As the impact of the JOBS Act begins to sink in, several issues have begun to emerge relating to Title I - Reopening American Capital Markets to Emerging Growth Companies, commonly referred to as the "IPO On-Ramp." Title I is designed to streamline the IPO process and simplify, for up to five years, the Securities Exchange Act reporting requirements for so-called "Emerging Growth Companies." In this alert, we detail some of the rising issues associated with the IPO On-Ramp and how issuers and investment bankers may approach these issues in the future.
Emerging Growth Companies
Title I is applicable only to the newly-created class of issuers called emerging growth companies. An emerging growth company ("EGC") is a company which has total gross revenues of less than $1 billion for the last completed fiscal year and would not qualify as a "large accelerated filer," as defined by Securities and Exchange Commission ("SEC") rules. Furthermore, an EGC cannot have sold common equity securities pursuant to an effective registration statement before December 9, 2011 and must not have issued $1 billion or more of non-convertible debt during the previous three years. An issuer can remain an EGC for up to approximately five years following the issuer's IPO.
The JOBS Act does not expressly define "total gross revenues" and this is not a generally accepted accounting procedures ("GAAP") financial measure. However, since enactment of the JOBS Act, SEC representatives have indicated they will use the GAAP term "total revenues." In addition, the SEC has indicated informally that the $1 billion debt ceiling will be determined based on the amount of debt the registrant has "issued" regardless of the amount of debt currently outstanding. This interpretation is based on the plain language of the JOBS Act. Accordingly, if a company has issued, either in public or private offerings, $1 billion in debt over an extended period, that company would not be entitled to EGC status.
Changes for IPOs and other registered offerings
The JOBS Act significantly changes the IPO process for EGCs, and also effects other changes to non-IPO registered offerings:
Although most, if not all, EGCs undoubtedly will use the provisions of the JOBS Act related to executive compensation disclosure, it remains to be seen how the changes to the offering process will be implemented.
For example, underwriters of EGC securities must decide if or to what extent they wish to use the JOBS Act's test-the-waters provisions. Care should be taken to ensure any materials used in connection with these communications are subject to full due diligence procedures and to indemnification by the issuer.
Underwriters will also have to decide whether issuers should take advantage of the provisions requiring only two years of audited financial statements in registration statements and the relief from §404(b). Certain institutional investors may be prohibited by internal policies from investing in companies that take advantage of these provisions. Furthermore, representatives from the SEC have indicated they may seek additional disclosure in registration statements if the third year of audited financial statements includes unfavorable information about the issuer. Institutional investors may also have strong views about the ability of EGCs to elect to comply with new accounting rules in accordance with the same timetable applicable to private companies.
We anticipate that the securities industry will eventually develop informal market standards that address most, if not all, of these issues. Until these develop, we recommend that both issuers and underwriters proceed with caution before taking advantage of these provisions.
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