Specialized Legal Assistance for Emerging Growth Company
In order for businesses to be classified as emerging growth companies (EGCs), they need to fulfill certain criteria to maintain their EGC designation. However, due to the intermittent and non-linear nature of business performance and profitability, determining whether your emerging growth company complies with the relevant rules and requirements outlined in the Securities Act can pose a challenge.
What Is An Emerging Growth Company (EGC)?
Title I of the JOBS Act, established on April 5, 2012, introduced a new classification for issuers known as "emerging growth companies" (EGCs). An EGC is defined by having total annual gross revenues below $1.07 billion in its most recently completed fiscal year and having conducted its first equity sale in a registered offering after December 8, 2011. The EGC status is relinquished on the earlier of (i) the last day of the fiscal year in which its revenues exceed $1,070,000,000; (ii) the last day of the fiscal year following the fifth year post-IPO; (iii) the date it issues more than $1,070,000,000 in non-convertible debt over the preceding three years; or (iv) the date it qualifies as a large accelerated filer, indicated by a non-affiliated public float valued at $700 million or more.
What Are The Benefits Of An EGC?
An emerging growth company (EGC) enjoys various advantages, such as reduced disclosure obligations in both initial public offerings (IPOs) and regular reporting, exemption from the auditor attestation requirements outlined in Section 404(b) of the Sarbanes-Oxley Act, the ability to confidentially submit registration statements, specific test-the-waters rights in IPOs, and simplified communication and reporting with analysts throughout the EGC IPO process.
Since the passage of the JOBS Act, the FAST Act has provided additional benefits to an EGC, including the omission of certain historical financial statements in registration statements, an advantage that the Securities and Exchange Commission (SEC) has now extended to all companies. Moreover, the ability to file confidential registration statements has also been expanded to include all companies.
While a smaller reporting company shares some benefits with an emerging growth company (EGC), there are distinctions in the scaled disclosure requirements. To provide a concise overview, it's essential to highlight the similarities and differences in disclosure obligations between an EGC and a smaller reporting company.
EGCs And The Five-Year Rule
The first emerging growth companies will begin losing EGC status as the fifth anniversary of the creation of an EGC has now passed. Those companies that will lose status due to the passage of time are almost unilaterally not pleased with the impending change and concurrent increase in regulatory compliance.
Can An EGC Qualify As AN SRC?
A company that exits EGC status and does not qualify as a smaller reporting company will either be a non-accelerated filer, accelerated filer, or large accelerated filer with concurrent disclosure requirements.
Real-World Impact
In accordance with Section 404(a) of the Sarbanes-Oxley Act, companies are obligated to incorporate in their annual reports on Form 10-K a statement from management regarding the company's internal control over financial reporting (ICFR). This statement should:
Affirm management's responsibility for establishing and sustaining the internal control structure.
Include management's evaluation of the effectiveness of the ICFR.
Section 404(b) further mandates that the independent auditor must attest to and report on management's judgment. Essentially, for an auditor to review, gather information on, and provide certification for management's ICFR, they must conduct an independent audit of the internal control structure.
Limited information and guidance are available regarding an auditor's responsibilities under Section 404(b), which includes PCAOB Auditing Standard No. 5. While various estimates exist, a general consensus, based on a broad assessment, suggests that the average annual cost of compliance with Section 404(b) for a company with a public float ranging from $75 to $250 million exceeds $250,000, and in some cases, the costs can be much higher.
During a meeting of the SEC Advisory Committee on Small and Emerging Companies on September 13, 2017, an executive from a biotechnology company, which is losing its status as an emerging growth company and will no longer qualify as a smaller reporting company, sought relief. Among the challenges faced by the company, the auditor attestation requirements under Section 404(b) of the Sarbanes-Oxley Act were highlighted as particularly significant.
Sutro Biopharma's CEO, William Newell, presented to the Advisory Committee, supporting the proposed expansion of the definition of a smaller reporting company. However, he also advocated for the continued exemption of smaller reporting companies, including pre-revenue entities like Sutro, from compliance with Section 404(b). Notably, Sutro, being pre-revenue like many biopharma companies, emphasized the financial burden of Section 404(b) compliance on companies with a substantial public float, diverting funds that could otherwise be allocated for growth and increased staffing.
Furthermore, Sutro, being a private company, highlighted the onerous compliance costs as a hindrance to accessing public markets. This perspective aligns with the SEC's public discussions about the imperative to invigorate the U.S. IPO market, a sentiment expressed by Chair Jay Clayton and Commissioner Michael Piwowar in their respective speeches.
There is optimism for companies facing these challenges. The current SEC administration is in favor of facilitating capital-raising initiatives and reducing regulatory burdens for both large and small companies. The prospective Financial Choice Act carries the potential to raise the compliance threshold for Section 404(b) for companies with a public float of $500 million or more.
Additionally, the SEC Government-Business Forum on Small Business Capital Formation actively supports the revision of the smaller reporting company definition and advocates for an increase in the compliance threshold for Section 404(b). These efforts signify a collective push towards regulatory adjustments that could benefit companies, especially those with substantial public floats, by potentially easing compliance requirements and fostering a more favorable environment for capital
Differences Between EGCs And SRC Disclosure Requirements
The scaled-down disclosures for smaller reporting companies and emerging growth companies include, among other items:
Only three years of business description as opposed to 5.
Two years of financial statements as opposed to 3.
Eliminate certain line-item disclosures, such as graphs and selected financial data.
Relief from the 404(b) auditor attestation requirements.