SEC Adjusts Definition of Emerging Growth Companies
On September 9, 2022, the Securities and Exchange Commission (the “SEC”) adopted a number of inflation-related adjustments under the Jumpstart Our Business Startups Act (the “JOBS Act”), including an adjustment to the revenue cap in the definition of “emerging growth company” (“EGC”), as well as adjustments to certain thresholds and limitations in the crowdfunding exemption under Regulation Crowdfunding.
EGCs are currently defined to mean, among other things, an issuer that had total annual gross revenues of less than $1,070,000,000. Under the JOBS Act, the SEC is required, every five years, to index to inflation that annual gross revenue limitation to reflect the change in the Consumer Price Index for All Urban Consumers published by the Bureau of Labor Statistics. As adjusted, the new inflation-adjusted EGC revenue cap will be $1,235,000,000, up from $1,070,000,000.
The JOBS Act became law in April 2012 with a goal of improving access to capital markets and easing compliance burdens for newer and smaller public companies. The JOBS Act made registration and reporting requirements easier for companies classified by the SEC as “emerging growth companies” or “EGCs.”
Our client advisory summarizes the changes adopted and highlights how these changes could impact growing startups. The new inflation-adjusted amounts will become effective upon publication in the Federal Register.
Summary of the ChangesTitle I of the JOBS Act added Securities Act Section 2(a)(19) and Exchange Act Section 3(a)(80) to define the term “emerging growth company”. Pursuant to the statutory definition, the SEC is required every five years to index to inflation the annual gross revenue amount used to determine EGC status to reflect the change in inflation. The amendments increase that amount from $1,070,000,000 to $1,235,000,000.
Title III of the JOBS Act added Securities Act Section 4(a)(6), which provides an exemption from the registration requirements of Securities Act Section 5 for certain crowdfunding transactions. Sections 4(a)(6) and 4A of the Securities Act set forth dollar amounts used in connection with the crowdfunding exemption, and, similar to the EGC definition, Section 4A(h)(1) states that such dollar amounts shall be adjusted by the SEC not less frequently than once every five years to reflect the change in inflation.
Why Is This Important?The inflation adjustment of the total annual gross revenue threshold for EGCs is designed to maintain the scope of registrants that may qualify as an EGC, preserving the economic effects associated with the option to claim EGC status.
According to the SEC, the inflation adjustment amendment could marginally expand the number of issuers that may claim EGC status, thus extending the economic effects, including impacts on efficiency, competition, and capital formation, of the option to claim this status to issuers that fall between the current $1,070,000,000 gross revenue threshold and the $1,235,000,000 gross revenue threshold that will define EGC eligibility under the amendments. Using the number of filers and the distribution of filer revenues in calendar year 2021, the SEC estimates that the inflation adjustment of the EGC revenue threshold will increase the overall number of EGCs by 51, from approximately 1,704 (23.7% of the total number of filers (7,199)) to approximately 1,755 (24.4% of the total number of filers (7,199)); among them, the number of domestic issuers that qualify as EGCs would increase by 45, from approximately 1,391 (22.3% of the total number of domestic-form filers (6,232)) to approximately 1,436 (23.0% of the total number of domestic-form filers (6,232).
The amendments to Regulation Crowdfunding adjust the thresholds in Rules 100(a)(2) and 201(t) in accordance with inflation as required by Section 4A(h) of the Securities Act and are not expected to increase disclosure or compliance costs incurred by an issuer. The adjustment will cause some issuers to become subject to less extensive financial statement requirements and may lower disclosure or compliance costs for these issuers. The adjustment will also increase the amounts of securities that may be sold to a given investor, which may expand some issuers’ ability to raise capital and some investors’ ability to gain exposure to Regulation Crowdfunding investment opportunities.
ConclusionThis adjustment by the SEC expands the number of companies that can take advantage of the eased registration and reporting requirements for EGCs. An EGC can take advantage of JOBS Act accommodations for up to five years. These accommodations include less extensive narrative disclosure than required of other reporting companies (particularly in the description of executive compensation), the requirement to provide audited financial statements for two (instead of three) years and the ability to use test-the-waters communications with qualified institutional buyers and institutional accredited investors.
Kelley Drye lawyers are available to assist with any questions you may have regarding these issues.