Foster Swift Business & Corporate Law Report
May 2, 2012
On April 5, 2012, President Obama signed into law the "Jump Start Our Business Startups Act," commonly known as the JOBS Act. This Act has five key parts intended to improve access to capital for small businesses. A brief description of each part follows.
1) The "On Ramp"
Title I, commonly called the "On-Ramp," is intended to facilitate access to the public trading markets for emerging growth companies. Generally, "emerging growth company" refers to a company that has annual revenues of less than $1 billion. An emerging growth company is subject to reduced governance and financial requirements for a period of five years after going public, with limited exceptions. This provision applies to companies that do their first public offering after December 8, 2011. Examples of the special rules for emerging growth companies include:
- Exemption from the requirement that public companies hold a periodic, non-binding shareholder vote on executive compensation arrangements.
- Exemption from certain executive compensation disclosure requirements.
- Modified financial reporting requirements.
- Exemption from auditor certification regarding internal controls.
- Opportunity to pre-file non-public registration statements with the Securities and Exchange Commission (SEC).
- "Test the waters" communications permitted with qualified institutional buyers or institutions that are accredited investors before filing a registration statement.
2) General Solicitation of Accredited Investors and Qualified Institutional Buyers
Within 90 days after enactment of the JOBS Act, the SEC is required to amend Rule 506 of Regulation D to permit general advertising or general solicitation in offerings in which all investors are accredited investors. The catch is that the rule is required to specify the steps the issuer must take to verify that each purchaser is accredited. This is a significant deviation from past practice under Regulation D, where the issuer is allowed to rely upon a mere representation from an investor as to accredited investor status. It will be interesting to see the verification steps the SEC decides to require, particularly given the tight timeframe. The SEC is required to implement a similar rule change under Rule 144A with respect to qualified institutional buyers.
For the first time ever, Congress has added an exemption from registration for small offerings tailor-made for general solicitation through a web based platform. The Act as passed requires as a condition for the exemption, that the solicitation be made by means of a platform provided by an intermediary registered with the SEC. Unfortunately, in our opinion, the burdens placed on the intermediaries are so significant that there is a good chance the market will not develop viable intermediary providers. Certain members of the House of Representatives think the burdens added to the crowdfunding title by the Senate are ill-conceived. These House members will attempt to amend this part of the JOBS Act. In any event, the crowdfunding concept will have to await SEC rulemaking, so that realistically, in our estimation, we are about a year away from seeing any real world capital raising opportunities created by this legislation. For a more thorough discussion of the crowdfunding title of the JOBS Act, please see the article posted on our Biz Tech Law Blog at www.michiganitlaw.com.
4) Regulation A
For decades, Regulation A has been an infrequently used exemption that applies to offerings that do not exceed $5 million. Although technically an exemption and not a registration, a registration-like filing with the SEC is required, making a Regulation A exemption uneconomical in most cases for offerings of such a small size, because legal and other expenses eat up too high a percentage of the capital raised. The JOBS Act increases the Regulation A maximum offering size to $50,000,000. Public solicitation will be permitted and the number of investors is not limited (so long as the number of investors does not trigger the public company reporting requirements). With this increase in permitted offering size, it is possible that Regulation A will become more attractive to issuers who are interested in raising capital without becoming a full fledged public company. State registration laws will be preempted for Regulation A offerings. Like many other provisions of the JOBS Act, the SEC needs to amend applicable regulations for this provision to be available.
5) Increase in Maximum Number of Shareholders Before Registering as a Public Company
Under the pre-JOBS Act law, since 1964, companies that had $10 million in assets and 500 or more shareholders were required to register with the SEC to become publicly reporting companies whether or not they raised capital through an IPO. The JOBS Act significantly increases this threshold to become a reporting company. Now, a company that has 2,000 or more shareholders, or 500 or more shareholders who are not accredited investors, is required to begin filing public reports. Shareholders who received their shares pursuant to an employee compensation plan in a transaction that was exempt from registration are not included in the shareholder count. Similarly, depending on the crowdfunding rules ultimately issued by the SEC, shareholders who receive their shares pursuant to a crowdfunding offering might not count towards the cap for private companies.
In short, Congress has taken some major steps in seeking to reduce the regulatory burdens for small companies in raising capital. Whether or not these steps will have much impact will depend on the SEC's rulemaking process and market acceptance of the new structures put in place. Please contact Iris Linder (517-371-8127 or by email) or any other Foster Swift attorney for more information.