While much of the focus of the JOBS Act has been on its impact on entrepreneurs, the bill also could have significant effects on buyout shops, lawyers say.
For one thing, the bill, which is rocketing toward adoption in Congress, and which President Barack Obama has said he will sign, could ease restrictions that buyout shops face in raising capital for funds and debt for deals. It could also increase the flexibility that companies have both while they are in sponsor portfolios and after they go public.
“There are a lot of aspects of this law that will benefit the private equity model,” said Matthew E. Kaplan, a partner at the law firm Debevoise &Plimpton LLP. “There have been calls for capital formation reform for quite a while.”
Much of the early attention on the Jumpstart Our Business Startups Act.has focused on the Facebook problem, in which the social network has experienced such an active secondary market for the private trading of its shares that it will be practically forced to go public after it accumulates 500 shareholders.
All told, the JOBS Act is a compilation of six pieces of legislation, some of which had passed the House previously, and were repackaged by House Majority Leader Eric Cantor, Kaplan said. While some changes may require rulemakings by the Securities and Exchange Commission, much of the law could take effect immediately
The lawyers said the law is likely to affect buyout shops in at least four major areas:
The JOBS Act eliminates the ban on general solicitation for sponsors going to market to raise a new fund. Under current securities law, Regulation D Rule 506 provides a “safe harbor” provision exempting such funds from registration only if the sponsor refrains from promoting the offering to the general public. Under the new law, the exemption is no longer at risk if the fund receives publicity, as long as the sponsor accepts commitments only from accredited investors.
“That will not cause the offering to lose its private placement status,” but existing limits apply to who is defined as an accredited investor, Kaplan said. “Those are the only people to whom private equity firms are marketing their funds in any event.”
This will make for easier communications in fund private placements, said Richard E. Farley, a partner at the law firm Paul Hastings LLP. “Anything you can say in an offering document, you can now say, virtually, in a press release.”
A similar ban on general solicitation applies to private debt deals, such as high-yield bonds. Here again, the ban goes away, as long as the dealmaker ultimately arranges financing only with qualified institutional buyers.
In principle, that would allow a sponsor to sell high-yield debt by advertising in the New York Times, Kaplan said. “You still need reasonable policies and procedures to ensure that you are ultimately selling these securities to the appropriate investors, to qualified institutional buyers.”
Realistically, however, debt marketing is not likely to change much, Farley said. “You are not going to be advertising to a wider group, because there is no wider group to advertise to.”
3) Managing The Portfolio
Especially when a company seeks to expand, the JOBS Act could make it easier to raise additional capital. Under the Securities Act of 1933, a company is now limited to a $5 million capital raise before registration requirements kick in. Under the new law, that ceiling will rise to $50 million.
The new law also will make it easier to bring in additional investors, and, especially in growth capital situations, will make it easier for companies to use equity compensation to attract and retain employees. No longer will employees count toward the shareholder trigger for public company reporting, which will rise to 2,000 persons of record from the existing 500-shareholder limit, Kaplan said. “A private company can stay private longer, from the perspective of granting equity compensation deep into the ranks of their employees or bringing in additional investors.”
This is the area where the JOBS Act could have its biggest impact on the buyout market, especially by easing the rules on IPOs. Basically any company with less than $1 billion in revenue is considered an “emerging growth company” under the law, offering significant relief from disclosure requirements.
For instance, a company will be able to submit the first draft of its registration statement privately to the SEC for review, Kaplan said. “You can discuss more sensitive issues on a confidential basis with the SEC so that the first public filing you make has the benefit of SEC review.”
The new law also will require only two years of financial statements rather than three, so the management discussion will involve only one set of period-to-period changes, rather than two, and it will require less disclosure of executive compensation.
In addition, the new law will enable a company to conduct a pre-filing roadshow to see if there’s enough interest in the market even to even go through the IPO process, Kaplan said. “You can test the waters before you file an IPO prospectus.”
But the new law will not do away with rules on fraud, material misstatements or omissions, and it will not change state securities laws. Nor is it likely to prompt sponsors to use crowdfunding platforms such as Kickstarter, Farley said. “It’s theoretically possible, but I don’t really see it. When you’re selling the equity, you want to have a very managed process, with a share price trading market when you’re done that doesn’t trade like dogshit. The last thing you want is a trading market in your equity that is artificially depressed because there are no market makers and there’s sloppy trading.”
After its IPO, an emerging growth company can delay compliance with certain regulations, such as the Sarbanes-Oxley audit requirement that management attest to the quality of internal controls, as well as the Dodd-Frank mandated disclosure of the ratio of executive compensation to regular employee compensation. A post-IPO company also can delay compliance with new or changed accounting requirements.
“This law includes significant changes to long-standing federal securities laws and regulations and in many ways will change the way offerings are conducted and the methods and timing of capital raises, probably incrementally at first,” Kaplan said. “These things tend to evolve over time.”
If there is a surprise in the legislation, it may be that it is happening at all. “I think it’s a function of this being an election year,” Farley said. “I doubt this would have gotten done if it were not an election year, at least not as quickly. It could have gotten done eventually – I think it’s a good law – but it would have taken a longer period of time and the votes would have been a lot less lopsided.”