JOBS Act Seeks to Ease Capital Raising for Emerging Growth Companies
On April 5, 2012, President Obama is expected to sign into law the Jumpstart Our Business Startups Act or "JOBS Act." The JOBS Act has the potential to stimulate investments in emerging growth companies by both reducing restrictions on the manner in which those companies may seek funding and by easing regulatory burdens imposed on these companies both during and following the fund raising process. Below is a summary of the provisions of the JOBS Act, which include:
- Creation of a transitional "on-ramp" for emerging growth companies that would simplify many of the requirements to which public companies are subject.
- Public advertising of securities offerings (so called "general solicitations"), eliminating many of the proscriptions on how securities had to be offered in "private placements" and opening means such as the Internet for offerings.
- A major change in the federal securities laws to allow so-called "crowdfunding," thereby facilitating the raising of capital from investors, regardless of whether they are "accredited."
- An increase in the limit for "Regulation A" public offerings.
- An increase in the number of stockholders that a company may have before being required to register under federal securities laws.
Several provisions of the JOBS Act require the Securities and Exchange Commission to adopt new rules or amend existing rules. The SEC may also adopt rules clarifying provisions of the JOBS Act. We will monitor that rulemaking process. Please do not hesitate to contact us with any questions regarding the JOBS Act.
Transitional "On-Ramp" for Emerging Growth Companies
Title I of the JOBS Act creates a new category of company referred to as an "emerging growth company." An emerging growth company is an issuer that (1) had total annual gross revenues of less than $1 billion (to be adjusted for inflation by the SEC every five years) during its most recently completed fiscal year, (2) has been public for less than five years, (3) has not issued more than $1 billion in non-convertible debt during the previous three years and (4) does not qualify as a "large accelerated filer," which, generally, is a company that has a public float of $700 million or more. Title I of the JOBS Act would provide emerging growth companies with the following benefits:
- An exemption from the requirement of having its auditors attest to the company's internal control. The chief executive and chief financial officers would still be required to certify that internal controls and procedures are adequate.
- An exemption from mandatory audit firm rotation requirements, and any new rule implementing "auditor discussion and analysis."
- Permission to include only two years of audited financial statements when going public rather than three, and to not include financial information prior to those years in Securities Act and Securities Exchange Act filings.
- Ability to provide the more streamlined discussion of executive compensation that is currently permitted from companies with a public float of less than $75 million.
- An exemption from the "say-on-pay" and "say-on-golden parachute" requirements of the Securities Exchange Act. The "say-on-pay" exemption would extend one year beyond the time a company no longer qualifies as an emerging growth company (or three years if the company qualified as an emerging growth company for two years or less).
- An exemption from the requirement to provide disclosure in proxy materials regarding the relationship between executive compensation and the company's financial performance and regarding the ratio of chief executive officer compensation to the compensation of all other employees.
- An exemption from any new or revised accounting standard until that standard would apply (if at all) to companies that are not public or in the process of becoming public.
- Permission to engage in oral or written communications with potential investors that are "qualified institutional buyers" or institutions that are "accredited investors" to determine whether investors might have an interest in a contemplated securities offering, either prior to or following the date of filing of a registration statement with respect to that offering. A prospectus would still be required to be made available to investors prior to any sale of securities.
- Ability, prior to an initial public offering, to confidentially submit to the SEC a draft registration statement for confidential nonpublic review, provided that the initial confidential submission and all amendments thereto are publicly filed with the SEC not later than 21 days before the date on which the company conducts a road show for the public offering. Unlike other confidential SEC submissions, these confidential submissions would not be obtainable by the public pursuant to the Freedom of Information Act.
In addition, the bill would permit the publication by a broker or dealer of research reports about an emerging growth company proposing to make a public offering of its common equity prior to the filing by that company of a registration statement and immediately after becoming public. Rules restricting which persons of a broker or dealer that may arrange for communications between a securities analyst and a potential investor or restricting securities analysts from attending communications with management that are attended by persons of a broker or dealer that are not securities analysts would not apply to emerging growth companies.
All companies that are not currently public or that have become public after December 8, 2011 are eligible to be treated as emerging growth companies, but may elect not be treated as an emerging growth company with respect to the financial accounting standards exemptions described above if it elects to do so prior to its first filing under the Securities Act or Securities Exchange Act. That election must apply to all of those exemptions and may not be changed.
Public Advertising ("General Solicitations")
Title II of the JOBS Act requires the SEC to amend its rules within 90 days to allow the use of general advertisements (so-called "general solicitations") to solicit investors for non-publicly traded securities without having to register with the SEC or state regulators as long as all purchasers of the securities are "accredited investors" or "qualified institutional buyers." The JOBS Act requires companies to take reasonable steps to ensure that purchasers are accredited investors or qualified institutional buyers using methods to be determined by the SEC. By eliminating the requirement that there not be a general solicitation, the Internet and other means for soliciting investors will be opened.
Intermediaries that facilitate these general solicitations will not be subject to regulation as a broker or dealer solely by providing ancillary services if the intermediary does not receive a commission for securities transactions, does not possess funds or securities in connection with securities transactions and is not disqualified due to prior disciplinary history. "Ancillary services" include the provision of due diligence services, so long as those services do not include, for separate compensation, investment advice or recommendations, and the provision of standardized documents, so long as the intermediary does not negotiate the terms of securities transactions and does require the use the standardized documents as a condition of using the intermediary.
Title III of the JOBS Act creates a "crowdfunding" private placement exemption. The JOBS Act allows companies to raise up to $1 million during any 12-month period without registering with the SEC or state regulators, regardless of whether any of the investors qualify as an "accredited investor." The amount raised during that period from any single investor may not exceed, if either the annual income or the net worth of the investor is less than $100,000, the greater of $2,000 or 5% of the annual income or net worth of that investor (as applicable) and, if either the annual income or net worth of the investor is equal to or more than $100,000, 10 percent of the annual income or net worth of that investor (as applicable), not to exceed a maximum aggregate amount sold of $100,000.
Companies making a crowdfunding offering are required to satisfy several other requirements, including, among other requirements and any additional rules the SEC may establish, (1) conducting the offering through a broker or "funding portal" (as described below), (2) providing investors with a reasonable opportunity to rescind the purchase prior to the sale, (3) not advertising the terms of offering, except for notices which direct investors to the relevant broker or funding portal, (4) filing financial statements periodically with the SEC and (5) filing with the SEC and the relevant broker or funding portal a variety of information, including:
- Certain basic information about the company.
- The names of its directors, officers and persons holding more than 20 percent of the outstanding equity of the company.
- Its business plan.
- Its financial statements (which must be reviewed by a public accountant if the target offering amount is more than $100,000 and must be audited if the target offering amount is more than $500,000 or other amount the SEC may establish).
- The terms of the company's existing securities, including how those terms may be modified, and a summary of the differences between each existing security and the security being offered, including how the rights of the securities being offered may be materially limited, diluted or qualified by rights of holders of existing securities.
- How the offered securities are being valued, and examples of methods for how those securities may be valued by the company in the future.
- The risks to purchasers of the securities relating to minority ownership in the company and the risks associated with corporate actions, including additional issuances of securities, a sale of the company or its assets or transactions with related parties.
Issuers and their directors, partners and executive officers will be liable for an action for rescission or damages for any misstatements or omissions in the above information unless the person did not know, and in the exercise of reasonable care could not have known, of the misstatement or omission.
Brokers and funding portals acting as intermediaries in crowdfunding offerings are also required to satisfy several requirements, including, among other requirements and any additional rules the SEC may establish, (i) registering with the SEC and any other applicable self-regulatory organization, (ii) providing disclosures, including disclosures related to risks and other investor education materials, (iii) ensuring that each investor reviews investor-education information and affirms that the investor understands the risks of the investment, (iv) obtaining a background and securities enforcement regulatory history check on each officer, director and person holding more than 20 percent of the outstanding equity of the issuer, (v) ensuring that all offering proceeds are only provided to the issuer when the aggregate capital raised from all investors is equal to or greater than the issuer's target offering amount, and allowing all investors to cancel their commitments to invest, (vi) making efforts to ensure that no investor exceeds the investment limits described above, (vii) protecting the privacy of information collected from investors and (viii) prohibiting its directors, officers or partners from having any financial interest in an issuer using its services.
A person may act as a "funding portal" if, in addition to satisfying any other requirements imposed by the SEC, that person does not offer investment advice or recommendations, solicit purchases, sales or offers to buy securities offered or displayed on its website or portal, compensate employees, agents or other persons for the solicitation or sale of securities displayed or referenced on its website or portal or hold, manage, possess or otherwise handle investor funds or securities.
Purchasers of securities being sold in crowdfunding offerings may not transfer the securities within one year of purchase unless the securities are transferred to the issuer, to an "accredited investor," as part of a registered offering or to a family member.
Foreign companies and public companies may not make crowdfunding offerings.
The SEC is required to adjust the dollar amounts referred to above for inflation. The SEC is also required to adopt rules that would disqualify companies from making crowdfunding offerings, as well as brokers and funding portals from acting as intermediaries in crowfunding offerings, based upon their disciplinary history and the disciplinary history of their officers, directors and other related persons.
The crowdfunding exemption preempts state registration, documentation and offering requirements. State filing fees are also preempted, except from the State of the principal place of business of a crowdfunding issuer and the State in which purchasers of a majority of the securities being issued in a crowfunding offering are resident. States, however, will retain the ability to bring enforcement actions for fraud, deceit or unlawful conduct against issuers, brokers and funding portals.
Increase in Small Offering Limit
Title IV of the JOBS Act would amend Regulation A by increasing the limit of all securities sold within the prior 12-month period in reliance on Regulation A from $5 million to $50 million. Section 3(b) of the Securities Act authorizes the SEC to exempt from registration securities offerings that do not exceed $5 million. Pursuant to this authority, the SEC created Regulation A which provides an exemption from registration for public offerings not exceeding $5 million in any 12-month period. Companies that choose to make an offering in reliance on Regulation A must still file an offering statement with the SEC for review. The principal advantages of Regulation A offerings, as opposed to registered offerings, are that required disclosures are simplified and that the completion of an offering under Regulation A does not result in the issuer being required to file periodic reports under the Securities Exchange Act unless it would otherwise be required to file those reports because of the amount of its assets and the number of its shareholders. Also, as with securities that are registered, securities issued in a Regulation A offering may be freely traded after being issued. The JOBS Act, however, requires the filing of audited financial statements annually with the SEC and permits the SEC to require the filing of periodic reports under the Securities Exchange Act if it determines necessary in the public interest. The SEC would also be required to adopt rules that would disqualify companies from making an offering under Regulation A based upon the disciplinary history of the company and its officers, directors and other related persons. Finally, the SEC would be required to review the $50 million cap every two years and increase it as the SEC deems appropriate.
The JOBS Act provides that offerings made in reliance on Regulation A will be exempt from state "blue sky" laws if offered or sold on a national securities exchange or to a "qualified purchasers" to be defined by the SEC.
Increase in Shareholder and Asset Size Limits
Currently, registration with the SEC is required for companies with assets in excess of $1 million and more than 500 holders of any class of its equity securities. This requirement has posed problems for certain widely held emerging growth companies. As a result of Title V of the JOBS Act, these triggers will be revised so that registration with the SEC will be required for companies with assets in excess of $10 million and more than either 2,000 holders or 500 holders who are not "accredited investors." Persons who receive securities pursuant to a company employee compensation plan would not be counted in determining whether that company has exceeded the holder trigger. In addition, the JOBS Act requires the SEC to adopt rules within 270 days that will exclude purchasers of securities in "crowdfunding" transactions from the calculation of the holder trigger.