The IPO On-Ramp, unlike most other provisions, of the Jumpstart Our Business Startups Act ("JOBS Act") did not require rulemaking by the Securities and Exchange Commission ("SEC") to become effective. That said, the SEC has put out answers to FAQs and may issue other guidance or rules in the future, so further developments should be monitored.
In rating the success of different provisions of the Act, the IPO On-Ramp would rank high on everyone's list. It has been widely used and easy to use. Almost every technology- or life science-based company that files for an IPO starts the process using a confidential filing under the IPO On-Ramp.
The IPO On-Ramp is available only to an "Emerging Growth Company," defined as a securities issuer that:
- Had less than $1 billion in annual gross revenue during its immediately preceding fiscal year (to be adjusted for inflation every five years);
- Either has not yet made a registered sale of common equity securities, or has only done so in the last five years;
- Has not issued more than $1 billion in non-convertible debt securities in the preceding three years; and,
- Is not a "large accelerated filer" under the Securities Exchange Act of 1934 ("Exchange Act"). Generally, a company becomes a large accelerated filer when its common equity held by non-affiliates reaches $700 million.
Unfortunately, companies that made registered offerings of their common equity securities before December 8, 2011 are excluded from this definition and, therefore, are ineligible for JOBS Act "Emerging Growth Company" relief and cannot use the IPO On-Ramp.
A company will cease to be an Emerging Growth Company upon the first to occur of: (i) the fiscal year after it ceases to satisfy the criteria listed above, or (ii) the sixth fiscal year after it registers a common equity offering even though its annual revenue remains under $1 billion and it does not become a large accelerated filer.
Under the JOBS Act, Emerging Growth Companies receive the following special benefits for their IPOs under the Securities Act of 1933 ("Securities Act"):
- They are allowed to "test the waters" for interest in their IPO from high net worth investors who are "Qualified Institutional Buyers" or "Accredited Investors" so they can try to ascertain a level of interest before incurring the expense of registration.
- They are allowed to receive a "confidential nonpublic review" from the SEC of their draft registration statements, rather than having to make the drafts available to the public in an electronic filing. This change preserves a company's confidentiality while the review is ongoing, and presumably allows the draft statement to never be made public if the company decides to cancel the offering. But the initial drafts submitted will have to be publicly filed 21 days before a "road show" if the offering goes forward.
- Prohibitions on "sell-side research" are eased. Regulators may not impose "quiet periods" and other restrictions on communications by research analysts associated with firms participating in the offering. Note, however, that there are a number of research analyst rules that will not be affected, and concerns about liability under Rule 10b-5 will remain, so these changes probably will not have a significant effect on offerings.
Emerging Growth Companies will also receive the following assistance with their reporting and compliance burdens under the Exchange Act:
- Some relief on audited financial statement and "management discussion and analysis" requirements for years prior to registration;
- Exemption from the requirement that auditors attest to the company's internal controls report. This exemption can result in significant cost savings;
- Exemption from any requirements of audit firm rotation that might be issued by the Public Company Accounting Oversight Board ("PCAOB") –– which at present are not threatened, but were proposed at the time the JOBS Act was passed;
- Exemption from any future PCAOB audit principles unless the SEC determines that the rules must apply in the public interest. Note, however, that companies must opt-in or opt-out on an all-or-none basis; they cannot pick and choose among different accounting standards;
- Exemption from "Say-On-Pay" and "Say-On-Golden-Parachute" requirements; and,
- With regard to executive compensation disclosure:
- Exemption from proposed Dodd-Frank Rules on disclosure of CEO pay relative to median pay for company employees; and,
- Permission to meet less onerous "smaller reporting company" requirements for general executive compensation disclosures which include:
- Omitting the "compensation discussion and analysis" requirements;
- Presenting data for fewer executive officers; and,
- Omitting some of the required tables.
Although few observers would attribute the recent comeback in the IPO market to the JOBS Act, the IPO On-Ramp has had a significant positive impact on start-up offerings. Confidential submissions have permitted Emerging Growth Companies to begin the arduous process of seeking SEC approval of offering documents without public disclosure of sensitive information. The ability to terminate the review without public disclosure has removed a huge downside to commencing the IPO process.
Competitors often use the information in the registration statement against young companies that file for IPOs. If a company becomes a public company, that information is fair game. But if an IPO dies and the company remains a private company, the damage is done and money has not been raised to offset this loss.
Consider some examples of the type of information that can harm a business by becoming public. The world might suspect that a business has more current liabilities than current assets, or that it has a balloon payment on a loan that is due in two months, or that its patent claims have limited scope, or that a competitor has a controlling interest, but these are only suspicions until a registration statement confirms any one of them. Likewise, the Vice President of Technology Development may well not know how much top officers are compensated or that the Vice President of Finance owns more stock options than the Vice President of Technology Development until the latter reads it in a registration statement. Unnecessary disclosure could well affect the Vice President of Technology Development's morale or result in the Vice President jumping ship to the detriment of the potential issuer.
The ability to "test the waters" also has had some positive effects for some offerings, although securities lawyers are still working out "best practices" for protecting Emerging Growth Companies that do so.
Both the ability to test the waters and the ability to have filed information remain confidential enable businesses and their investors to better control the timing of the IPO process and the effect on the company. Management knows how long the offering is likely to take if it both is talking to investors and is in receipt of SEC staff comments. Knowing that there is no big accounting issue to deal with allows a company to predict with greater accuracy when its registration statement is likely to become effective.
If the IPO filing is withdrawn, the company has not damaged its reputation with a big public failure. Of course, it's difficult to keep a filing entirely secret. Too many people know. Rumors often fly around industries and Wall Street. But rumors are different than Page One publicity.
Emerging Growth Companies have the choice to take advantage of all, some, or none of the JOBS Act's securities reporting exemptions (except that they must "opt in" to greater accounting requirements on an all-or-nothing basis). We expect many, if not most, Emerging Growth Companies to use the exemptions from shareholder advisory votes on compensation and the opportunity to scale back burdensome executive compensation disclosures. Most will probably choose to extend the compliance date for auditor attestation, and many will take advantage of reduced financial reporting requirements.
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