Nearly eight weeks after the Jumpstart Our Business Startups Act (“JOBS Act”) was signed into law, the first group of Emerging Growth Companies (each, an “EGC”), as defined in Section 101 of the JOBS Act, have publicly filed registration statements to the SEC that include EGC-specific risk factors. In a May 21, 2012 post on The Corporate Counsel blog, Broc Romanek identified nine such companies:
· Blue Earth Inc.
· Cimarron Software, Inc.
· KYTHERA Biopharmaceuticals, Inc.
· LegalZoom.com, Inc.
· OncoMed Pharmaceuticals, Inc.
· Plesk Corp.
· Shutterstock, Inc.
· Simple Products Corporation· Supernus Pharmaceuticals, Inc.
In its registration statement, each EGC (other than Supernus Pharmaceuticals) included a risk factor that generally discusses its exemption from certain reporting requirements pursuant to the JOBS Act and some potential resulting effects on the market for its shares. Additionally, two of the three EGCs that have elected to avail themselves of the extended implementation period for new or revised financial accounting standards included additional risk factor disclosure relating to this election. Finally, some EGCs have included expanded risk factor disclosure relating to the exemption from compliance with the auditor attestation requirements under Section 404(b) of the Sarbanes-Oxley Act of 2002.
Exemption from Reporting Requirements
The general EGC risk factor included in the registration statement of each of these companies (other than Supernus Pharmaceuticals) provides a paragraph that identifies the company’s ability to take advantage of exemptions from various reporting requirements otherwise applicable to non-EGC public companies. These exemptions include:
- not being required to comply with the auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act
- reduced disclosure obligations regarding executive compensation in periodic reports and proxy statements
- exemptions from the requirements of holding a nonbinding advisory vote on executive compensation and shareholder approval of any golden parachute payments not previously approved.
The general EGC risk factor also includes a discussion of how long the company will remain an EGC, and possible events that would terminate its EGC status. These companies also included a discussion of market risks associated with relying on these exemptions, similar to the following:
“We cannot predict if investors will find our common stock less attractive because we may rely on these exemptions. If some investors find our common stock less attractive as a result, there may be a less active trading market for our common stock and our stock price may be more volatile.”
Supernus Pharmaceuticals, which had not yet decided whether to take advantage of the exemptions, included in the Summary section of its registration statement a discussion of the EGC reporting exemptions and the duration of its EGC status that is similar to the discussion contained in the general risk factor presented in the registration statements of the other EGCs. It did not, however, include a market risk discussion. Instead, Supernus Pharmaceuticals highlighted that, should it choose to take advantage of these exemptions, the disclosures received by shareholders may be different than those that shareholders may receive from other public companies:
“We may choose to take advantage of some but not all of these reduced burdens. We have not taken advantage of any of these reduced reporting burdens in this prospectus, although we may choose to do so in future filings. If we do, the information that we provide stockholders may be different than you might get from other public companies in which you hold stock.”
Another company identified the possibility that, should it take advantage of these exemptions, investors and analysts may have greater difficulty evaluating the company:
“If we avail ourselves of certain exemptions from various reporting requirements, our reduced disclosure may make it more difficult for investors and securities analysts to evaluate us and may result in less investor confidence.” (Shutterstock)
Finally, one company stated that it may forgo the exemptions in the future, and that doing so would cause the company to incur greater expenses:
“Because the JOBS Act has only recently been enacted, it is not yet clear whether investors will accept the more limited disclosure requirements that we may be entitled to follow while we are an ‘emerging growth company.’ If they do not, we may end up electing to comply with the disclosure requirements as if we were not an ‘emerging growth company,’ in which case we would incur the greater expenses associated with such disclosure requirements.” (OncoMed Pharmaceuticals)
Delayed Adoption of New or Revised Accounting Standards
Under Section 102(b) of the JOBS Act, EGCs are not required to adopt new or revised accounting standards until the date that a private company is required to adopt such new or revised accounting standards, if such standards apply to private companies. Six of the nine companies elected not to avail themselves of this extended transition period available to EGCs. We believe that many EGCs and underwriters are choosing not to delay the adoption of new accounting standards, primarily due to concerns about comparability of the EGCs’ financial results with others in its industry. It is notable that the EGCs in our survey group that have elected to delay the adoption of new accounting standards do not appear to be engaging in underwritten offerings. It remains to be seen whether, and under what circumstances, investment banks will be willing to underwrite initial public offerings of EGCs that elect to rely upon this exemption.
The six companies that have decided not to delay the adoption of new accounting standards noted the availability of the exemption and disclosed their irrevocable decision to “opt out” of the exemption. One company included this disclosure only in its risk factor (Blue Earth), two companies included this disclosure in their risk factors and their MD&A (Legal Zoom and OncoMed Pharmaceuticals) and three included it only in their MD&A (KYTHERA Biopharmaceuticals, Shutterstock and Supernus Pharmaceuticals).
All three companies that are availing themselves of the extended transition period disclosed in their risk factors that they would be delaying the adoption of new or revised accounting standards pursuant to the exemption. One company noted its reliance on the extended transition period in the general discussion of the risks associated with the exemptions from reporting requirements available to EGCs (Plesk). The other two companies disclosed that their reliance on the exemptions from reporting requirements, and their decision to avail themselves of the extended transition period, may make it more difficult for them to raise capital:
“Because of the exemptions from various reporting requirements provided to us as an ‘emerging growth company’ and because we will have an extended transition period for complying with new or revised financial accounting standards, we may be less attractive to investors and it may be difficult for us to raise additional capital as and when we need it. Investors may be unable to compare our business with other companies in our industry if they believe that our financial accounting is not as transparent as other companies in our industry. If we are unable to raise additional capital as and when we need it, our financial condition and results of operations may be materially and adversely affected.” (Cimarron; Simple Products)
Sarbanes-Oxley Accounting Attestation
Each company referenced the permitted exemption from the auditor attestation requirements of Section 404(b) under the Sarbanes-Oxley in the general EGC risk factor. Several companies also explicitly noted that they would not be required to comply with Section 404(b) until termination of their EGC status and that, at that time, their auditors could issue an adverse opinion on their internal control over financial reporting. This disclosure was generally included in a risk factor that addressed Sarbanes-Oxley compliance or, in one case (KYTHERA Biopharmaceuticals), in a risk factor that addressed public company compliance requirements generally:
“Our independent registered public accounting firm will not be required to formally attest to the effectiveness of our internal control over financial reporting until the later of the year following our first annual report required to be filed with the SEC, or the date that we are no longer an ‘emerging growth company.’ At such time that an attestation is required, our independent registered public accounting firm may issue a report that is adverse in the event that it is not satisfied with the level at which our controls are documented, designed or operating. Our remediation efforts may not enable us to avoid a material weakness in the future.” (Shutterstock)