The Jumpstart Our Business Startups Act (known as the “JOBS Act”) has received a great deal of attention in the startup world since it was enacted on April 5, 2012, even though some of its provisions are not yet in effect. One of the primary goals of the JOBS Act is stimulating startup activity by giving small companies easier access to capital. It has been widely successful—there was a 73 percent increase in IPOs during the first year after the JOBS act was enacted.
Below are three ways the JOBS Act has impacted small businesses, and how you can potentially benefit from it.
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1. Disclosure Exemptions: Faster, Cheaper IPOs
Title I of the JOBS Act, commonly known as the IPO On-ramp, is meant to encourage initial public offerings (“IPOs”). In the IPO On-ramp, the Securities and Exchange Commission (“SEC” or the “Commission”) created a new company category called emerging growth companies, or EGCs.
EGCs are companies with total annual gross revenues of less than $1 billion during its most recently completed fiscal year. Under the provisions of the IPO On-ramp, EGCs are exempt from several registration requirements and have pared-down requirements for disclosure. EGCs now make up 85 percent of all IPOs.
Two exemptions have been heavily used: reduced disclosure requirements for executive information, and reduced disclosure requirements for internal controls. The benefit of these exemptions is that they lower the burden of cost and time invested in registering an IPO.
The most used exemption is the reporting of executive information. Prior to the JOBS Act, all companies filing an IPO were required to provide compensation information, discussion and analysis of five named executives in the IPO registration.
Now, ECGs are only required to provide compensation disclosure for three executives and are exempt from preparing compensation, discussion and analysis sections for the registration statement. A whopping 94 percent of ECGs made use of this exemption.
The exemption with the second most impact is the exemption from Sarbanes-Oxley’s 404(b) disclosure rules. Section 404(b) requires that management must give an assessment of the company’s internal controls, and an external auditor must attest to that assessment. EGCs are exempt from obtaining such an attestation, and they have a year from the date of IPO to provide assessment of internal controls.
According to a Latham and Watkins study, 98 percent of EGCs intend to use or have reserved the right to use this exemption.
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2. Confidential Review of Solicitation: Less Pre-IPO Visibility
The SEC created a unique perk for EGCs aiming for an IPO: confidential review of registration statements. With this provision, EGCs are allowed to submit draft registration statements to the SEC. This means that startups can begin the SEC review process without risking disclosure of intent and/or sensitive information prior to the IPO. Additionally, should the company choose not to pursue an IPO – whether the procedure is postponed or terminated – potential investors and competitors will be unaware of the abandoned IPO.
The SEC does not publish statistics on the number of confidential submissions, but some experts suggest that as many as 87 percent of companies are taking advantage of this benefit. Another source states that in the first half of 2013, 100 percent of technology and life sciences companies took advantage of it. After all, as one expert notes, there is no real downside!
3. General Solicitation: Easier Access to Potential Investors
Title II of the JOBS Act went into effect on September 23, 2013. Title II added Section 506(c) to Regulation D: it lifts the general solicitation and advertising ban on private offerings with the caveat that purchasers must be verified as accredited investors.
The ability to solicit and advertise marks a fundamental change in a startup’s access to capital. Frequently, the seed capital for startups comes from friends and family. Beyond that, entrepreneurs must expand their personal networks to reach other potential investors, but – at least, prior to the lifting of the ban – without making general solicitations or advertising.
According to an address by the director of the SEC’s Division of Corporate Finance, as of March 2014 – six months since the effective date of Section 506(c) – as many as 900 offerings used the new rule. As impressive as that may seem, it is far less than the number of traditional offerings.
A significant factor in issuers’ hesitance to rely on 506(c) is the requirement that issuers “take reasonable steps to verify” a potential purchaser’s accredited status. Taking responsibility for that level of due diligence can be daunting; however, issuers may use services such as VerifyInvestor.com to undertake the diligence.
Overcoming the hurdle of verifying accredited status is well worth the effort. The ability to reach a wide pool of potential investors is not the only benefit. Accredited investors are typically high-net worth individuals; the requirement may mean that small companies can raise money with fewer investors.