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How Title I of the JOBS Act Significantly Changed the IPO Playbook

October 20, 2014 by Lonnie_Finkel

Title I of the JOBS ActHistorically, federal securities laws have imposed significant – some would say onerous – disclosure and reporting requirements on companies seeking to raise money in the public equities markets. Testing the market was, for the most part, unlawful for fear of conditioning the market of prospective investors to your offering. Comments from the staff of the Securities and Exchange Commission (“SEC”) on your offering documents seemed never ending. Once your stock traded publicly, quarterly reporting requirements consumed untold resources in exchange for little if any benefit to your company or the investing public. If you’re at the helm of a growth-oriented company, pursuing an initial public offering (“IPO”) is now a little more within reach, thanks to the Jumpstart Our Business Startups (“JOBS”) Act of 2012.

Two years ago, the JOBS Act became law. Title I of the JOBS Act significantly changed the IPO playbook, creating a new category of issuer called an emerging growth company (“EGC”) and rewriting the rules for EGC IPOs. An EGC is a company with annual revenue of less than one billion for its most recently completed fiscal year. In the past two years, companies with less than $250 million in annual revenue accounted for about 85 percent of priced EGC IPOs. During the second year of the Act, foreign private issuers represented almost 15 percent of priced EGC IPOs, compared to 10 percent during the first full year of the Act.

What is so special about Title I? If you are running an EGC, it gives you a menu of options and allows you to choose all, some, or none of the market entry accommodations afforded to EGCs as your company becomes public. After two years of experience, we find that EGCs continue to use these accommodations to varying degrees.

Testing the Waters. Before or after filing a registration statement, you and your bankers may meet with qualified institutional buyers (“QIB”) and other institutional accredited investors to gauge their interest in your offering. This testing-the-waters provision significantly modifies the communications restrictions under Section 5 of the Securities Act, and authorizes a new way to approach the market. Testing the waters is occurring more frequently and is especially popular in certain industries such as life sciences and technology, where issuers tend to have shorter operating histories and often need to communicate highly scientific or technical information to potential investors.

Confidential SEC Review. As an EGC, you may initiate the SEC registration process confidentially by submitting a draft registration statement for nonpublic review by the SEC. Confidential filing allows you and your management team to gain useful feedback from prospective investors while maintaining confidentiality as you await clearance from industry regulators and market conditions favorable to your offering. The SEC’s review of a confidential submission should not take any longer than a review of a publicly filed registration statement. Expect your first set of comments within 30 days of submission. Approximately 90 percent of EGCs that priced an IPO in year two began the process with a confidential submission. This is a significant increase in the percentage of EGCs that submitted confidentially as compared to year one.

Phased-In Financial Disclosure. As an EGC, you may go public using two years, rather than three years, of audited financial statements and as few as two years, rather than five years, of selected financial data. After the IPO, your company must phase into full compliance by adding one additional year of financial statements in each future year until you present the traditional three years of audited financial statements plus two additional years of unaudited selected financial data.

Internal Controls Audit. EGCs are temporarily exempt from the internal controls audit required by Section 404(b) of the Sarbanes-Oxley Act of 2002. As in year one, nearly all EGCs that priced an IPO in year two indicated an intention to use the JOBS Act’s extended phase-in for compliance with Section 404(b) of Sarbanes-Oxley or reserved the right to do so in the future. Consistent with year one, approximately 25 percent of EGCs that priced an IPO in year two disclosed a significant deficiency or material weakness in internal control over financial reporting. None of these issuers indicated an intention to comply with Section 404(b) of Sarbanes-Oxley sooner than required.

Executive Compensation Disclosure. As an EGC, you may use streamlined executive compensation disclosures, and are exempt from the shareholder advisory votes on executive compensation required by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. Eighty-five percent of EGCs that priced an IPO in the second year of the Act took advantage of this accommodation, generally by dispensing with compensation discussion and analysis in their filings.

Extended Phase-In for New GAAP. EGCs may use private-company phase-in periods for new accounting standards. Seventy-seven percent of EGCs that priced an IPO in the second year of the Act irrevocably opted out of the accommodation for the extended phase-in for new accounting standards and elected from day one to follow the public company phase-in periods for new or revised accounting standards. This is consistent with the trend in year one.

Exemption from PCAOB Rules. Your company would be exempt from any Public Company Accounting Oversight Board rules that, if adopted, would mandate auditor rotation or auditor discussion and analysis.

Over the past two years, the standard IPO playbook has changed to include confidential submission, phased-in financial disclosure, extended relief from Section 404(b) of Sarbanes-Oxley, and streamlined executive compensation disclosure. Market practices surrounding testing the waters have also emerged, and deal teams almost always consider whether to test the waters. The extended phase-in for new accounting standards has not gained much favor with EGCs. In sum, the trends identified after the first year of the Act have continued or increased as EGCs and other market participants have adopted a new IPO playbook.

Finkel Law Group, with offices in San Francisco and Walnut Creek, has a thriving securities and corporate finance practice that over the last 18 years has helped hundreds of privately held companies raise capital in the private equity and debt markets. We know our way around federal and state securities laws, and are adept at explaining in plain English what those requirements mean to you. When you need intelligent, insightful, conscientious and cost-effective legal counsel to assist you with a securities or corporate finance transaction, please contact us at (415) 252-9600, or info@finkellawgroup.com to speak with one of our attorneys about your deal

Filed Under: Business & Financing Tagged With: emerging growth companies, financing, raise capital, regulation

   
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