The JOBS Act
Emerging growth companies and overview of the IPO process for these companies
The Jumpstart Our Business Startups Act (the JOBS Act) has had the effect of increasing the number of companies electing to pursue an initial public offering (IPO) and to provide those companies a transition period or “on-ramp” to the public markets, allowing them to focus resources on growth of their businesses before having to expend resources toward complying with many of the regulations often cited as costly and burdensome for newly public companies. The so-called “IPO on- ramp” provisions, which are contained in Title I of the JOBS Act, reduce a number of existing financial disclosure, corporate governance, and other regulatory burdens on a new category of issuer, referred to as an “emerging growth company.” The JOBS Act was supplemented by the passage of the Fixing America’s Surface Transportation Act (FAST Act) in December 2015, which further streamlined the IPO process for emerging growth companies.
Qualifying as an emerging growth company (ECG)
Subject to certain exceptions, an emerging growth company (EGC) is defined as an issuer of securities that had gross revenues of less than $1 billion during its most recently completed fiscal year. An issuer would qualify as an EGC even if its gross revenues exceeded $1 billion in years prior to its most recent fiscal year. In some instances, companies that began (and had not yet completed) the IPO process as an emerging growth company would lose that status on the first day after achieving $1 billion in revenues. This required companies that were EGCs to add significant amounts of additional disclosure during the IPO process. With the passage of the FAST Act, these companies would not lose the benefit of EGC status during the IPO process as long as the IPO occurred within one year.
Gross revenues are measured with reference to total revenues as presented on the income statement presentation under U.S. Generally Accepted Accounting Principles (GAAP) or International Financial Reporting Standards (IFRS) as issued by the International Accounting Standards Board (IASB), if used as the basis of reporting by a foreign private issuer. If the financial statements of a foreign private issuer are presented in a currency other than U.S. dollars, total annual gross revenues for purposes of this test should be calculated in U.S. dollars using the exchange rate as of the last day of the most recently completed fiscal year. When calculating gross revenues, financial institutions may exclude gains and losses on dispositions of investment portfolio securities.
Length of transition period
An issuer that is an EGC as of the first day of that fiscal year will continue to maintain that status until the earliest of:
- the last day of the fiscal year in which it achieves $1 billion of gross revenues;
- the last day of the fiscal year that includes the fifth anniversary of its IPO;
- the date on which it has issued more than $1 billion in nonconvertible debt during any previous rolling three-year period (excluding issuances in A/B debt exchange offers); or
- the date on which it is deemed to be a “large accelerated filer” (which requires, among other things, having common equity held by nonaffiliates with a market value of $700 million or more).
Advantages of emerging growth company status
The IPO on-ramp provisions of the JOBS Act offer EGCs a number of advantages during the IPO process, including:
- confidential submission and review of IPO registration statements;
- reduced financial statement audit and disclosure requirements;
- reduced executive compensation disclosure requirements;
- the ability to engage in oral or written “test- the-waters” communications with certain types of potential investors to gauge interest before or after filing; and
- liberalizing the use of research reports and easing restrictions on analyst
The IPO on-ramp provisions of the JOBS Act also reduce the costs and burdens of being a public company for EGCs after completion of their IPOs by providing:
- an exemption from the public accounting firm attestation to issuer internal controls required by Section 404(b) of the Sarbanes-Oxley Act of 2002 (SOX);
- scaled-back financial and compensation disclosure requirements for future registration statements, periodic reports, and other reports to be filed with the Securities and Exchange Commission (SEC);
- exemptions from “say-on-pay” vote (and votes on the frequency of “say on pay” votes), certain other required shareholder actions, and certain proxy statement disclosures;
- exemptions from mandatory audit firm rotation and any auditor’s discussion and analysis requirements; and
- relief from the requirement to comply with any update issued by the Financial Accounting Standards Board (FASB) to its Accounting Standards Codification until the date that a company that is a private company is required to comply with such new or revised accounting standard if such standard does not apply to private companies.
In this regard, EGCs that are foreign private issuers and reconcile their home country GAAP financial statements to U.S. GAAP may also take advantage of the extended transition period for complying with updates issued by the FASB to its Accounting Standards Certification in their U.S. GAAP reconciliation.
EGCs have the option to confidentially submit to the SEC a draft registration statement for confidential, nonpublic review by the SEC prior to public filing. This allows an EGC to explore the possibility of an IPO without exposing any confidential information to its competitors or the market generally until 15 days (after the passage of the FAST Act) before the date on which it begins to conduct its roadshow, and without risking the embarrassment associated with pulling the IPO should the EGC do so.
The confidential submission process is only available for EGCs that have not already completed a public offering of common equity securities, including offerings under employee benefit plans or pursuant to a resale registration statement. EGCs that have completed public offerings of debt securities may use the confidential submission process. Foreign private issuers may also be eligible to submit their draft registration statements on a non-public basis under existing policies of the SEC’s Division of Corporation Finance; however, the benefits of this policy are not available to foreign private issuers that take advantage of any benefit available to EGCs.
EGCs may “scale back” financial and compensation disclosures in their IPO registration statements and subsequent filings under the Securities Exchange Act of 1934. In particular, IPO registration statements for EGCs may contain:
- two years of audited financial statements, including those of acquired businesses, rather than the standard three-year statement;
- with the FAST Act, this two-year period is based on the time of the effectiveness of the As a result, EGCs would not be required in initial submissions to the SEC to include audited financial statements for years that would not be required if the two-year period were determined from the effective date;
- selected financial information for the years including and after the earliest audited period presented (i.e., as little as two years of selected financial information), rather than the traditional five-year period;
- management’s discussion and analysis (MD&A) of the periods covered by the audited financial statements (i.e., as little as two years plus “stub” periods), rather than the required three-year period; and
- the streamlined and simplified compensation disclosures required of smaller reporting companies, meaning that that the registration statement need not include, among other things, a detailed compensation discussion and analysis section or tabular information for more than three executive officers and certain executive compensation
With respect to the scaled executive compensation disclosure requirements, ECGs must still consider whether there is additional, material compensation disclosure that would be useful to investors to understand how the EGC’s executive compensation programs operate.
EGCs may follow all or some of these “scaled” disclosure provisions, except that in their initial filing or submission they must decide whether to take advantage of the extended transition period for complying with any of the FASB’s updates to its Accounting Standards Codification. If an EGC decides to take advantage of such extended transition period, it may later choose to reverse its election. Most EGCs have not been electing to take advantage of these extended periods.
Although the JOBS Act refers to domestic company rules and forms, a foreign private issuer that qualifies as an EGC may comply with the scaled disclosure provisions to the extent relevant to the form requirements for foreign private issuers.
While these changes are designed to reduce costs, EGCs may find that providing the traditional level of historical financial disclosure is helpful in the IPO marketing process. Most EGCs have still elected to present financial statements for a full three years and also five years of selected financial data.
Issuers must avoid illegal offers and not engage in communications and activities that might be viewed as impermissibly affecting the market for the securities to be offered. The JOBS Act amends Section 5 of the Securities Act of 1933 to add a new Section 5(d), which permits EGCs to engage in oral and written communications with institutional or highly sophisticated prospective investors to gauge their interest in a contemplated securities offering before or during the “quiet period” or during the “waiting period.” Issuers should pay careful attention to the timing, content, and delivery mechanism of each communication. In particular, written communications are subject to SEC review and could complicate the IPO process if they are inconsistent with the prospectus or roadshow presentation. As a matter of standard practice, the SEC requests copies of any “testing the waters” communications made in reliance on Section 5(d) as well as any research reports.
The “IPO on-ramp” provisions make becoming a public company more attractive by reducing costs and burdens for EGCs after they go public, often by simplifying and streamlining disclosures. One of the most significant of these benefits is an exemption from the requirement contained in Section 404(b) of SOX to obtain an internal controls attestation and report from a registered independent public accounting firm while the issuer remains an EGC. For many, perhaps most, companies seeking to complete an IPO, this will delay by at least three years the need to comply with this requirement of SOX. It should be noted, however, that EGCs will still be required to establish and maintain “disclosure controls and procedures” and internal controls, and their principal executive officer and principal financial officer will still be required to certify Form 10-Q and 10-K filings.
The time-intensive process of submitting confidentially and executing an IPO as an EGC can take 12 to 16 weeks from initial filing to effectiveness, which is typical for a non-EGC issuer to complete the IPO process as well. As with IPOs of non-EGC issuers, the exact time taken to complete an IPO for an EGC can vary widely and depends on market conditions, the complexity of the transaction, the EGC’s readiness prior to embarking on the IPO process, and many other factors. The IPO process for EGCs can be broken down into the following stages.
Prior to official IPO process launch
Decision to go public: While the EGC should still evaluate its internal readiness, including industry position and growth prospects, it also has the flexibility to assess investor interest in a contemplated offering of its securities to determine whether it is ready to go public.
Testing the waters: The EGC and its advisors should consider whether to engage in test-the- waters communications with “qualified institutional buyers” or “accredited investors to gauge interest in a contemplated offering of its securities.
Internal controls: Once the decision has been made to prepare for an IPO, the EGC should still take the actions other issuers take: select an appropriate board of directors, prepare audited financials (with a qualified independent registered public accounting firm), and begin establishing internal controls.
Selection of advisors: The EGC should still carefully select its IPO advisors, including the right investment bank and counsel experienced in the industry and types of initial public offerings of the EGC.
IPO process - week 1
Organizational meeting: The traditional organizational meeting would still occur in the case of an IPO for an EGC. However, if an EGC is uncertain of its ultimate timing for its IPO, it may decide to work more informally with a few underwriters to prepare for an eventual formal kickoff of the IPO process with the organizational meeting.
IPO process - weeks 2 to 4
Drafting: The EGC would still prepare the same Form S-1 registration statement and prospectus. The drafting process is also largely the same as that for traditional IPOs. The contents of the S-1 registration statement are different in the following ways:
- the financial statements may include two (rather than three) years of audited financial statements and select financial statement info for the previous two (rather than five) years;
- the MD&A of the EGC’s performance need not cover more than the past two (rather than three) years plus any “stub” periods;
- the compensation disclosure and analysis for executives and board members need not include more information than is required of a smaller reporting company, meaning that the document need not include, among other things, compensation discussion and analysis or tabular information for more than three executive officers, and may omit certain compensation-related tables such as the grant of plan-based awards, and option exercise tables; and
- the EGC must make affirmative disclosure in the registration statement as to whether it will elect to “opt out” of new accounting standards that are not also applicable to private
Due diligence: The due diligence process for an IPO of an EGC is the same as that for traditional IPOs. Because this process is time-intensive, an EGC should consider its overall readiness to complete an IPO before embarking on the IPO process.
Legal and other documentation: In addition to the prospectus, the EGC and underwriter’s counsel will work with the investment bank, the EGC, and the auditors to draft the underwriting agreement, auditor’s comfort letter, and other documentation. The primary differences in the documentation of traditional IPOs and those of an EGC include:
- underwriting agreement will contain additional representations and warranties relating to a company’s status as an EGC and representations and covenants relating to test- the-waters communications; and
- the lock-up agreements for existing shareholders no longer need contain what are known as “booster shot” provisions—where the typical 180-day lock-up period can be extended if the EGC issues an earnings or other material press release or if material news about the EGC is released prior to the expiration of the lock-up
Determine listing venue: The EGC should still determine earlier in the process whether it is eligible to list on the NYSE or other exchange and reserve a ticker symbol.
IPO process - week 5
Confidential submission: A draft Form S-1 registration statement should be submitted confidentially to the SEC. In general, draft registration statements submitted through the confidential submission process are the same as registration statements filed outside of it, and until an EGC publicly files its S-1 registration statement, these submissions remain confidential.
IPO process - weeks 6 to 7
Testing the waters: The EGC and its advisors should consider whether to engage in test- the-waters communications with “qualified institutional buyers” or “accredited investors” to gauge interest in the contemplated offering of its securities. In addition to helping the EGC gauge investor interest, such communications could provide valuable information and experiences and impact the crafting of the marketing story for the impending roadshow. Most EGCs do engage in “testing the waters” meetings at least once before or during the IPO process. It is important to note that the SEC will require that the EGC provide copies of any materials, such as PowerPoint presentations displayed or used in these meetings, and therefore these materials should be reviewed carefully, even if the meetings occur months prior to an IPO.
Roadshow presentation: The preparation of the roadshow presentation and the roadshow itself is not notably different for EGCs than it is for companies engaging in traditional IPOs. Before finalizing the key roadshow messages, the EGC should consider taking advantage of the testing- the-waters provisions of the JOBS Act to help further refine the roadshow messaging.
IPO process - week 8
Initial comments on prospectus from SEC: The SEC comment process for confidential submissions takes a similar amount of time as traditional IPOs—with the SEC taking approximately 30 days to review and provide comments to the initial submission. Subsequent rounds of comments can take a range of time depending on the complexity of the issues and additional disclosures included by the EGC. Comment letters and related correspondence for completed IPOs of EGCs are made public within a few months of the effective date of the registration statement.
IPO process - weeks 9 to 12
- Continue submitting confidential draft Form S-1 amendments, responding to SEC comments confidentially, and receiving incremental confidential comment letters until SEC comments are resolved.
- A Form S-1 registration statement should be filed publicly with the SEC at least 15 days before roadshow
- Lock-up agreements and Financial Industry Regulatory Authority (FINRA) questionnaires should be widely circulated shortly before the public filing. At this stage, the employees and existing investors of the EGC would then know of the proposed
- Continue to consider engaging in test-the- waters
Discuss offering structure: The EGC and the investment bank should determine if there will be more than sufficient investor demand for the contemplated offering of its securities, so that the EGC can determine whether to make the decision to publicly file the registration statement.
IPO process - week 13
- Finalize offering size and structure and convey valuation information to the SEC in order to resolve any issues regarding valuation of the EGC’s common stock in prior equity transactions, such as grants of employee stock options.
- Publicly file S-1 Registration Statement if not yet previously
IPO process - week 14 to 16
- File a Form S-1 amendment with the red herring prospectus that includes price range and offering
- Launch roadshow
- Price the IPO
- The next day, the EGC begins publicly trading on the NYSE, rings the opening bell, and hosts other key marketing events associated with being a public company
- Closing of the IPO
The JOBS Act and FAST Act have helped relieve some of the burdensome requirements smaller companies face in accessing the U.S. capital markets and made going public more attractive by reducing the associated costs and burdens for a period of transition while these companies grow. Many EGCs are benefiting from being able to explore an IPO without incurring as many of the costs, without disclosing confidential information, and avoiding any embarrassment associated with publicly withdrawing the IPO should the EGC do so.
Jeffrey R. Vetter, Co-Chair, Securities and Corporate Finance; and Partner, Corporate, Fenwick & West LLP