How Life Science Companies Can Benefit from the JOBS Act
The Jumpstart Our Business Startups Act (“JOBS Act”) aids small- and medium-sized life science companies by easing the regulatory requirements for capital formation and by providing new funding alternatives. When fully implemented by the Securities and Exchange Commission (“SEC”), it will facilitate private offerings and will provide the ability to raise up to $50 million in an unregistered public offering. In addition, the provisions of the JOBS Act now in effect encourage companies to consider initial public offerings at an earlier stage in their development.
Private Offerings
Use of Publicity in Rule 506 Offerings
Section 201(a) of the JOBS Act requires the SEC to eliminate the prohibition against general solicitation and general advertising for offerings made pursuant to Rule 506 of Regulation D, provided that all purchasers of such securities are accredited investors1.
The JOBS Act deadline for this rulemaking is July 4, 2012, although it is uncertain whether the SEC will be able to meet this or the other deadlines for rulemaking contained in the JOBS Act. Once the SEC completes its rulemaking, an issuer or a person acting on behalf of an issuer will be able to promote the sale of a security through a general solicitation or general advertising without registering the security under the Securities Act if all of requirements of Rule 506 are satisfied and all of the purchasers in the offering are accredited investors.
The rules to be adopted by the SEC must require issuers to take reasonable steps to verify that the purchasers in the Rule 506 offering are accredited investors. It is anticipated that this will require more than the self certifications from investors customarily used in the past. It remains to be seen whether these rules will affect the manner in which general solicitation and general advertising may be undertaken.
Restricted access website services may play a more prominent role in future Rule 506 offerings. While such services now operate under no-action letters and interpretive advice provided the staff of the SEC2, the JOBS Act expressly authorizes third parties to operate websites or other platforms that facilitate the offer, sale, negotiation, or advertisement of Rule 506 transactions, and to provide “ancillary services” (such as due diligence or standard documentation) without having to register as a broker-dealer under Section 15(a)(1) of the Securities Exchange Act of 1934 (Exchange Act). This exemption is conditioned only upon the third party (1) receiving no compensation in connection with the purchase or sale of the security, (2) not holding investor funds or securities in connection with the transaction and (3) not being subject to statutory disqualifications based on prior bad acts.
The easing of the existing restrictions on publicity should benefit life science companies seeking capital by permitting them to reach a greater number of potential investors than they can under the existing rules. This benefit will become available only after Rule 506 is amended by the SEC, as required by the JOBS Act. Until that time, the prohibition on general solicitation and general advertising applies and Rule 506 offerings should be undertaken using the customary past practices.
Crowdfunding
The JOBS Act permits private companies to raise up to $1 million in a 12-month period through crowdfunding. To qualify for this exemption from registration, the offering must be made through an intermediary, who may be a registered broker-dealer or a “funding portal” – a new type of entity created by the JOBS Act.3 This exemption must be implemented by SEC rulemaking and the JOBS Act requires those rules to be in place by the end of this year. An issuer who sells securities pursuant to the crowdfunding exemption must file certain information with the SEC, provide that information to the broker or the funding portal, and make that information available to potential investors. After the offering, the issuer will be required to file annually with the SEC and provide to investors reports of the results of operations and financial statements of the issuer. Securities purchased in connection with the crowdfunding exemption are restricted securities and may not be transferred during the one-year period beginning on the date of purchase except to the issuer or an accredited investor. Sales of securities pursuant to the crowdfunding exemption will not be subject to state law registration. However, states will have jurisdiction with respect to fraud or deceit in connection with an offering using the crowdfunding exemption.
While this crowdfunding exemption may be of benefit entrepreneurs and early stage companies, it will be limited utility to life science companies because of the limit on the dollar amount that can be raised, the administrative and reporting requirements it imposes, and the possible creation of a substantial unsophisticated shareholder base. Because of these factors, it is also uncertain whether an institutional investor would be willing to provide subsequent financing to a company that has sold securities in reliance on the crowdfunding exemption.
Increase of Shareholder Threshold for Public Company Reporting
The JOBS Act amends Section 12(g)(1)(A) of the Exchange Act to increase the threshold number of record holders which triggers registration under the Exchange Act from 500 record holders to 2,000 record holders, or 500 record holders who are not accredited investors.4 In determining whether these thresholds have been exceeded, an issuer can exclude persons who received securities pursuant to an employee compensation plan in transactions exempt from registration under the Securities Act of 1933 (Securities Act).
This provision benefits life science companies by extending the time when they will become subject to SEC reporting and by permitting equity based compensation to be issued without an impact on that date.
Exempt Public Offerings Up To $50 Million
The existing exemption for small public offerings provided by Regulation A has seldom been used, presumably because it is limited to an offering of no more than $5 million. With an increased limit of $50 million, this form of small public offering may be of interest to life science companies and their investors because the securities purchased are unrestricted and may be freely resold. An issuer will also be able to "test the waters" prior to the offering on terms to be established by the SEC. The securities will also be exempt from state blue sky laws registration if they are offered and sold on a national securities exchange or if they are sold to a qualified purchaser, as defined by the SEC.
An issuer using this exemption will be required to file an offering statement with the SEC which includes audited financial statements, a description of its business, its financial condition, its corporate governance principles, its use of investor funds, and other items to be determined by the SEC. In addition, the JOBS Act authorizes the SEC to require an issuer using this type of offering to file periodic reports.
There is no rulemaking deadline in the JOBS Act for this new exemption.
When implemented by SEC rulemaking, this new exemption should provide an attractive means for a life science company to conduct a small public offering and create a public trading market in its securities. It could prove more attractive vehicle than so called “alternative public offerings”, such as reverse shell mergers, because a company completing an offering under this new exemption would not automatically become subject to Exchange Act reporting.
Registered Public Offerings by Emerging Growth Companies
The JOBS Act makes an initial public offering (“IPO”) by smaller companies more attractive by easing some of the burdens of the IPO process and by easing the subsequent public reporting requirements. Companies with less than $1 billion in annual gross revenues (so-called “emerging growth companies”) can take advantage of the following benefits in an IPO –
This "on ramp" to becoming a public company can provide substantial benefits to a life sciences company in a position to consider going public. The ability to test the waters and file a registration statement on a confidential basis can help private avoid the embarrassment of a failed IPO due to lack of investor interest and avoid needlessly exposing competitive and other sensitive information if an offering cannot be completed. In addition, filing a registration statement on a confidential basis could be of strategic benefit to an emerging growth company pursuing a dual track IPO and private M&A sale process. In addition to these considerations, emerging growth companies going public will benefit from the eased disclosure obligations, which should reduce their expenses.
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1 The term “accredited investor” is defined in Rule 501 under the Securities Act. The term includes (but is not limited to): natural persons with individual or joint net worth with a spouse of more than $1 million excluding the value of their primary residence; natural persons with incomes of more than $200,000 (or joint incomes of $300,000 for married couples) per year for the past two years, with a reasonable expectation that such income levels will be attained in the current year; and certain banks, business development companies, trusts and other entities.
2 See SEC Interpretation: Use of Electronic Media, Securities Act Release No. 7856 (April 28, 2000).
3 There is also a limit on the amount of securities that may be sold to any one investor in any 12-month period.
4 The registration threshold in Section 12(g)(1)(A) has two parts – it also requires an issuer to have $10 million in total assets.
Private Offerings
Use of Publicity in Rule 506 Offerings
Section 201(a) of the JOBS Act requires the SEC to eliminate the prohibition against general solicitation and general advertising for offerings made pursuant to Rule 506 of Regulation D, provided that all purchasers of such securities are accredited investors1.
The JOBS Act deadline for this rulemaking is July 4, 2012, although it is uncertain whether the SEC will be able to meet this or the other deadlines for rulemaking contained in the JOBS Act. Once the SEC completes its rulemaking, an issuer or a person acting on behalf of an issuer will be able to promote the sale of a security through a general solicitation or general advertising without registering the security under the Securities Act if all of requirements of Rule 506 are satisfied and all of the purchasers in the offering are accredited investors.
The rules to be adopted by the SEC must require issuers to take reasonable steps to verify that the purchasers in the Rule 506 offering are accredited investors. It is anticipated that this will require more than the self certifications from investors customarily used in the past. It remains to be seen whether these rules will affect the manner in which general solicitation and general advertising may be undertaken.
Restricted access website services may play a more prominent role in future Rule 506 offerings. While such services now operate under no-action letters and interpretive advice provided the staff of the SEC2, the JOBS Act expressly authorizes third parties to operate websites or other platforms that facilitate the offer, sale, negotiation, or advertisement of Rule 506 transactions, and to provide “ancillary services” (such as due diligence or standard documentation) without having to register as a broker-dealer under Section 15(a)(1) of the Securities Exchange Act of 1934 (Exchange Act). This exemption is conditioned only upon the third party (1) receiving no compensation in connection with the purchase or sale of the security, (2) not holding investor funds or securities in connection with the transaction and (3) not being subject to statutory disqualifications based on prior bad acts.
The easing of the existing restrictions on publicity should benefit life science companies seeking capital by permitting them to reach a greater number of potential investors than they can under the existing rules. This benefit will become available only after Rule 506 is amended by the SEC, as required by the JOBS Act. Until that time, the prohibition on general solicitation and general advertising applies and Rule 506 offerings should be undertaken using the customary past practices.
Crowdfunding
The JOBS Act permits private companies to raise up to $1 million in a 12-month period through crowdfunding. To qualify for this exemption from registration, the offering must be made through an intermediary, who may be a registered broker-dealer or a “funding portal” – a new type of entity created by the JOBS Act.3 This exemption must be implemented by SEC rulemaking and the JOBS Act requires those rules to be in place by the end of this year. An issuer who sells securities pursuant to the crowdfunding exemption must file certain information with the SEC, provide that information to the broker or the funding portal, and make that information available to potential investors. After the offering, the issuer will be required to file annually with the SEC and provide to investors reports of the results of operations and financial statements of the issuer. Securities purchased in connection with the crowdfunding exemption are restricted securities and may not be transferred during the one-year period beginning on the date of purchase except to the issuer or an accredited investor. Sales of securities pursuant to the crowdfunding exemption will not be subject to state law registration. However, states will have jurisdiction with respect to fraud or deceit in connection with an offering using the crowdfunding exemption.
While this crowdfunding exemption may be of benefit entrepreneurs and early stage companies, it will be limited utility to life science companies because of the limit on the dollar amount that can be raised, the administrative and reporting requirements it imposes, and the possible creation of a substantial unsophisticated shareholder base. Because of these factors, it is also uncertain whether an institutional investor would be willing to provide subsequent financing to a company that has sold securities in reliance on the crowdfunding exemption.
Increase of Shareholder Threshold for Public Company Reporting
The JOBS Act amends Section 12(g)(1)(A) of the Exchange Act to increase the threshold number of record holders which triggers registration under the Exchange Act from 500 record holders to 2,000 record holders, or 500 record holders who are not accredited investors.4 In determining whether these thresholds have been exceeded, an issuer can exclude persons who received securities pursuant to an employee compensation plan in transactions exempt from registration under the Securities Act of 1933 (Securities Act).
This provision benefits life science companies by extending the time when they will become subject to SEC reporting and by permitting equity based compensation to be issued without an impact on that date.
Exempt Public Offerings Up To $50 Million
The existing exemption for small public offerings provided by Regulation A has seldom been used, presumably because it is limited to an offering of no more than $5 million. With an increased limit of $50 million, this form of small public offering may be of interest to life science companies and their investors because the securities purchased are unrestricted and may be freely resold. An issuer will also be able to "test the waters" prior to the offering on terms to be established by the SEC. The securities will also be exempt from state blue sky laws registration if they are offered and sold on a national securities exchange or if they are sold to a qualified purchaser, as defined by the SEC.
An issuer using this exemption will be required to file an offering statement with the SEC which includes audited financial statements, a description of its business, its financial condition, its corporate governance principles, its use of investor funds, and other items to be determined by the SEC. In addition, the JOBS Act authorizes the SEC to require an issuer using this type of offering to file periodic reports.
There is no rulemaking deadline in the JOBS Act for this new exemption.
When implemented by SEC rulemaking, this new exemption should provide an attractive means for a life science company to conduct a small public offering and create a public trading market in its securities. It could prove more attractive vehicle than so called “alternative public offerings”, such as reverse shell mergers, because a company completing an offering under this new exemption would not automatically become subject to Exchange Act reporting.
Registered Public Offerings by Emerging Growth Companies
The JOBS Act makes an initial public offering (“IPO”) by smaller companies more attractive by easing some of the burdens of the IPO process and by easing the subsequent public reporting requirements. Companies with less than $1 billion in annual gross revenues (so-called “emerging growth companies”) can take advantage of the following benefits in an IPO –
- Testing the waters communications. An emerging growth company may communicate with potential investors that are qualified institutional buyers and institutional accredited investors to determine investor interest in a contemplated securities offering.
Confidential filing of registration statement. An emerging growth company may file the registration statement for its initial public offering on a confidential basis, provided that the initial registration statement and all amendments are filed on a public basis at least 21 days before the commencement of a road show.
Reduced audited financial statement requirements. An emerging growth company only needs to provide two (instead of three) years of audited financial statements in its registration statement for an initial public offering. Selected financial data is not required for earlier periods.
Reduced executive compensation disclosure. An emerging growth company only needs to provide the executive compensation disclosure required of smaller reporting companies under Item 402 of Regulation S-K.
Exemption from new accounting standards. An emerging growth company does not need to comply with new or revised accounting standards issued by the Financial Accounting Standards Board after April 5, 2012 until such standards apply to private companies.
Securities analyst communications. The restrictions on research analysts’ participation in discussions with IPO underwriting clients are relaxed. Research reports can be published about an emerging growth company that is conducting an initial public offering of its common equity securities. The restrictions on the timing of post-IPO research reports and public appearances by research analysts have also been eased.
- Auditor attestation of internal controls. An emerging growth company does not need to provide the auditor attestation of internal controls otherwise required by Section 404(b) of the Sarbanes-Oxley Act of 2002. However, an emerging growth company must still provide management's assessment and conclusions regarding the effectiveness of internal controls and procedures.
Stockholder advisory votes on executive compensation and golden parachute compensation. An emerging growth company does not need to hold stockholder advisory votes on executive compensation and golden parachute compensation.
Executive compensation disclosure. An emerging growth company only needs to provide the executive compensation disclosure required of smaller reporting companies under Item 402 of Regulation S-K. In addition, an emerging growth company need not provide disclosures comparing executive compensation to the company’s financial performance or the ratio of the total annual compensation of the Company’s CEO to the median total compensation of all employees, which would otherwise be required by Section 14(i) of the Exchange Act and Section 953(b)(1) of the Dodd-Frank Wall Street Reform and Consumer Protection Act.
Selected financial data. An emerging growth company does not need to provide selected financial data for any period before the earliest audited period in its IPO registration statement.
New accounting standards. An emerging growth company does not need to comply with new or revised accounting standards issued by the Financial Accounting Standards Board after April 5, 2012 until such standards apply to private companies.
Certain PCAOB requirements. An emerging growth company will be exempt from any rules of the Public Company Accounting and Oversight Board (PCAOB) requiring mandatory audit firm rotation or requiring a supplement to an audit report providing additional information about an audit. An emerging growth company will also be exempt from any future PCAOB rules applying to audits unless the SEC determines that they are necessary or appropriate in the public interest.
This "on ramp" to becoming a public company can provide substantial benefits to a life sciences company in a position to consider going public. The ability to test the waters and file a registration statement on a confidential basis can help private avoid the embarrassment of a failed IPO due to lack of investor interest and avoid needlessly exposing competitive and other sensitive information if an offering cannot be completed. In addition, filing a registration statement on a confidential basis could be of strategic benefit to an emerging growth company pursuing a dual track IPO and private M&A sale process. In addition to these considerations, emerging growth companies going public will benefit from the eased disclosure obligations, which should reduce their expenses.
_____________________________________________
1 The term “accredited investor” is defined in Rule 501 under the Securities Act. The term includes (but is not limited to): natural persons with individual or joint net worth with a spouse of more than $1 million excluding the value of their primary residence; natural persons with incomes of more than $200,000 (or joint incomes of $300,000 for married couples) per year for the past two years, with a reasonable expectation that such income levels will be attained in the current year; and certain banks, business development companies, trusts and other entities.
2 See SEC Interpretation: Use of Electronic Media, Securities Act Release No. 7856 (April 28, 2000).
3 There is also a limit on the amount of securities that may be sold to any one investor in any 12-month period.
4 The registration threshold in Section 12(g)(1)(A) has two parts – it also requires an issuer to have $10 million in total assets.
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