JOBS ACT INCREASES THE ABILITY OF PORTFOLIO COMPANIES, START-UP VENTURES AND SMALL BUSINESSES TO RAISE CAPITAL AND ACCESS THE PUBLIC MARKETS

Transcription

1 CLIENT MEMORANDUM JOBS ACT INCREASES THE ABILITY OF PORTFOLIO COMPANIES, START-UP VENTURES AND SMALL BUSINESSES TO RAISE CAPITAL AND ACCESS THE PUBLIC MARKETS On March 27, 2012, the U.S. House of Representatives passed the Jumpstart Our Business Startups Act, or the JOBS Act. Having been passed by the U.S. Senate on March 22, 2012, the JOBS Act will go before President Obama and is expected to be signed into law. 1 The JOBS Act represents a substantial change in existing law and practice and is intended to provide significant benefits to portfolio companies of venture capital and private equity funds and other start-up ventures and small businesses when seeking to raise capital or gain access to the public markets. The primary highlights of the JOBS Act are as follows: Creates the new category of emerging growth companies (generally defined to include U.S. or non-domestic issuers with less than $1 billion in annual gross revenues during their most recently completed fiscal year), or EGCs, and eases access to the public markets for EGCs for a period of up to five years, and reduces the requirements of the financial disclosure, governance and certain other securities laws and procedures for EGCs. Eliminates the restrictions against general solicitation and general advertising in connection with certain private placements of securities to accredited investors or qualified institutional buyers. Creates an exemption for a new form of capital raising, known as crowdfunding, which allows certain U.S. non-reporting issuers to raise up to $1 million annually by selling small amounts of stock to numerous individuals, without being obligated to register with the SEC provided that certain disclosures are made available to the SEC and potential investors and the transaction is conducted through a U.S. registered broker or funding portal. Relaxes the thresholds for when a private company would become subject to the public company reporting and disclosure requirements by only requiring registration of companies that have assets exceeding $10 million and a class of equity securities (excluding certain exempted securities) held of record by either 2,000 persons or 500 persons who are not accredited investors. Importantly, for purposes of computing these thresholds, issuers may exclude employees holding only securities issued pursuant to an employee equity compensation plan in transactions exempt from the registration requirements, and investors who use the crowdfunding exemption under the JOBS Act. 1 H.R The portions of the JOBS Act relating to emerging growth companies become effective upon enactment and are available to issuers upon the first sale of their common equity securities pursuant to an effective registration statement. Certain other provisions of the JOBS Act require the SEC to revise its rules to give effect to the Act no later than 90 days to one year (as applicable to the respective section of the JOBS Act) after enactment. NEW YORK WASHINGTON PARIS LONDON MILAN ROME FRANKFURT BRUSSELS in alliance with Dickson Minto W.S., London and Edinburgh

2 Increases the threshold for certain types of securities offerings (known as Regulation A offerings) to allow an issuer to offer and sell (privately or publicly) up to $50 million in securities within a 12-month period in reliance on the exemption, provided that certain disclosures are made available to the SEC and potential investors (including annual audited financials) and that other requirements are satisfied. We have summarized in more detail below certain of the key provisions of the JOBS Act that we believe are most relevant to venture capital and private equity investors, private funds and capital markets professionals. Emerging Growth Companies An EGC is defined as an issuer with a total annual gross revenue of less than $1 billion during the most recently completed fiscal year. An issuer will be an EGC until the earliest of the last day of the fiscal year in which the issuer had gross revenues of $1 billion; the last day of the issuer s fiscal year that is five years after the date of its initial public offering, or IPO, on an effective registration statement; the date on which the issuer has, during the prior three year period, issued more than $1 billion in non-convertible debt; or the date on which the issuer is deemed to be a large accelerated filer. 2 An issuer is ineligible to be considered an EGC if it first sold its common stock in an IPO on or prior to December 8, The JOBS Act is expected to reduce the costs of conducting an IPO for an EGC. The Act permits an EGC to explore an IPO without disclosing sensitive information to the market. The Act also seeks to reduce ongoing costs associated with being a public company after an IPO. The primary benefits of the JOBS Act to EGCs are summarized below. Pre-IPO Benefits to EGCs Confidential Submission of Registration Statement The JOBS Act allows an EGC to submit its draft registration statement to the SEC for confidential, non-public review prior to making any public filing, provided that the initial registration statement and any amendments are filed at least 21 days prior to the offering road show presentation by the issuer s management. It should be noted that confidential submission of registration statements was previously only permitted for foreign private issuers, and in December 2011, the SEC significantly limited the ability of foreign private issuers to make 2 A large accelerated filer is an issuer that meets the following requirements: the issuer has an aggregate worldwide market value of the voting and non-voting common equity held by its non-affiliates of $700 million or more as of the last business day of the issuer s most recently completed second fiscal quarter, the issuer has been subject to the reporting requirements of the Securities Exchange Act of 1934, as amended, or the Exchange Act, for a period of at least 12 months, the issuer has filed at least one annual report pursuant to the Exchange Act and the issuer is not eligible to use the requirements for smaller reporting companies for its annual and quarterly reports (a smaller reporting company generally is an issuer with a public float of less than $75 million, or if the issuer has no public float, with annual revenues of less than $50 million)

3 confidential submissions. However, under the JOBS Act, all EGCs, including foreign private issuers, will be permitted to submit an IPO registration statement confidentially. Confidential submission will allow an EGC to begin the SEC review process without publicly revealing sensitive commercial and financial information to its competitors. Pre-IPO Communications with Investors The JOBS Act expands the permissible communications that an EGC may engage in with potential investors by allowing an EGC, or its representatives, to engage in oral or written communications with potential investors that are qualified institutional buyers or institutions that are accredited investors, in order to determine whether such investors have an interest in investing in the company. These communications may occur prior to or following the date that the registration statement is filed. Research Reports The flexibility of brokers and dealers to issue research reports will be increased by the JOBS Act amendments to the Securities Act of 1933, as amended, or the Securities Act, which provide that publication or distribution of a research report 3 by a broker or a dealer about an EGC in connection with its IPO will not be deemed to constitute a regulated offer of securities under the Securities Act, even if the broker or dealer is participating (or will participate) in the offering. 4 Analyst Communications The SEC and any registered national securities association cannot impose any rules that restrict, based on their functional role, which associated persons of a broker, dealer or member of a national securities association may arrange for communications between analysts and potential investors, or restrict a securities analyst from participating in any communications with the management of an EGC that is also attended by any other associated person of a broker, dealer or member of a national securities association whose functional role is other than a securities analyst. Post-IPO Benefits to EGCs Reduced Financial Disclosure An EGC is required to provide only two years of audited financial statements in its IPO registration statement on Form S-1 or Form F-1, and in any other registration statement. In addition, an EGC is not required to present selected financial data (for any period prior to the earliest audited period presented with its IPO) in any other registration statement or in its annual and periodic reports. 3 4 A research report means a written, electronic, or oral communication that includes information, opinions or recommendations with respect to securities of an issuer, or an analysis of a security or an issuer, whether or not it provides information reasonably sufficient upon which to base an investment decision. The Exchange Act is also amended to prohibit the SEC or any registered national securities association from adopting or maintaining any rule or regulation to prohibit any broker-dealer or member of a national securities association from publishing or distributing any research report or making an appearance with respect to securities of an EGC during the post-ipo quiet and lock-up periods. FINRA would need to amend certain rules which restrict such activities by research analysts, however, research analysts will still need to comply with the unaffected provisions of those rules

4 Auditor Attestation Report The registered public accounting firm that prepared or issued the EGC s audit report is not required to provide an attestation report on the EGC s internal controls under the Sarbanes-Oxley Act. This exemption will be available so long as a company is deemed to be an EGC. Compensation Disclosure The JOBS Act exempts an EGC from the Dodd-Frank Act s 5 say on pay requirements, which require a public company to hold a non-binding stockholder advisory vote at least once every three years on executive compensation and a shareholder vote on executive severance payments known as golden parachutes. The JOBS Act further exempts EGCs from the Dodd-Frank Act s requirement that public companies calculate and disclose the median compensation of all employees compared to the CEO. 6 In addition, the Act reduces the disclosure requirements regarding executive compensation and management s discussion and analysis for an EGC s annual report and proxy statement. 7 Accounting Pronouncements and Standards An EGC will not be required to comply with new or revised U.S. GAAP accounting pronouncements applicable to public companies until such pronouncements are also applicable to private companies. Any Public Company Accounting Oversight Board, or PCAOB, rules requiring audit firm rotation or a supplement to an auditor s report in which the auditor would be required to provide additional information about the audit and the financial statements of the issuer do not apply to an audit of an EGC. Additional rules adopted by the PCAOB after the enactment of the JOBS Act do not apply to an audit of an EGC unless the SEC determines that the application of the requirements is necessary in the public interest, after considering investor protection and whether the action will promote efficiency, competition and capital formation. Other Notable Provisions Relating to EGCs Opt-in An issuer that completed its IPO after December 8, 2011 is eligible to be considered an EGC and as such may elect to furnish less information in its future SEC filings. An EGC may forgo the regulatory exemptions afforded to it and instead opt-in to certain regulatory requirements as it sees fit. However, EGCs cannot selectively opt-in to comply with new or revised accounting standards. An EGC must declare in its registration statement whether or not it will use the extension of time for all new or revised accounting standards applicable to EGCs The Dodd-Frank Wall Street Reform and Consumer Protection Act (Pub. L , H.R. 4173). Note that an EGC will still need to comply with all stock exchange corporate governance and listing requirements. The reduced disclosure requirements are those generally available to smaller reporting companies

5 The SEC is directed to conduct a review of Regulation S-K with the aim of simplifying and modernizing the registration process, as well as reducing costs and other burdens for EGCs. Elimination of the Solicitation and Advertising Restrictions The Securities Act generally requires any offer or sale of securities to be registered with the SEC or to qualify under an applicable exemption from registration, such as the private offering exemption of Section 4(2) of the Securities Act or the related safe harbor exemption promulgated by the SEC. Regulation D contains three rules providing exemptions from the registration requirements, allowing some companies to offer and sell their securities without having to register the offering with the SEC. Rule 506 of Regulation D promulgated under the Securities Act provides one such safe harbor for private placement offerings, subject to a number of conditions, one of which previously was that there be no general solicitation or general advertising used to market the securities. Historically, the prohibition on general solicitation and general advertising has limited the ability of certain issuers to raise private capital due to the lack of access to traditional means of exposure, including current media. The JOBS Act removes the prohibition on general advertising and general solicitation and directs the SEC, within 90 days after enactment, to revise the applicable rules. After the removal of the prohibition, participants in these types of private offerings will presumably be free to solicit investor interest publicly and across various forms of media, including newspaper advertisements, internet web pages, , and social media such as Facebook and Twitter. The amendments are summarized below. Rule 506 of Regulation D Rule 506 generally provides a safe harbor from Securities Act registration for offers and sales of securities to purchasers that are accredited investors and to 35 persons that are not accredited. The revisions to Rule 506 will provide that the prohibition against general solicitation or general advertising shall not apply to offers and sales made pursuant to the Rule, provided that all purchasers (not offerees) of the securities are accredited investors. The issuer will be obligated to take reasonable steps using methods determined by the SEC to verify that the purchasers are accredited investors. 8 Rule 144A Rule 144A is the safe harbor from Securities Act registration for offerings of securities made to qualified institutional buyers. Within 90 days after enactment, the SEC is also directed to revise Rule 144A to provide that securities sold pursuant thereto may be offered to persons other than qualified institutional buyers, including by means of general solicitation or general advertising, provided that the securities are sold only to persons the seller reasonably believes to be qualified institutional buyers. 8 The JOBS Act also provides that revised Rule 506 will continue to be treated as a regulation issued under section 4(2) of the Securities Act, a technical change likely intended to preserve the existing preemption of state securities ( blue sky ) laws for Rule 506 offerings

6 Application to Private Funds The transactions under revised Rule 506 will not be deemed to be public offerings under the Federal securities laws as a result of general advertising or general solicitation. This appears to allow private funds relying on exemptions under Section 3(c)(1) or 3(c)(7) of the Investment Company Act of 1940, as amended (which require, among other things, that an issuer not offer its securities pursuant to a public offering), to avail themselves of general solicitation or general advertising to offer securities under Rule 506, as revised. 9 Clarification of Broker-Dealer Registration Requirements The JOBS Act also clarifies that a person who maintains a platform that permits the offer or sale of securities or permits general solicitations (including online) or who provides ancillary services, such as due diligence services, with respect to securities, in each case, offered and sold in compliance with Rule 506 of Regulation D is not required to register with the SEC as a broker or dealer so long as, among other things, the person does not receive compensation in connection with the sale of such securities. Crowdfunding The JOBS Act amends the Securities Act to create a new registration exemption 10 for certain crowdfunding transactions, which we refer to as the crowdfunding exemption. Generally crowdfunding allows certain U.S. non-reporting issuers to raise up to $1 million annually by selling small amounts of stock to numerous individuals, without being obligated to register with the SEC, provided that certain disclosures are made available to the SEC and potential investors and that the transaction is conducted through a U.S. registered broker or funding portal. 11 Crowdfunding has the potential to be a less costly way to provide more sources of funding to start-up ventures and small businesses. However, such benefit will need to be weighed against certain of the requirements imposed on brokers, funding portals and issuers, including the cost of the annual reporting and other disclosure requirements. To qualify for the crowdfunding exemption, certain conditions must be satisfied, including: However, as the SEC has not yet promulgated any rules, applicability of the amendments to private funds remains subject to the SEC s adoption of rules implementing Title II of the JOBS Act. The JOBS Act amends the Securities Act to create a new Section 4(6). A funding portal is defined as any person acting as an intermediary in a transaction involving the offer or sale of securities for the account of others solely pursuant to Section 4(6) of the Securities Act that does not offer investment advice or recommendations; solicit purchases or sales of securities offered or displayed on its website or portal; compensate employees, agents or others for such solicitation; possess or otherwise handle investor funds or securities; or engage in such other activities as the SEC, by rule, determines appropriate

7 Applicability The issuer must be a non-reporting U.S. issuer which is not an investment company 12 or excluded by the definition of investment company pursuant to certain sections thereof or otherwise excluded by SEC rulemaking. 13 Generally most private equity, venture capital and hedge funds will not be able to avail themselves of the crowdfunding exemption. Limit on Amounts Raised The aggregate amount sold to all investors by the issuer, including any amounts sold in reliance on the crowdfunding exemption during the 12- month period preceding the date of the investment, cannot exceed $1 million. 14 Limit on Individual Investments The maximum investment per investor cannot exceed: o The greater of $2,000 or 5% of the investor s annual income or net worth 15 within any 12-month period, if the investor s annual income or net worth is less than $100,000; or o 10% of the investor s annual income or net worth, not to exceed a maximum amount of $100,000, if either the annual income or net worth of the investor is equal to or more than $100,000. Investment Must Be Made through a U.S. Registered Broker or Funding Portal The crowdfunding transactions must be conducted through a U.S. registered broker or funding portal that complies with the crowdfunding exemption requirements. Obligations of Intermediaries A person acting as a broker or funding portal intermediary must take certain actions, including: o Registering with the SEC as a broker or funding portal and registering with any applicable self-regulatory organization; o Providing such disclosures to investors as the SEC may require, including disclosures related to risks and certain other investor education materials; As defined in Section 3 of the Investment Company Act of The SEC is required to promulgate rules within 270 days following enactment. The rules will address numerous aspects of the crowdfunding exemption, including disqualification provisions for investors who are felons or other types of bad actors. Dollar amounts are required to be adjusted by the SEC at least once every five years. The income and net worth standards are to be calculated in the same manner as any SEC rules regarding the calculation of income and net worth for accredited investors

8 o Ensuring that each investor reviews the investor education materials in accordance with standards established by the SEC, affirms the potential for a risk of loss and answers various questions demonstrating an understanding of the risk and such other matters as the SEC may require; o Taking measures to reduce the risk of fraud, including obtaining background and securities enforcement regulatory history checks on each director, officer and stockholder holding more than 20% of the outstanding equity of the issuer; o Making certain information provided by the issuer available to the SEC and potential investors not more than 21 days prior to the first day on which securities are sold to any investor (or such other period as the SEC may establish); o Ensuring that all offering proceeds are provided to the issuer only when the aggregate capital raised from all investors is equal to or greater than the target offering amount; o Allowing investors to cancel their commitments to invest as the SEC may require in rulemaking; o Making such efforts as the SEC determines appropriate in rulemaking to ensure that no investor in a 12-month period has purchased securities offered pursuant to the crowdfunding exemption that, in the aggregate from all issuers, exceed the investment limits summarized above; o Taking steps to protect the privacy of information collected from investors as the SEC determines appropriate in rulemaking; o Not compensating promoters, finders or lead generators for providing the broker or funding portal with the personal information of any potential investor; o Prohibiting the directors, officer and partners of the broker or funding portal from having any financial interest in any issuer using the broker or funding portal; and o Complying with such other requirements as the SEC may establish in rulemaking. Issuer Disclosure Obligations The issuer must file with the SEC and provide to investors (including potential investors) and the relevant broker or funding portal, certain information, including information about: o The names of directors and officers and each person holding more than 20% of the shares of the issuer, as well as a description of the issuer s business, capital structure, and other terms of the securities offered and of existing rights of stockholders; - 8 -

9 o A description of the financial condition of the issuer, including for offerings that, together with all other crowdfunding offerings in the prior 12 months, have, in the aggregate, target offering amounts of (i) $100,000 or less, the issuer shall provide income tax returns for the most recently completed year and financial statements of the issuer certified by the principal executive officer; (ii) more than $100,000, but not more than $500,000, the issuer shall provide financial statements reviewed by an independent public accountant; and (iii) more than $500,000, the issuer shall provide audited financial statements; and o A description of the terms of the offering, including the stated purpose and intended use, the target offering amount, the offering price and certain other terms. No Advertising The issuer cannot advertise the terms of the offering, except for notices which direct investors to the broker or funding portal. Limits on Offering Compensation The issuer cannot compensate any person to promote its offering through communication channels provided by a broker or funding portal, unless such compensation is clearly disclosed in accordance with such rules that the SEC may require. Annual Reporting Obligation Annually the issuer must file with the SEC and provide to investors the issuer s results of operations and financial statements as determined by SEC rules. Transfer Restrictions Securities issued pursuant to the crowdfunding exemption cannot be transferred by the investor for one year after purchase, unless they are registered or transferred to the issuer or an accredited investor or family member, or in connection with the investor s death or divorce, and subject to such other limitations as the SEC may establish. State Regulation Crowdfunding offerings will be exempt from state regulation relating to registration, documentation and offering requirements. States, however, retain the authority to take enforcement actions with regard to the issuer, funding portal and other persons or entities using the crowdfunding exemption. Relaxation of Thresholds for Becoming a Reporting Company Section 12(g) of the Exchange Act and its related rules previously required a company (including private funds that rely on the exemption from registration in Section 3(c)(7) of the Investment Company Act of 1940) with more than $10 million in assets to register any class of equity securities that were held of record by 500 or more persons. Pursuant to the JOBS Act, the threshold for registration of securities with the SEC under Section 12(g) of the Exchange Act has been amended to require registration for companies that have assets exceeding $10 million and a class of equity security held by either (i) 2,000 persons or (ii) 500 persons who are not accredited - 9 -

10 investors. 16 Additionally, the definition of held of record in Section 12(g) will not include securities held by persons who received the securities pursuant to an employee compensation plan in transactions that were exempt from the registration requirements of Section 5 of the Securities Act and investors who purchased securities pursuant to the crowdfunding exemption. 17 Increased Threshold for Regulation A Offerings The JOBS Act amends Section 3(b) of the Securities Act to increase the threshold for certain types of securities offerings (known as Regulation A offerings) to allow an issuer to offer and sell up to $50 million 18 in securities (previously the threshold was $5 million) within a 12-month period in reliance on the exemption. Under the amended provisions, the SEC is required to adopt rules or regulations in accordance with the following: The only securities that may be offered are equity and debt securities and debt securities convertible or exchangeable for equity interests, including any guarantees of such securities; The securities may be offered and sold publicly or privately, and the securities will not be considered restricted securities ; The civil liability provisions in Section 12(a)(2) of the Securities Act shall apply to any person offering or selling such securities; The issuer may solicit interest in the offering prior to filing any offering statement, subject to compliance with SEC rules; The issuer must file with the SEC annual audited financial statements and such other periodic filings as the SEC may require; and The SEC may impose additional terms and conditions, which may include a requirement that the issuer electronically file with the SEC and distribute to prospective investors an offering statement and certain other information Section 12(g) was also amended with regard to banks and bank holding companies. The JOBS Act requires registration if such entities have total assets of $10 million and a class of equity security held of record by 2,000 or more persons, regardless of accredited investor status. A bank or bank holding company will cease to be subject to Exchange Act reporting if its shareholder base falls below 1,200 record holders. The JOBS Act directs the SEC to promulgate rules exempting securities acquired in a crowdfunding transaction from Section 12(g) of the Exchange Act. Every two years the SEC is required to review the offering amount limitation and increase such amount as the it determines appropriate

11 The JOBS Act exempts such offerings from state securities laws relating to registration, documentation and offering requirements if the securities are offered and sold on a national securities exchange or sold to qualified purchasers, as defined by the SEC. 19 * * * * * * * * * * * * * * * If you have any questions regarding this memorandum, please contact Gregory Astrachan ( , gastrachan@willkie.com), Gordon Caplan ( , gcaplan@willkie.com), Robert Langdon ( , rlangdon@willkie.com), Martin Miller ( , mmiller@willkie.com), Daniel Schloendorn ( , dschloendorn@willkie.com), or the Willkie attorney with whom you regularly work at (212) Willkie Farr & Gallagher LLP is headquartered at 787 Seventh Avenue, New York, NY and has an office located at 1875 K Street, NW, Washington, DC Our New York telephone number is (212) and our facsimile number is (212) Our Washington, D.C. telephone number is (202) and our facsimile number is (202) Our website is located at April 3, 2012 Copyright 2012 by Willkie Farr & Gallagher LLP. All Rights Reserved. This memorandum may not be reproduced or disseminated in any form without the express permission of Willkie Farr & Gallagher LLP. This memorandum is provided for news and information purposes only and does not constitute legal advice or an invitation to an attorney-client relationship. While every effort has been made to ensure the accuracy of the information contained herein, Willkie Farr & Gallagher LLP does not guarantee such accuracy and cannot be held liable for any errors in or any reliance upon this information. Under New York s Code of Professional Responsibility, this material may constitute attorney advertising. Prior results do not guarantee a similar outcome. 19 The Comptroller General is required to conduct a study on the impact of state laws regulating Regulation A offerings and transmit a report to the Committee on Financial Services of the House of Representatives and the Committee on Banking, Housing and Urban Affairs of the Senate not later than three months following enactment of the JOBS Act