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Laws don’t often get their own parties. But for the irresistibly named Jumpstart Our Business Startups (JOBS) Act, President Obama held a rare public ceremony in the White House’s Rose Garden in its honor. Even more notably, this party was quite bipartisan—Republican House Majority Leader Eric Cantor stood right next to Obama as he signed the legislation. Since that day in April 2012, the most common criticism about the JOBS Act has been that it doesn’t really exist yet. Many provisions, such as the more controversial element of the act allowing companies to raise financing through public “crowdfunding,” are still undefined by the SEC. Other sections remain untested.
Now, almost a year after it was signed into law, the JOBS Act has, at least temporarily, quieted many of its critics. That’s because its primary goal of giving some companies an easier path to completing an initial public offering (IPO) seems to be gaining traction.
How so? First of all, the JOBS Act provisions are popular. Two-thirds of the U.S. exchange-traded IPOs in 2012 were by companies taking advantage of a new category of equity issuer established by the act: the “emerging growth company” (EGC). This designation provides options for lighter regulation such as exemptions from certain provisions of the Sarbanes-Oxley Act.
Second, in a year that was considered a poor one for public offerings, marred by looming fiscal cliffs (the only kind) and overhyped social media IPOs (the only kind), shares of companies that went public under the JOBS Act outperformed those of companies that took the more conventional route. That has prompted growing optimism that 2013 may be a turnaround year for IPOs and new business growth.
No matter how the year unfolds, one thing is certain. As outgoing SEC Chair Elisse Walter acknowledged recently, the JOBS Act signals a “seismic shift in the way companies, particularly small and emerging ones, raise capital and how individual investors participate in that process.”
If the earthquake metaphor isn’t telling enough, perhaps a nautical one will convey the act’s potential impact in terms of encouraging investment: “a rising tide lifts all boats.” Business leaders and legal professionals typically regard taxes and regulation as some of the biggest impediments to starting and expanding companies—tying them down. Sarbanes-Oxley, for example, sank some companies’ plans for going public—a step that often precedes an upswell in hiring. At the same time, conducting an IPO has always been an expensive and complicated process that prevents many companies from even considering the option. In a tough economic climate, the JOBS Act throws a lifeline to many small and mid-sized businesses seeking to raise capital.
So what exactly is this new breed as defined by the JOBS Act? It will be helpful to understand exactly what qualifies as an emerging growth company and how the legislation that defines it is intended to create an “IPO on-ramp” for such entity.
An EGC is a company with less than $1 billion in revenues for its most recently completed fiscal year. That deliberately covers a wide swath of businesses, and those businesses can now talk to the market in a variety of new ways. For example, EGCs can engage in oral and written communications with potential investors and the SEC. In effect, an EGC has a unique opportunity to “test the waters” to assess interest in, and the potential success of, an IPO.
Plus, to make an IPO even more attractive (and to reduce the costs typically associated with going public), the act creates a transition period of up to five years during which a company does not have to comply with certain ongoing disclosure and compliance requirements. For example, an EGC is exempted from the requirement under Sarbanes-Oxley to have an independent auditor attest to the company’s assessment of its internal controls and procedures. There are also reduced disclosure rules regarding executive compensation and relief from complying with financial accounting standards that are not generally applicable to private companies.
That just leaves one question: why wouldn’t a company considering an IPO do so as an EGC? The advantages seem self-evident, and the disadvantages almost non-existent. So far, the exceptions would appear to be when a company is competing with others with non-EGC status and the disclosure exemptions might actually put the company at a disadvantage, or when there is a clear indication from the market that a company should not take the approach.
Either way, the game has definitely changed. The jury is still out as to whether the JOBS Act will live up to its name, even if early indications look promising, and there are plenty of critics waiting to pounce with noisy “I told you so” pronouncements about the risks associated with so much reduced accountability.
Still, attorneys advising companies will at least want a rudimentary understanding of these fun new options available, so they can provide informed guidance and smart insight.
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