Inigo Montoyo: "You keep using that word. I do not think it means what you think it means."
Vizzini, as played by Wallace Shawn in the enduringly delightful flick "The Princess Bride," displays the down side of over-thinking. Vizzini would have made a fine JOBS Act author.
Enacted in April, the Jumpstart Our Business Startups (JOBS) Act is intended to help a select group of growing companies to more easily attract investors and raise capital. The title of the legislation, which is about as subtle as a Hollywood summer blockbuster's plot, suggests that more employment opportunities will arise for U.S. citizens if growing private companies and newly public companies (of a certain sort) can:
A) More easily prepare for and conduct initial public offerings (IPO); and
B) Raise capital, even after completing small IPOs, without contending with many traditional U.S. Securities and Exchange Commission (SEC) compliance obligations.
This sounds promising and laudable. And no doubt many of the law's supporters in Congress will promote the fact that they supported the JOBS Act in their reelection campaigns. The average citizen on Main Street may not know exactly what the JOBS Act does, but it sure sounds promising.
But it's not so simple.
A central component of the new law is the "emerging growth company" (EGC) classification. Pre-IPO companies with less than $1 billion in sales or market capitalization would not be required to comply with (among other things) Sarbanes-Oxley Section 404(b) -- the super-sized SOX clause that requires an external auditor to attest to, and report on, management's assessment of its internal controls -- for up to five years.
Here's the rub: The definition of EGC status -- including when it expires and what the implications of losing the classification are -- are almost as dizzying as Vizzini's intellect.
Gaining EGC status seems relatively straightforward: a company needs to have total annual gross revenues of less than $1 billion during its most recently completed fiscal year. Maintaining EGC status is another story, and in many ways a more important one since losing EGC status determines when the company will need to comply with Section 404(b), a compliance endeavor that requires a load of expertise, processes and time.
The JOBS Act currently indicates that companies may retain their EGC status until the earliest of the following:
- The last day of the fiscal year of the issuer following the fifth anniversary of the date of the company's initial public offering of common equity securities;
- The last day of the fiscal year during which the issuer had total annual gross revenues of $1 billion or more;
- The date on which the issuer has, during the previous three-year period, issued more than $1 billion in nonconvertible debt; or
- The date on which such issuer is deemed to be a "large accelerated filer."
This information appears in a summary of the JOBS Act Protiviti published just before the law was finalized. The eight-page report describes a potentially difficult -- but not terribly unlikely -- situation an ECG company could experience:
For instance, assume an EGC is a December 31 year-end reporting company and, because of an unusual one-time event that was not anticipated, its revenues spiked in the fourth quarter, causing it to exceed the $1 billion threshold. Based on the language included in the JOBS Act, the annual revenue test is as of the last day of the company's fiscal year. If the company fails to meet that test by exceeding the $1 billion threshold, it loses its "EGC status" as of the end of that year, which would subject it to the attestation requirements of Section 404(b) for that year unless it is exempted as a nonaccelerated filer. These circumstances would require a very keen sense of anticipation, some advance preparation, as well as quick and nimble action on very short notice for the company to engage its external auditor in the Section 404(b) attestation process.
As Protiviti and others have noted, the SEC could issue interpretations that create transitional periods related to Section 404(b) compliance triggers. Regardless, understanding the JOBS Act requires a battle of wits.
What's more, the law's Section 404(b) loophole is only one of several other components, most of which also relax previous compliance requirements for pre-IPO and some newly public companies. These components deal with SEC Regulation A, Rule 506 of SEC Regulation D and other rules that previously limited the means by which small businesses may attract investors (e.g., via advertising). The law also provides new rules concerning crowdfunding; a section of the law addressed in this SEC FAQ list.
Will the JOBS Act make good on its good intentions? We'll see. The legislation suffered some unfortunate (and unavoidable) poor timing thanks to Facebook's disappointing IPO, which may have cooled some IPO aspirants from going public for a while.
Despite my criticism of the law's overthinking, its intentions are sound and beneficial. Maybe additional guidance from the SEC will help EGC companies avoid classic blunders -- like getting involved in land wars in Asia, or neglecting the triggers that strip companies of their EGC status.