JOBS Act Risk Disclosures IPOs

The new law, which loosens reporting requirements for smaller businesses, has prompted some companies to actually add information to their regulatory filings.

CFO Magazine
Sarah Johnson

In the run-up to Facebook’s initial public offering, which is expected to happen within days, smaller, lesser-known companies are preparing for their own foray onto U.S. stock exchanges as well. Naturally, they are alerting investors in public filings that their small stature and lack of public-company experience can make investing in their stock a risky endeavor. Some are going even further and emphasizing that the Jumpstart Our Business Startups (JOBS) Act is itself a risk factor.




Seal of the U.S. Securities and Exchange Commission. (Photo credit: Wikipedia)

Over the past week, at least 13 companies … have warned investors in their prospectuses filed with the Securities and Exchange Commission that the JOBS Act’s breaks on SEC rules could actually be a turnoff. “We cannot be certain if the reduced disclosure requirements applicable to emerging growth companies will make our common stock less attractive to investors,” reads a statement in boldface type by Cimarron Software in an S-1 form submitted to the SEC yesterday.

The trend may reflect an unintended consequence of the JOBS Act, which lawmakers hope will lead to a more active IPO market, according to Michael Stocker, a partner at law firm Labaton Sucharow, who represents institutional investors. The filings are saying “that because the companies are willing to take advantage of the related standards for disclosures under the JOBS Act, one real risk is that they will be punished by investors, since investors won’t be getting as much information and they may have less confidence in how the companies are doing,” says Stocker.




What investors want (Photo credit: tjohansmeyer)

Indeed, so-called emerging-growth companies — those that take in less than $1 billion a year in revenue — can wait up to five years after their IPO before following all of the rules that larger listed businesses have to follow. They can submit two audited financial statements with the SEC instead of three, they can avoid holding say-on-pay votes, and, most significantly, they are not required to get their auditors’ signoffs on internal controls over financial reporting.

… Not all companies preparing for an IPO that qualify as emerging-growth companies have included the law as a risk factor.




Logo og McDermott Will & Emery (Photo credit: Wikipedia)

However, they may want to consider doing so, according to Thomas J. Murphy, a partner at law firm McDermott Will & Emery who helps companies with their public offerings. “It’s cheap insurance and good disclosure to call out for people places where you differ from other public companies,” he says.
The additional disclosure implies the company using it is trying to be comprehensive. Moreover, the lines of text may help it later on if it runs into trouble. “If an emerging-growth company has a failure of its controls and has to restate its financial statements, the disclosure is going to be a plus when that company defends itself against a lawsuit,” Murphy says. The business can respond by saying, “We warned you that there weren’t auditors looking independently at this.”

The plaintiffs’ bar could have a retort, however, Stocker suggests. “All the disclosure says is that because of the JOBS Act, the company’s stock may not trade as high a volume or [for as] good a price as you may hope,” he says. “It’s not saying because of the JOBS Act you may get a nasty surprise at the end of five years.”

Related articles

• The New Landscape for Business Startups and Their Investors (toddballenger.typepad.com)
• Going Public In Private: The Boom In Secret IPOs (forbes.com)
• Much Ado About the JOBS Act: Fear Mongering vs. Idealism Cloud (pandodaily.com)

A Look at Obama's JOBS Act

The Network Journal:

By: ANN BROWN

Wednesday, April 25, 2012

• Business

On the surface, President's Obama's recently signed the JOBS Act, for Jump-Start Our Business Start-Ups, which will roll back restrictions on the way start-up companies can raise money from individual investors, seems like a win-win for small businesses. But says management, strategy and branding consultant Steven Mason, president of the Brand Mason, there is more to it.

"The JOBS Act is a boon to private companies, which drive job creation and the GDP. The most significant impact of the recently passed JOBS Act is that private companies will be able to raise money from individuals who are not "accredited". This means that investors who have not been considered wealthy enough by the SEC to be designated an accredited investor will now be able to make direct equity investments in private companies,” says Brian Hamilton, CEO of financial information company Sageworks and a noted expert on privately-held companies. “It would be hard to overstate the implications of this legislation as it allows small investors access to a market that previously didn't exist to them. Additionally, it gives private companies access to millions of dollars they couldn't previously tap into. It introduces some risk for a new class of investors, but it is very positive for private companies."

BEA logo (Photo credit: willida)

Small businesses can throw a wider net for investors, says Mason. "If you are good at getting hundreds of people to invest small amounts of money, you can potentially raise a large amount of money," he says. Potentially, the bill gives more freedom to startups—and investors. “Small investors can direct investments to their community,” explains  David M. Williams, founding director of professional consultant firm Business Enhancement Associates. “It allows small businesses to go public without SEC filing. It also exempts small businesses from Sarbanes-Oxley audit requirements for five years.”

Among other things, it would allow them to raise small sums from investors via the Internet. According to Obama,  websites will be closely monitored by the Securities and Exchange Commission. Some critics say this component of the bill may leave people vulnerable to fraudulent online schemes. “The abundance of online options for connecting unaccredited investors with private companies presents an inherent potential for fraud and misrepresentation and may draw in undiscerning investors,” notes Hamilton.

There are other cons, he points out. “Comparatively riskier investment opportunities will become available to unaccredited investors since new companies are always the least well known and many young companies fail,” he says. “As far as IPO investing is concerned, private conversations with the SEC about disclosures are not released immediately, and while the company may benefit, it's hard on investors seeking transparent information.”

Also, “crowd-funding platforms and this type of investing are so new that there is likely to be additional fraud. The risk factors of these investments should be made clear. Maximum amounts that individuals can invest based on their income is at a minimum now,” says Hamilton.

David M. Williams, founding director of professional consultant firm Business Enhancement Associates, agrees. “Crowdfunding investors would have no control in management decisions, and no guarantee that their interests would be represented. Small investors add liability, investors who would normally not be qualified or accredited. And the lack of SEC oversight or Sarbanes-Oxley guidelines make fraud or mismanagement more likely,” he says. There are other drawbacks to the bill he says. “It adds the burden of up to 200 shareholders to management used to closely-held ownership. It also complicates future equity raises, debt financing or recapitalization,” says Williams.

Among the other negatives, says Mason, are "you can raise a maximum of $1,000,000 in any 12-month period and individuals can't invest whatever they want. They are limited to investing percentages of their income and net worth and there's only so much they can invest in one year, across all crowdfunded companies." There are restrictions that may also hinder small businesses seeking funding under the new bill. "Funding Portals have to be registered with the SEC and the SEC hasn't even written all the regulations for them yet, so if the regulations are onerous enough, the entire point of this crowdfunding could be a chimera. Basically, the SEC and the government have the power to make this a complete boondoggle, because these Funding Portals are subject to so many restrictions that it's going to cost issuing companies real money just to comply," Mason points out. "There are significant accounting fees companies will have to incur, and if they are raising more than $500K, they'll need audited financial statements, which are very expensive."

Occupy the Jobs Act (Photo credit: DonkeyHotey)

Adds Mason, “What's happening is that a new surge of available capital will enter the market, making possible a far greater diversity of startups otherwise unable to get funding through other sources, at least in their early stage. At the same time, those funding these businesses will not be professional investors, and there are intriguing issues associated with their different expectations as well as with the ultimate success or failure of their endeavors. Last, while President Obama signed the bill, I would not characterize the bill as an "Obama policy" as the impetus for the main features of the bill did not come from the President. Further, the JOBS bill imposes a number of SEC reporting requirements on those seeking crowdsourced funding: it's not as easy as it sounds, but it certainly sounds great politically.”

The bill was supported by bipartisan lawmakers and entrepreneurs.

Related articles

• Crowdfunding. Who's In? Who's Not? (isellerfinance.wordpress.com)
• The Effect of the JOBS Act on Small Businesses and Investors (beamemphis.blogspot.com)
• More on the JOBS Act: Crowdfund Your Next Round (siliconbayounews.com)

FAQ: What the new U.S. crowdfunding bill means for entrepreneurs

Image via CrunchBase

LinkedIn

Scott Edward Walker is the founder and CEO of Walker Corporate Law Group, PLLC, a law firm specializing in the representation of entrepreneurs.

Last week, the U.S. House of Representatives passed a crowdfunding bill that will allow startups to offer and sell securities via crowdfunding sites and social networks. If passed by the Senate and signed off by the President, the bill will become a law, giving entrepreneurs new options for raising money for their companies. …

What is crowdfunding?

As the term suggests, crowdfunding is funding from a crowd of people; that is, many people provide small amounts of money to finance something. Crowdfunding has its roots in charitable causes, including the advent of microfinancing …

Can startups use crowdfunding now?

Under current laws, startups may not sell stock or other securities through crowdfunding sites or social networks… They may, however, accept donations.
This is because of applicable federal securities laws ... The laws include the following:

• A prohibition against “general solicitation” — which means that a company may not offer or sell securities unless there is a substantive, pre-existing relationship between the company (or a person acting on its behalf) and the prospective investor. (See “Can I Raise Money For My Startup Via Twitter?”)

• Disclosure and state law compliance requirements if the investors are not “accredited investors” — which usually makes the offering too costly and onerous. (See “Ask the attorney — securities laws.”)

• A requirement that any intermediaries (including websites) must be registered with the SEC as a “broker-dealer” in order to legally accept any transaction-based compensation in connection with the sale of securities. (See “Finder keepers could be losers, weepers”).

What will the new crowdfunding bill do?

Basically, if this new crowdfunding bill becomes a law, all of the foregoing prohibitions and requirements will be lifted, and a startup will be able to sell securities through crowdfunding sites like Kickstarter, or social networks like Twitter or Facebook, so long as the company (and its intermediary, if applicable) comply with the bill. According to the bill, the company will have to meet these key provisions:

• The company may only raise a maximum of $1 million, or $2 million if the company provides potential investors with audited financial statements.

• Each investor is limited to investing an amount equal to the lesser of (i) $10,000 or (ii) 10% of his or her annual income.

• The issuer or the intermediary, if applicable, must take a number of steps to limit the risk to investors, including (i) warning them of the speculative nature of the investment and the limitations on resale, (ii) requiring them to answer questions demonstrating their understanding of the risks, and (iii) providing notice to the SEC of the offering, including certain prescribed information.

Are there any downsides to crowdfunding for startups?

Yes, there are several key downsides that you need to be aware of before jumping into crowdfunding.
First, startups must understand that minority stockholders have certain significant rights under state law, including voting rights, the right to inspect the company’s books and records, the right to bring a derivative claim on behalf of the company, and certain protections against oppression by the controlling stockholders. …
Second, having hundreds of stockholders is an administrative nightmare and will be time-consuming and costly. …
Third, startups will likely have difficulty raising funds from VCs and other sophisticated investors if they have hundreds of unsophisticated stockholders. …

What’s next?

Now we wait for the U.S. Senate, … The White House supports the House bill, so upon reconciliation, it will be signed into law. Then entrepreneurs will have a new option to consider when raising money for their startup.

About the Author, Scott Edward Walker

Scott Edward Walker is the founder and CEO of Walker Corporate Law Group, PLLC, a boutique corporate law firm specializing in the representation of entrepreneurs. Scott has 15+ years of broad corporate law experience, including nearly eight years at two prominent New York City law firms. He has built a strong team of lawyers, with offices in Los Angeles, San Francisco and Washington, D.C. You can follow him on Twitter as @ScottEdWalker or check out his blog.

Related articles

• Crowdfunding and Securities Fraud (professorbainbridge.com)
• Crowdfunding bill would expose investors to swindles (baltimoresun.com)
• Infographic: The Crowdfunding Landscape (readwriteweb.com)

How IPO Founders Keep Their Taxes Low

Via a popular way of going public, founding partners can enjoy whopping capital gains without the usual tax bite. Investors may be less than happy about it, though.

CFO.com
Robert Willens -
July 26, 2011

When a partnership goes to the public market for funding, and the offering is successful, the founding partners can enjoy a huge capital gain. …

By means of a popular going-public technique called a tax receivable agreement (TRA), however, the founding shareholders can enjoy hefty tax benefits. … For their part, though, investors may find it hard to factor the effects of TRAs into their calculations of the price of the offering.

TRAs are often used in combination with an "Up-C structure." The Up-C structure enables companies to acquire assets by issuing operating partnership units. Those units may make it possible for the founding owners from whom the company acquires assets to defer recognizing taxable gains until the company disposes of those assets. For example, among many other entities, DynaVox employed this structure in connection with its initial public offering last year.

When a partnership transforms itself into a corporation to make a public offering of ownership interests, the newly formed corporation often becomes a partner in the "operating" partnership. The remaining units in the partnership also continue to be held by the founders of the business. In such cases, the founders will be awarded "high-vote" stock in the corporation — equity that enables them to maintain voting control over the corporation's affairs. For their part, public investors will acquire low-vote stock.

Sometimes the IPO's proceeds will be used by the corporation to buy partnership interests from the founders. In addition, the founders will typically acquire an "exchange right" entitling them to trade partnership interests for low-vote shares issued by the corporation. When these exchanges are separate from the incorporation, they're taxable to the founders because immediately after the exchange the founders aren't in control of the corporation.

But the founders can gain a tax benefit through the use of a TRA. Each time the corporation buys a partnership interest in the partnership, or acquires an interest in a taxable exchange for its stock, the corporation's taxable income derived from the partnership will be diminished (because the purchase increases the amount of amortization and depreciation deductions the purchasing partner will enjoy) and, correspondingly, its tax liabilities will be minimized.

… But the TRA, which is almost standard operating procedure in these types of incorporations, shifts the tax benefits to the persons who transferred the partnership interests to the corporation.

The … TRA … provides that ". . .we will enter into a TRA with our existing owners (the founders) that will provide for the payment by [the company] to our existing owners of 85 percent of the (tax) benefits that [the company] is deemed to realize as a result of the current tax basis in the intangible assets of. . . (the partnership) and the increases in basis resulting from our purchases or exchanges. . . ." The corporation goes on to say that these payments will be "substantial."

TRAs may be fully legal; however, the entire import of these agreements in the price of an IPO might not be fully appreciated by all investors. To the extent the TRAs are not taken into account by such shareholders, they may lead to market inefficiencies.

Robert Willens, founder and principal of Robert Willens LLC, writes a biweekly tax column for CFO.com.

Related articles

• Small Business Break: Get a Refund of Taxes Paid in Previous Years (turbotax.intuit.com)
• Billionaire Anschutz Loses Big Tax Case (forbes.com)
• How big a bite do taxes take out of investors' gains? (usatoday.com)