Since last year, 2012 has been heralded as something of a comeback year for IPOs, with financial news outlet 24/7 Wall St. estimating that more than 200 companies are poised to go public this year (including a little startup called Facebook). A recent bill will make that process easier for those companies. President Obama signed the Jumpstart Our Business Startups (JOBS) Act into law April 5, commenting in a statement that “America’s high-growth entrepreneurs and small businesses play a vital role in creating jobs and growing the economy,” and that the act would help them raise capital, create jobs and strengthen the economy.
That’s a tall order. But in aiming to shore up the U.S. IPO market, the JOBS Act brings major change, creating a new category of issuer—the emerging-growth company, which it defines as having less than $1 billion in annual revenues—and creating a streamlined route to IPOs with fewer regulatory burdens along the way. And experts say some of its numerous provisions could become critical tools for companies in a broad range of positions.
“The provisions of the act touch on various points in the growth cycle,” says Matthew Kaplan, a partner at Debevoise & Plimpton, “from startup through maturing private company, and accessing the public capital markets, in terms of emerging growth companies taking advantage of IPO exemptions and transition periods and potential public companies that are looking to raise capital in private markets.”
The JOBS Act increases the number of shareholders a private company can have before it is required to comply with public company requirements to 2,000 from 500, and it excludes holders of employee equity compensation from that count.
“Private companies will be able to grant equity more deeply into the ranks of their employees. That may change compensation practices in private companies and the extent to which the employee base is actually a shareholding base,” Kaplan says.
Another threshold the act raises is the amount of securities and guarantees a private company can offer during a 12-month period, with the limit rising to $50 million from $5 million.
“They’ve provided an avenue for smaller things that otherwise would have potentially gone through the full-bore registration process,” says Jeff Dodd, a partner at Andrews Kurth. “That could be very attractive for small emerging companies doing the smaller offerings.”
For private companies eyeing an IPO, the exemptions in the JOBS Act from various parts of the Securities Exchange Act of 1933 are fairly significant and far-reaching. For instance, a “test the waters” provision permits companies to engage in prefiling marketing activities to gauge investor interest and to determine whether their valuation meets expectations, and experts say it could be a critical change.
“The ability to go out and, without violating gun-jumping rules, contact qualified institutional investors and institutional accredited investors to see whether there’s interest in an IPO is very, very important,” Dodd says, “especially now that IPOs take a long time.”
The JOBS Act also makes several changes to rules surrounding the IPO process. For instance, at the time of its IPO, a company now will have to submit two instead of the previous three years of audited financial statements, phasing into the three-year requirement after the IPO. Companies will have the ability to confidentially submit a draft registration statement to the SEC for nonpublic review. And research analysts have an expanded safe harbor to cover emerging growth companies earlier as well as during the IPO process.
The JOBS Act creates an “IPO on-ramp” for emerging-growth companies, exempting them from a number of regulatory requirements and giving them a one- to five-year post-IPO transition period to phase in compliance with rules including the often-challenging Sarbanes-Oxley Act Section 404(b) internal controls audit requirement and Dodd-Frank Act executive compensation rules. Scaling in say-on-pay regulations could be important, Dodd says, because it’s something many companies have struggled with.
But he expects that companies will likely still face pressure from underwriters and analysts to release as much financial data as their competitors, so the impact of lessening the financial statement-related burdens may not have as much impact as people believe.
Kaplan agrees. “One question is to what extent will emerging-growth companies and those that participate in their IPO process be comfortable with reduced financial statement or other disclosure in reliance upon the act’s provisions?” he says. “After all, antifraud provisions apply not just to material misstatements, but also to material omissions in offering documents.”
Many critics of the JOBS Act think its relaxed requirements and the opacity that several of its provisions creates will invite abuse. Among them is University of Missouri-Kansas City law professor Bill Black, former executive director of the Institute for Fraud Prevention. He says less disclosure in equities will create an ideal environment for pump-and-dump fraud schemes, the most common type of financial fraud, and that fraud will kill jobs and cost honest equity issuers.
“In the last crisis we had an opaque credit sector, and now this is going to make the equity sector much more opaque and create, again, more of a shadow financial system, this time equities as opposed to debt,” Black says. “The people who understand and work against fraud are opposed to this bill. It’s an atrocity.”
On April 11, the SEC announced it would begin accepting comments prior to starting the JOBS Act rulemaking process, which promises to be a lengthy task for the agency as it continues to interpret Dodd-Frank requirements.
Dodd says that the SEC’s approach to some of the rules will be greatly important. For instance, one provision would allow, with limitations, companies to raise capital through crowdfunding, or limited investments from a large group of people through websites such as Kickstarter. It’s one of the provisions of the JOBS Act that has people the most excited, Dodd says, but depending on how the SEC interprets it, it could end up having less of an impact than many expect. (Congress already reeled in crowdfunding provisions that were originally in the bill, requiring crowdfunding to flow through either a registered broker or fund portal and therefore eliminating some of the “Wild West” elements of the original provision.)
It’s yet to be seen whether the JOBS Act will indeed lead to more IPOs. There’s a possibility that with more flexibility to do so, companies may choose to remain private longer so they are more mature when they do go public or may never make it to an IPO because they have sufficient access to private capital. But it’s clear Congress’ intent was to create a streamlined path to the public market.
“The message is clear to the SEC as well as to practitioners,” Dodd says. “Congress is really opening up the ability for emerging companies to test the waters to see whether they can do an IPO, to get confidential reviews before they go out on road shows and to have somewhat less of a regulatory burden on them. So this is a significant act. In terms of raising capital for emerging companies, this is one of the more important acts I’ve ever seen.”