CLIENT ALERT: JOBS Act Fundamentals
President Obama recently signed into law the “Jumpstart Our Business Startups Act,” or the JOBS Act. The JOBS Act contains a combination of reforms to the U.S. securities laws and is intended to ease the regulatory burdens on raising capital for qualifying start-ups and growing companies. The JOBS Act provides scaled reporting relief to so-called “emerging growth companies” during a five-year “IPO On-Ramp” and relaxes restrictions on certain pre-IPO communications and reports by securities analysts who intend to participate in a securities offering. The JOBS Act also exempts “crowdfunding” from registration under the Securities Act of 1933 (“Securities Act”), allows general solicitation and advertising for private offerings to accredited investors and modifies the Regulation A exemption to enable issuers to raise up to $50 million per year of capital without registering the offering under the Securities Act. The provisions of the JOBS Act relating to emerging growth companies (“Title I”) are effective immediately. The Securities and Exchange Commission (“SEC”) will be adopting rules to give effect to the other JOBS Act provisions described above. The SEC recently announced that, as it did with the Dodd-Frank Act, it will accept public comments before the SEC even proposes its regulatory reform rules and amendments.
The “IPO On-Ramp” (Title I of the JOBS Act)
Title I of the JOBS Act establishes a new category of issuers called “emerging growth companies” (“EGCs”) that may take advantage of a so-called “IPO On-Ramp.” The new rules ease restrictions on the conduct of the IPO process for these companies and exempt certain newly public companies for up to five years from some of the more costly compliance measures required of public companies. An EGC is defined as an issuer that had total annual gross revenues of less than $1 billion during its most recently completed fiscal year. An EGC as of the first day of that fiscal year will continue to be deemed an EGC until the earliest of:
- the last day of the fiscal year of the company during which it had total annual gross revenues of $1 billion or more;
- the last day of the fiscal year of the company following the fifth anniversary of the first sale of common equity securities of the issuer pursuant to an effective registration statement under the Securities Act;
- the date on which the company has, during the previous 3-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” (generally, a company with $700 million or more in public float).
Issuers who sold common equity securities pursuant to an effective registration statement under the Securities Act on or before December 8, 2011 will not be considered EGCs. The following list highlights the most important exemptions and eased regulatory requirements for EGCs prescribed by the JOBS Act:
- An EGC will not need to provide more than two years of audited financial statements, more than two years of Management Discussion & Analysis or any “selected financial data” in its IPO registration statement;
- An EGC may apply for confidential review by the SEC of its IPO registration statement (provided the registration statement is publicly filed not later than 21 days before any road show), thus allowing an EGC to protect sensitive information from public disclosure for a limited period of time;
- EGCs may “test the waters” by communicating with qualified institutional buyers or institutions that are accredited investors to solicit their interest in the offering, either before or after filing a registration statement with respect to an offering;
- The antifraud prohibitions of the securities laws still apply to these communications, however, and issuers must still deliver a statutory prospectus to investors before selling any securities in their IPO;
- The JOBS Act creates a safe harbor for research reports by brokers and dealers that are published in advance of and during the registration period for common securities offerings by EGCs, even if the broker or dealer firm is participating or will participate in the offering as an underwriter;
- As with smaller reporting companies, auditors of EGCs will not need to attest to the company’s internal controls under the Sarbanes-Oxley Act. However, management of an EGC is still required to establish and maintain internal controls;
- The new Dodd-Frank executive compensation disclosure requirements (i.e., the “say-on-pay,” golden parachute and CEO pay ratio disclosure rules) will not apply to EGCs;
- EGCs will be able to take advantage of scaled-back compensation discussion and analysis disclosure;
- EGCs will not need to comply with new financial accounting standards until private companies also need to comply. However, EGCs may not “pick and choose” to comply with certain new accounting standards and not others. That is, should an EGC choose to comply with a new accounting standard, it must comply with all new accounting standards; and
- In the event that the Public Company Accounting Oversight Board adopts rules requiring “mandatory audit firm rotation” or “auditor discussion and analysis,” such rules will not be applicable to an audit of an EGC.
General Solicitation and Advertising for Private Offerings (Title II of the JOBS Act)
Title II of the JOBS Act will allow issuers who wish to raise capital through a private placement to use general solicitation and advertising to market an offering, such as through newspaper and internet advertisements, so long as they take reasonable steps, to be determined by the SEC, to ensure that all purchasers are “accredited investors.”
“Crowdfunding” (Title III of the JOBS Act)
Title III of the JOBS Act will exempt from registration under the Securities Act the capitalization of a start-up business through “crowdfunding.” Crowdfunding generally refers to the raising of small amounts of capital from a large number of investors, usually via the Internet, to support corporate, charitable or individual endeavors. The crowdfunding exemption will not be available to foreign private issuers, companies required to file reports pursuant to Section 13 or Section 15(d) of the Securities Exchange Act of 1934 (“Exchange Act”) or investment companies. The JOBS Act exempts the raising of capital through crowdfunding from state securities registration laws, although state antifraud laws will still apply. Issuers wishing to use crowdfunding will need to comply with certain requirements, including a capital raise threshold and limitations on individual investor contributions. The primary restrictions on crowdfunding are:
- Issuers may only raise an aggregate of $1.0 million in a 12-month period;
- Issuers using crowdfunding will have to file with the SEC and provide to investors certain disclosure, including a description of their capital structure, a business plan, intended use of proceeds and a description of their financial condition, as well as:
- for offerings that, together with all other crowdfunding offerings of the issuer within the preceding 12-month period, have, in the aggregate, target offering amounts of $100,000 or less, the income tax returns of the issuer for the most recently completed fiscal year and financial statements certified by the issuer’s CEO to be true and correct in all material respects;
- for offerings that, together with all other crowdfunding offerings of the issuer within the preceding 12-month period, have, in the aggregate, target offering amounts of more than $100,000 but not more than $500,000, financial statements of the issuer reviewed by an independent public accountant; and
- for offerings that, together with all other crowdfunding offerings of the issuer within the preceding 12-month period, have, in the aggregate, target offering amounts of more than $500,000 (or such other amount as the SEC may determine), audited financial statements;
The periods to be covered by the financial statements required to be provided in crowdfunding offerings are to be determined by the SEC.
- An investor may only contribute in the aggregate in any 12-month period (i) the greater of $2,000 or 5% of the investor’s annual income or net worth if the investor’s annual income or net worth is less than $100,000 or (ii) 10% of the investor’s annual income or net worth if the investor’s annual income or net worth is equal to or greater than $100,000 (not to exceed a maximum aggregate cap of $100,000);
- The capital raise must be conducted through a broker or “funding portal”;
- A “funding portal” means any person acting as an intermediary in a crowdfunding transaction, but that does not (i) offer investment advice or recommendations; (ii) solicit purchases, sales or offers to buy securities offered or displayed on its website or portal; (iii) compensate employees, agents or other persons for solicitation or based on the sale of securities displayed or referenced on its website or portal; or (iv) hold, manage, possess or otherwise handle investor funds;
- Funding portals will be required to register with the SEC and any applicable self-regulatory organization; and
- Issuers relying on the crowdfunding exemption may not advertise the offering except through notices directing potential investors to the funding portal.
Investors would generally not be able to sell securities acquired in a crowdfunding offering for up to one year. Issuers who use crowdfunding will be expressly liable in a private cause of action by an investor for material misstatements and omissions in the offering. Additionally, companies would need to file with the SEC and provide to investors annual reports including their results of operations and financial statements.
Raising the Cap for Small Company Offerings Without Registration (Title IV of the JOBS Act)
Pursuant to Regulation A under the Securities Act, certain non-reporting companies currently may raise up to $5 million per year without filing a registration statement with the SEC. The JOBS Act requires the SEC to amend Regulation A, or adopt a new regulation, to increase this threshold to $50 million per year (subject to potential biennial increase thereafter by the SEC), but would additionally require issuers using this exemption to provide further disclosure to participating investors. Under the modified Regulation A exemption:
- Issuers will be able to offer and sell up to $50 million of equity, debt or convertible debt securities in any 12-month period without registration under the federal securities laws;
- Issuers will be able to offer and sell the securities publicly;
- The securities sold in the offering will not be “restricted” securities, meaning that they will be freely tradeable;
- The civil liability provision in Section 12(a)(2) of the Securities Act will apply, under which issuers may be liable to investors for false or misleading statements or omissions in prospectuses or oral communications involved in the offer or sale of securities;
- The SEC may require issuers to file with the SEC and distribute to prospective investors an offering statement including financial statements and a description of operations, financial condition, corporate governance principles and intended use of investor funds;
- Issuers will be required to file audited financial statements with the SEC annually; and
- Issuers may be required by the SEC to file periodic reports containing specified disclosures.
Modified Regulation A offerings will be subject to state “Blue Sky” laws unless the securities are offered or sold on a national securities exchange or to certain qualified purchasers. However, the JOBS Act also requires the Comptroller General to conduct a study on the impact of “Blue Sky” laws on offerings made under Regulation A. It is possible this study may have the ultimate effect of causing the SEC to exempt Regulation A offerings from the Blue Sky laws, as these laws currently impose heavy restrictions and significant costs on Regulation A offerings.
The Regulation A exemption has not been widely used in the past primarily due to SEC review of these offerings and the burdens and costs of “Blue Sky” compliance. Companies will need to await the outcome of SEC rulemaking and the Comptroller General’s study to determine whether they may avail themselves of this exemption and whether the potential benefits to be derived outweigh the disclosure requirements and costs of compliance. Alternatively, companies may wish to continue to conduct exempt offerings under Regulation D under the Securities Act.
Eased Registration Thresholds (Title V of the JOBS Act)
The JOBS Act raises the threshold for mandatory registration under the Exchange Act whereby companies become obligated to file periodic and current reports with the SEC, such as Forms 10-K and 10-Q. Existing rules require a company to register under the Exchange Act when it has assets of $10 million and 500 shareholders of record. The JOBS Act raises the threshold to either 2,000 shareholders of record or 500 shareholders of record who are not accredited investors. In addition, employees of the issuer who receive securities pursuant to an employee compensation plan will not count towards the shareholder threshold. The JOBS Act also directs the SEC to issue a rule exempting crowdfunding investors from the above calculation.
Although the various provisions of the JOBS Act are only loosely related, they all have the common purpose of attempting to lower the hurdles faced by public and private companies seeking to access the capital markets. The JOBS Act, therefore, may be welcome relief for both startups and growing companies who are deterred by the high regulatory costs and restrictions imposed by the securities laws when raising capital or maintaining their public company status in the first years of operation. We intend to update this client alert as the SEC issues further substantive guidance and regulations related to the JOBS Act.
For more information regarding the JOBS Act and its application to your company or capital-raising activities, please contact the Olshan attorney with whom you regularly work or one of the attorneys listed below.
 “Accredited investors” include (i) a corporation or partnership with assets exceeding $5 million, (ii) a natural person having a net worth, or joint net worth with that person’s spouse, that exceeds $1 million (excluding the value of such individual’s primary residence), and (iii) a natural person with income exceeding $200,000 in each of the two most recent years or joint income with that person’s spouse exceeding $300,000 in each of those years (and having a reasonable expectation of reaching the same income level in the current year).