The JOBS Act IPO On-Ramp

New IPO On-Ramp provisions provide emerging growth companies with opportunities to go public sooner

August 2012

The public equity markets have long been viewed by companies as the “holy grail” of capital formation. Once a company goes public, it can sell additional shares to the public to raise capital when needed, and can use its shares as currency to make acquisitions. However, since the late 1990s, the public equity markets have been an option for fewer and fewer companies. The number of publicly traded companies listed on exchanges in the United States has fallen from 8,823 in 1997 to under 5,000 at the end of 2011, according to the World Federation of Exchanges. In addition, the number of companies going public through an underwritten initial public offering (an “IPO”) has fallen dramatically, from a high of almost 1,300 during 1996 and 1997 combined to fewer than 200 during 2010 and 2011.

In March of 2011, the Treasury Department formed a group of industry and business leaders focused on emerging growth companies to investigate the drop off in public companies and IPOs, and to explore the link between going public and job creation and retention. Among its findings, the “IPO Task Force” determined that since 2007, the average company going public had been in existence approximately 9.5 years, more than double the historic average of 4.8 years from inception to IPO. The IPO Task Force also determined that among companies that had gone public, 92% of the job growth within those companies had taken place after the IPO, and that since the mid-1990s, emerging companies were far more likely to seek an exit through a merger or acquisition transaction, resulting in a loss of jobs as acquisition targets were consolidated into larger companies making the acquisitions.

The IPO Task Force identified several causes of the slowdown in IPOs. In particular, they focused on the increased regulatory burden (much of which grew out of the requirements imposed by Sarbanes-Oxley) that greatly increased the cost of both going public and staying public, the shift in investment banking business models that favored low-cost, high-volume trading over “buy and hold” investing, and an IPO process that deprived smaller investors of both information and access to an issuer’s securities at an IPO.

IPO-On Ramp Provisions for the Emerging Growth Company

The IPO Task Force made several recommendations, many of which were incorporated into the “IPO On-Ramp” provisions of the JOBS Act signed into law earlier this year. These provisions will make it easier for emerging companies to go public, and to stay public once they have completed an IPO, with an eye towards stimulating job creation. These provisions are effective immediately, and are not subject to SEC rulemaking.

The legislation creates a new class of companies referred to as “emerging growth companies.” An emerging growth company is any company that had total annual gross revenue of less than $1 billion in its most recent fiscal year. A company is no longer an emerging growth company on the earlier of: (1) the fifth anniversary of its IPO; (2) its total annual gross revenue reaches $1 billion or more; (3) its public float is $700 million or more; or (4) it issues more than $1 billion in non-convertible debt in the previous three years. Any company that sold securities in a registered public offering prior to December 8, 2011 is excluded from the definition of emerging growth company. Foreign issuers are eligible to be treated as emerging growth companies.

The changes to the current regulatory regime surrounding IPOs should make it easier for emerging growth companies to go (and stay) public, including by:

Allowing confidential review by SEC staff of draft registration statements prior to making the registration statement public. Previously, a company considering an IPO may have decided against it due to the fact that it would have to file a publicly available registration statement that included confidential information about the company. Under the new rules, an emerging growth company can submit a draft registration statement for nonpublic review by the SEC, which will allow the company to determine if there are significant problems with the registration statement and to work with the SEC on a confidential basis to resolve those problems. If the company then decides to go forward with its IPO, it will have to file the initial confidential submission for the public to see at some point before it sells securities in its IPO.
Allowing underwriters in IPOs to prepare research reports before and following the offering. Previously, the company and its underwriters had to observe a “quiet period,” where no information could be disseminated about the company. Now, investment bankers (including those investment bankers involved in the IPO) may provide investors with research reports before the prospectus, and such research will not constitute an “offer” that could result in liability. In addition, some of the intra-company firewalls between the research and investment banking arms of underwriters have been removed, allowing more communication between management, its underwriters, and analysts.
Permitting a company considering an IPO to “test the waters” with certain types of investors. Where such communications previously were treated as “gun-jumping,” a company contemplating an IPO (or its representatives) can now, before or after filing a registration statement, engage in communications with potential investors that meet the definition of a Qualified Institutional Buyer under Rule 144A, to determine if they would be interested in the securities offering.
Reducing required financial disclosures and reporting requirements. The cost (in both dollars and time) of preparing the financial statements required for an IPO have shown to be a significant deterrent to companies going public. The new legislation reduces these burdens, and provides for reduced requirements for up to five years after the IPO. Some of these disclosure changes include:
- Reducing the selected financial data required under Item 301 of Regulation S-K to two years (from five years), reducing the audited financial statements (income statements) required to two years (from three years), and limiting the required management discussion and analysis of financial condition and results of operations only to those years for which audited financial information is provided (where previously prior years had to be discussed).
- Delaying compliance with the auditor attestation provisions required by Section 404 (b) of Sarbanes-Oxley (management’s assessment of internal controls) for as long as the company is deemed an emerging growth company, even after going public.
- Giving emerging growth companies the ability to “opt out” of compliance with new accounting principles adopted by the PCAOB, if the new principles are not applicable to non-reporting companies.
- Exempting emerging growth companies from the current requirements of a shareholder advisory votes on compensation (Say-on-Pay) and termination obligations (Say-on-Golden Parachutes). In addition, emerging growth companies do not have to provide a separate compensation discussion and analysis and can omit information for certain officers.

What It Means for Quality Companies

Many of the new provisions flow directly from the recommendations of the IPO Task Force, and are aimed at providing smaller companies better access to capital in order to spur job creation. There are some commentators and legislators that have been critical of these provisions of the JOBS Act, claiming that loosening of the current regulatory schemes will lessen the protections currently provided to investors. It is likely that as companies start to take advantage of the IPO On-Ramp provisions, some changes will need to be made to tweak the new requirements to fit what is happening in the marketplace. The bottom line, however, is that the new IPO On-Ramp provisions will provide quality companies that want to go public with a real opportunity to do so in an efficient and cost-effective manner, something that hasn’t been available for some time.

For additional information on this topic, please do not hesitate to contact Mark J. Tarallo or any other member of the Public Company practice group.

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