How the JOBS Act Changed the Rules of the IPO Game

A few weeks ago, a new law came into effect in the United States that made significant changes to how small companies can raise money. 

The Jumpstart Our Business Startups Act (better known by its nickname, the “JOBS Act”) aims to ease the process for startups to seek investments, with a potentially dramatic effect.

Now, two years after the JOBS Act became law, we can look back and see just what effect these changes have had on the process of taking startups through initial public offerings (IPOs), and how this affects Israeli startups.

The JOBS Act

The JOBS Act deals with regulation of both private and public offerings. While the private offering provisions provide for significant loosening of the regulatory process, important administrative rules still have not come into effect. Thus, it is still too early to assess the impact of these changes. The IPO rules, however, took effect very quickly so we have two full years of post-JOBS Act IPO trends.

The JOBS Act created a new category of companies, called emerging growth companies (EGCs). These companies enjoy a lighter regulatory burden so that they will have an easier “on-ramp” to an IPO. The American idea of an “emerging” company is any company that has less than $1 billion in revenues per year. As a practical matter, all but the very largest Israeli companies qualify as EGCs.

The special lighter IPO rules that apply to EGCs include:

• Confidential submission of early drafts of the prospectus to the SEC.
• An opportunity to “test the waters” by holding meetings with sophisticated investors in order to gauge the interest of potential participants in the IPO.
• Scaled financial disclosure, which allows companies to go public based on two years (rather than three) of audited financial results and two years (rather than five) of “selected financial data”.
• Extended time to comply with the internal controls provisions of the Sarbanes-Oxley Act, allowing up to five years to come into full compliance (rather than two years).

Confidential submission is a luxury that was available to non-US companies for many years. Curiously, the old “silent filing” rules that applied to non-US companies were curtailed significantly only a few months before the JOBS Act came into effect. The JOBS Act restored and even enhanced the confidentiality provisions, and extended them to all EGCs, whether US-based or not. This allows a company to begin the process of obtaining comments from the SEC without publicizing competitive information too far in advance of the IPO. Also, if the IPO process fails, whether for market conditions or other factors, a company can abandon a confidential filing quietly and without embarrassment.

The “test the waters” provisions are completely new and are a significant liberalization of the rules. Prior to JOBS, early contacts with potential investors were forbidden. 

Now, by allowing an EGC to contact potential IPO investors very early in the process, a company can get a reality check to help it gauge the potential for success of the IPO. The scaled financial disclosure provisions and the extended compliance time for Sarbanes-Oxley controls can significantly decrease IPO accounting expenses and compliance costs in the first few years following an IPO.

There are many factors that that have contributed to today’s very hot IPO market. Certainly, favorable economic conditions, particularly in certain industries, have played a role. There can be no doubt, though, that the removal of hurdles in the post-JOBS Act “IPO on-ramp” have been a factor.

Observers point, for example, to the successful US IPOs of “pre-revenue” companies like Energous, Flexion and Ampio. The ability to test the waters with sophisticated investors while maintaining confidentiality about the process allows these issuers to attain some confidence that they will be able to sell out their IPOs even though they have never seen a dollar of revenue. Presumably, there are others whose names we do not, and may never, know. This is because their initial contacts with investors persuaded them that their IPOs would not succeed.

Each year that the JOBS Act has been in effect has seen an increase in the percentage of US IPOs where the issuer was an EGC. In addition, each year has seen an increase in the proportion of confidential submitters. The scaled financial disclosures have been adopted by a majority of EGCs, and the extended time to comply with Sarbanes-Oxley financial controls has been adopted in nearly all EGC IPOs.

Implications for Israeli Startups

For Israeli startups, these changes should mean easier access to capital markets. In the past, smaller Israeli companies have turned to secondary stock markets in Europe and Asia where the financial regulations are less demanding and the IPO process less cumbersome. By moving closer to the reduced regulatory burden of these markets, the US has removed much of the friction in accessing America’s robust capital markets.