGCs are relatively small companies that are likely experiencing major growth. A company can qualify as an EGC until the earliest of the following conditions:
- The last day of the fiscal year during which total annual gross revenues exceed $1.07 billion
- The last day of the fiscal year following the fifth anniversary of the date of the first public sale of common equity securities
- The date on which the issuer has, during the previous three-year period, issued more than $1 billion in non-convertible debt
- The date on which such issuer is deemed to be a “large accelerated filer1”
Any company that does not yet meet any of the conditions above qualifies to be an EGC, regardless of its jurisdiction of incorporation or organization, thus, even foreign private issuers can receive the designation. Meeting the qualifications to be classified as an EGC is a prerequisite for the special rules discussed in this article.
The JOBS Act was passed to make it easier for companies to gain access to public capital, especially through an IPO. It created the IPO On-Ramp, a series of special rules and conditions for EGCs that make the requirements for soon-to-be and newly public companies less burdensome. The following sections present the details of the most important changes enacted by the JOBS Act, click on each drop-down for more information:
Ability to test the waters
Before filing a securities registration, the JOBS Act allows EGCs (or any person authorized to act on behalf of the EGC) to hold meetings with qualified institutional buyers and accredited investors2. This can be very beneficial for EGCs, as these meetings help to gauge the interest that exists in the market for the company’s shares as well as the amount of money that would potentially be earned in an IPO—all without starting the formal process. For example, if you were debating the timing of your company’s IPO, but wanted more confidence on the pricing window that would likely be achieved if the decision were made to issue publicly traded stock, the JOBS Act permits your investment banker to ask his/her customers how many shares they might purchase at various price points, without requiring the customer to make any commitment to order. Prior to the JOBS Act, such inquiries were not permissible.
Confidential SEC Filings
Confidentially filing registration statements with the SEC prior to going public used to be a provision available only to EGCs. However, beginning on July 10, 2017, the SEC will accept voluntary draft registration statement submissions from all companies for confidential/nonpublic review, meaning that all companies can now file and revise their forms S-1 privately with the SEC before they reach the public eye. Although the initial process is allowed to be confidential, a company must publicly file its initial submission—along with all subsequent amendments—no later than 15 days before a conducting its road show3. Allowing confidential filing with the SEC protects a company in the event of market changes or other unforeseen problems that could change the ideal timeframe to IPO, and the SEC hopes that this expansion of JOBS Act benefits to all companies will help to spur IPOs in the United States.
Phased Financial Reporting Requirements
EGCs are only required to provide two years of audited financial statements and two years of selected financial data in their IPO registration with the SEC. This is less burdensome than the three-year requirement for non-EGCs. After completing an IPO, the EGC will add additional reporting periods to its filings until it presents the full three years of audited financial statements that are required for public companies—thereby phasing-in to the full financial reporting requirements by one year after going public.
According to EY’s 2015 mid-year update on the JOBS Act, approximately 59 percent of EGCs had elected to take advantage of the smaller financial reporting burden as of mid-2015, and the practice is becoming more popular, especially among smaller EGCs.
Phase-in for new GAAP pronouncements
Although a company is public once it completes an IPO, the JOBS Act does not require that EGCs be fully compliant with new United States Generally Accepted Accounting Principles (GAAP) pronouncements until those pronouncements are required for both public and private companies. Therefore, if a new accounting standard gives more lead time for private company compliance than it does for public companies—such as with extremely complex standards, like revenue recognition—the EGC would get more time to comply.
However, it is important to note that a public EGC may not delay compliance for some new GAAP pronouncements and not others. Per Sec. 107(b) of the JOBS Act, if an EGC does not want delayed compliance, that company must:
- Make that choice by the time it first files a registration statement, periodic report, or other report with the SEC, and notify the SEC of the choice
- Comply with all standards in the same manner as a non-EGC
- Continue to comply with all standards in the same manner as a non-EGC for as long as the company qualifies as an EGC
A company cannot pick and choose standards for delayed compliance. Rather, it must elect to always follow either the delayed private company compliance schedule, or the public company timeline. However, if a standard allows for early adoption by private companies, an EGC that elects to follow the private company compliance schedule may follow the private company early adoption schedule without violating the conditions of the JOBS Act.
According to EY’s 2015 mid-year update on the JOBS Act, around 84 percent of EGCs decided not to adopt the extended accounting standard transition relief, presumably because they want to show results that are comparable to other public companies. However, as new, complex standards continue to come out, it may be beneficial for some EGCs to wait to comply.
Attestation on internal controls
An audit of internal controls—mandated in the Sarbanes Oxley Act section 404(b) (SOX 404)—can be one of the most challenging new requirements for public companies. However, while a company qualifies as an EGC, it is not required to obtain an auditor attestation report on internal controls over financial reporting (ICFR). Prior to the JOBS Act, all public companies were required to obtain a SOX 404 attestation of ICFR by their second annual audit report, which introduced a great deal of complexity and financial burden on the newly public companies. The IPO On-Ramp period makes the transition less drastic.
Mandatory auditor rotation and disclosure
As part of the JOBS Act, EGCs are not obligated to comply with any future rulings by the Public Company Accounting Oversight Board (PCAOB) requiring mandatory auditor rotation. Additionally, any requirement for an auditor to provide an “auditor discussion and analysis” supplement to the audit and financial statements does not apply to EGCs. Further, any additional rules adopted by the PCAOB do not apply to an audit of an EGC unless the SEC states that the new rules are required.
Executive compensation votes and disclosure
The JOBS Act releases EGCs from some obligations otherwise required under the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank). For example, public companies are required to hold nonbinding shareholder votes for say-on-pay4, say-on-frequency5, and say-on-golden parachute6 provisions. Dodd-Frank also requires that public companies disclose information about CEO pay ratios—the Pay Ratio Rule7 —and a pay-for-performance graph8. The JOBS Act releases EGCs from these obligations.
It is important to note that many of the regulations imposed by Dodd-Frank are currently under review by the Trump Administration, and that changes—which would likely result in an expansion of the beneficial provisions of the JOBS Act—are possible. Therefore, some of the reduced requirements for EGCs made possible by the JOBS Act may soon apply to all public companies, as the scope of Dodd-Frank is narrowed. Particularly, a February 6, 2017 public statement by the Acting Chairman of the SEC, Michael Piwowar, asked the SEC staff to reconsider the implementation of the Pay Ratio Rule because of perceived difficulties in compliance for public companies.
Threshold for public registration and reporting
Before the JOBS Act, if a company had more than $10 million in assets and a class of equity securities that was held by 500 or more persons, it was required to register with the SEC and report in accordance with the Exchange Act. Under the JOBS Act, the obligation to register with the SEC is not triggered until a company has assets exceeding $10 million and a class of equity security that is held by either (1) 2,000 persons, or (2) 500 persons who are not accredited investors.
Summary of JOBS Act Changes for EGCs
Impact of the JOBS Act
The results of the JOBS Act have been mixed—especially in the context of an ever-changing market. In 2012, when the JOBS Act was signed, there were 128 IPOs, and in the years following, the numbers increased dramatically (222 in 2013, 275 in 2014, and 170 in 2015). However, in 2016, the number of IPOs declined to 102, lower than before the Act was signed into law. Therefore, it appears that the JOBS Act spurred some market activity initially, but the results are inconclusive. It can be difficult to attribute market activity—both positive and negative—directly to a piece of legislation, which makes evaluating the effectiveness challenging.
Some opponents to the JOBS Act were concerned that by reducing the amount of required disclosures, it would expose investors to greater risks and more uncertainty. A smaller timeframe of financial information necessarily gives investors a less complete picture of an emerging company, which means that greater risk is possible. Particularly, crowdfunding poses an interesting dilemma, because it requires very few financial disclosures, but can be used to raise significant amounts of money—up to $1 million. When the JOBS Act was passed, these risks of a less transparent process were deemed acceptable in order to generate more economic growth; but, as early-stage funding sources continue to evolve outside of traditional angel investors and venture capital, it is possible that less-sophisticated investors could be hurt by decreased transparency and fewer regulatory restrictions. Time will tell if the benefits outweigh the heightened risks.
The JOBS Act makes the transition from a nonpublic to public company easier, primarily by decreasing the immediate regulatory requirements prior to an offering, and extending the IPO On-Ramp through the years right after the IPO. To help you in your IPO preparation, we have presented the most salient points of the current JOBS Act here. However, we recognize that the JOBS Act is dynamic, and the SEC will continue to make changes that you will need to be aware of. As you consider going public and review the various requirements put forth by the SEC, it is important that you determine if your company qualifies as an EGC issuer before you can take advantage of the available benefits. The IPO process is complex and demanding, but for many young companies, the JOBS Act eases some of that burden.
- Practical Law Company, “A Quick Guide To The JOBS Act”
- Latham & Watkins, “JOBS Act Establishes IPO On-Ramp”
- JOBS Act Text
- Harvard Law School Forum on Corporate Governance and Financial Regulation, “The JOBS Act: Did It Accomplish Its Goals?”
- EY, The JOBS Act: 2015 mid-year report
- SEC Announcement on the expansion of confidential filing allowance
- SEC Public Statement on Dodd-Frank by Michael Piwowar
- Large Accelerated Filer: A public company becomes a large accelerated filer when it first meets the following conditions at the end of its fiscal year:
i. An aggregate worldwide market value of voting and non-voting common equity of $700 million or more, as of the last business day of the company’s most recently completed second fiscal quarter
ii. The company has been subject to the requirements of section 13(a) and 15(d) of the Securities and Exchange Act for at least 12 calendar months
iii. The company has filed at least one annual report pursuant to section 13(a) or 15(d) of the Securities and Exchange Act
iv. The company is not eligible to use the requirements for smaller reporting companies
- An accredited investor, for individuals, is a person who: (a) had income in excess of $200,000 (or $300,000) with a spouse) in each of the prior two years, and expects the same for the current year, and (b) has a net worth over $1 million, either alone or with a spouse (excluding the value of a primary residence or any home-related loans).
- A presentation (or presentations) by a company that is preparing to conduct an IPO to potential buyers—such as analysts, fund managers, and large potential investors. The road show has a marketing purpose, and is expected to generate excitement and interest in the upcoming IPO.
- Under Dodd-Frank, public companies are required to have a nonbinding/advisory vote on the company’s executive compensation program at least once every three years.
- A vote to determine whether the say-on-pay vote will be held annually, biannually, or triennially
- When a company seeks shareholder approval of a merger or acquisition, it will be required to conduct a separate shareholder advisory vote to approve the disclosed golden parachute compensation arrangements between the target company and its own named executive officers or those of the acquiring company.
- As part of Dodd-Frank, a rule that requires a public company to disclose the ratio of the median of the annual total compensation of all employees to the annual total compensation of the chief executive officer.
- A disclosure of the relationship between executive compensation and the financial performance of a company, also with comparisons to peer companies.