SEC Issues Proposed Rules to Increase Financial Thresholds Applicable to Smaller Reporting Companies

The U.S. Securities and Exchange Commission (SEC) has proposed rules that would amend the definition of a “smaller reporting company” by significantly increasing the applicable financial thresholds. In an effort to promote capital formation and reduce compliance costs for smaller companies while maintaining important investor protections, the proposal to update the definition would expand the number of companies that qualify as smaller reporting companies, thus qualifying for lower levels of required disclosures in prospectuses and periodic filings (such as requiring disclosures for a reduced number of annual periods and the elimination of the need to include risk factor disclosures and certain financial data).

Smaller reporting companies may provide scaled disclosures under the SEC’s rules and regulations. Currently, smaller reporting companies are generally defined as companies that have less than $75 million worth of company shares that are held by the general public (i.e. public float), or companies that have zero public float and annual revenues less than $50 million.

The proposed rules would revise the definition of smaller reporting company to qualify a company with:

  • less than $250 million of public float, or
  • no public float and less than $100 million in annual revenues.

In addition, as in the current rules, once a company exceeds either of the thresholds, it will not qualify as a smaller reporting company again until public float or revenues decrease below a lower threshold. Under the proposed rules, a company would re-qualify as a smaller reporting company again once its public float is less than $200 million (instead of $50 million under the prior rules) or, if it has no public float, once its annual revenues are less than $80 million (instead of $40 million under the prior rules).

However, we should note that the SEC is not proposing to increase the $75 million threshold in the “accelerated filer” definition. Therefore, companies with public float between $75 million and $250 million may qualify as smaller reporting companies, but still be subject to the requirements that apply currently to accelerated filers, including the timing of the filing of periodic reports and the requirement that accelerated filers provide the auditor’s attestation of management’s assessment of internal controls over reporting required by Section 404(b) of the Sarbanes-Oxley Act of 2002 (unless a company is an “emerging growth company” under the JOBS Act).

Many smaller companies are challenged to meet the excessive reporting and compliance costs that come with being a public company, which the SEC has estimated to be about $2.5 million for initial compliance costs in the case of an IPO and $1.5 million annually for ongoing compliance. The proposed rules, however, would offer substantial compliance and regulatory cost savings to an expanded number of companies (for example by reducing certain financial and executive compensation disclosures in periodic reports and proxy statements).

This may lead to mid-size companies who are currently reluctant to go public to more readily consider that option. However, companies may remain reluctant to go public due to continuing concerns of an increased potential for claims made by investors and related liability.

Public comment on the proposed rules should be received by the SEC no later than 60 days after publication in the Federal Register.

For more information, please contact your Michael Best attorney; Michael H. Altman at mhaltman@michaelbest.com or 414.225.4932; or Daniel J. Gawronski at djgawronski@michaelbest.com or 608.283.0124.

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Freedom is Just Another Word for Nothing Left to Lose — sung by Janis Joplin, “Me & Bobby McGee”

Paul Jones, co-chair of Venture Best, the venture capital practice group at Michael Best, has been selected as a regular contributor of OnRamp Labs, a Milwaukee Journal Sentinel blog covering start-ups and other Wisconsin technology news. Paul’s most recently contributed piece, “Freedom is Just Another Word for Nothing Left to Lose – sung by Janis Joplin, “Me & Bobby McGee” can be found under their Business Tab in the Business Blog section: Click here to view his latest blog.

A short excerpt can be found below:

High impact entrepreneurs come to the arena with a wide range of handicaps their bigger, established competitors largely don’t face.

Startups are notoriously short of capital, talent and time. They typically compete with better-armed, established businesses with ample capital and human resources, and substantial brand equity. It is a wonder, to me, that even a small portion of startups succeed.

But they do. And so you have to ask how. How can small, undercapitalized startups with nothing but ideas and small overmatched teams, in the space of a few short years, not just compete in, but win sizeable markets. They must, it seems to me, have some advantages; some assets that, when properly deployed, more than make up for their obvious liabilities. What are those assets?

Click here to read more.

Startup Valuation on the Back of an Envelope

Paul Jones, co-chair of Venture Best, the venture capital practice group at Michael Best, has been selected as a regular contributor of OnRamp Labs, a Milwaukee Journal Sentinel blog covering start-ups and other Wisconsin technology news. Paul’s most recently contributed piece, “Startup Valuation on the Back of an Envelope” can be found under their Business Tab in the Business Blog section: Click here to view his latest blog.

A short excerpt can be found below:

“Over the years, I’ve developed a deck of slides and some related spreadsheets walking through how venture investors think about valuing startups.

I’ve given the talk to dozens of audiences mostly consisting of entrepreneurs and angel investors. It usually takes about an hour. Recently, I was asked to cover the subject in about ten minutes. Honestly, my first thought was that it couldn’t be done.

But then, as most entrepreneurs discover early on, necessity proved the mother of invention. So, if you are looking for the basics – just the bottom line, actually – on startup valuation here it is.”

Click here to read more.

You’re So Vain

Paul Jones, co-chair of Venture Best, the venture capital practice group at Michael Best, has been selected as a regular contributor of OnRamp Labs, a Milwaukee Journal Sentinel blog covering start-ups and other Wisconsin technology news. Paul’s most recently contributed piece, “You’re So Vain” can be found under their Business Tab in the Business Blog section: Click here to view his latest blog.

A short excerpt can be found below:

I am often asked what some of the big obstacles are in terms of building a self-sustaining high impact entrepreneurship and investing sector in the Badger State. Two of the popular candidate answers, not that popularity means a lot, are a lack of capital and a lack of talent.”

 Click here to read more.

First Billion-Dollar Exit for Crowdfunding. Well, Sort Of.

Paul Jones, co-chair of Venture Best, the venture capital practice group at Michael Best, has been selected as a regular contributor of OnRamp Labs, a Milwaukee Journal Sentinel blog covering start-ups and other Wisconsin technology news. Paul’s most recently contributed piece, “First Billion-Dollar Exit for Crowdfunding. Well, Sort Of.” can be found under their Business Tab in the Business Blog section: Click here to view his latest blog.

A short excerpt can be found below:

Enthusiasts for the brave new world of equity crowdfunding got some good news recently when various media outlets, including Forbes reported on the first billion-dollar exit by a crowdfunded startup. And so the crowdfunding revolution rolls on: power to the people.”

Click here to read more.

What if the Age of the Unicorn is Over?

Paul Jones, co-chair of Venture Best, the venture capital practice group at Michael Best, has been selected as a regular contributor of OnRamp Labs, a Milwaukee Journal Sentinel blog covering start-ups and other Wisconsin technology news. Paul’s most recently contributed piece, “What if the Age of the Unicorn is Over?” can be found under their Business Tab in the Business Blog section: Click here to view his latest blog.

A short excerpt can be found below:
The years 2014 and 2015 were good to high impact entrepreneurs. VC investments soared, and pricing and other financing terms were as friendly as they have been since the dot-com bubble burst.

It’s the age of the Unicorn. And conventional wisdom, supported by some recent data (declines in venture funding, particularly startup and early stage capital, and the “de-horning” of several Unicorns) suggests that it is coming to an end. What will that mean for high impact startups in 2016?”

Click here to read more.

Developments Regarding “General Solicitation” and Demo Days

Each year, our Venture Best attorneys attend numerous demo days, venture fairs and similar business plan competitions, including both “Premier Nights” for gener8tor’s winter and summer classes. Area startups and emerging companies use these events as platforms to build relationships with potential investors and pitch their companies. However, it is not always clear whether a company’s “pitch” at such events violates the SEC’s ban on general solicitation in private offerings.

When raising money in the private markets, startups and emerging companies most often rely on Regulation D of the Securities Act of 1933, as amended. Rule 506 of Regulation D is overwhelmingly relied upon (as opposed to Rule 504 or Rule 505) as it provides for no limit on the amount that the company may raise and exempts the company from certain state law registration requirements.

Rule 502(c) explicitly bans the offer or sale of any securities under Regulation D by any form of general solicitation or general advertising, which includes (i) any advertisement, article, notice or other communication published in any newspaper, magazine, or similar media or broadcast over television or radio, and (ii) any seminar or meeting whose attendees have been invited by any general solicitation or general advertising.

Historically, companies found Rule 502(c) to be vague and an overly burdensome hurdle to raising money. Such growing criticism of Rule 502’s prohibition on general solicitation was one of the issues addressed by the JOBS Act in 2012, and the SEC issued final rules on a new Regulation D exemption (Rule 506(c)) that allows general solicitation if certain additional steps are taken to verify that an investor is “accredited.” See our client alert on the general solicitation rules here.

Although the implementation of the general solicitation rules gave startups and emerging companies a way to raise money by using general solicitation, it also called into question whether the SEC would put a stake in the ground and declare a company’s attendance or pitch at a demo day as general solicitation. Accordingly, in August 2015, the SEC indicated its position (among other things) that a demo day or venture fair does not necessarily constitute general solicitation.

According to the SEC, whether a demo day or venture fair pitch constitutes a general solicitation will depend on the facts and circumstances of each case. Of course, there is no general solicitation if a company’s pitch to an audience does not involve an offer of a potential investment. However, if a company’s pitch does include an offer of a potential investment, such pitch may not constitute general solicitation if attendance is limited to persons with whom the company or the event organizer has a pre-existing, substantive relationship or who have been contacted through a pre-existing informal, personal network (such as an “angel investor” group).

Historically, the SEC has shown no sense of urgency to enforce the ban on general solicitation or other anti-fraud provisions as they relate to demo days. Perhaps, the SEC has chosen to keep such events “off-the-radar” because such events tend to contribute to the economic growth of a community and are typically managed by credible investors. However, in light of the SEC’s recent clarification of what constitutes general solicitation, it is unclear if or when the SEC will choose to enforce their position.

Accordingly, a bi-partisan group of Members of Congress recently introduced H.R.4498 – the Helping Angels Lead Our Startups Act (HALOS Act). A similar bi-partisan bill is also in the Senate.

The HALOS Act would exempt demo days (that meet certain sponsorship requirements) from all general solicitation requirements, while allowing a company to include in its pitch (a) that it is in the process of offering securities or planning to offer securities, (b) the type and amount of securities being offered, (c) the amount of securities being offered that have already been subscribed for, and (d) the intended use of proceeds of the offering.

The status of the HALOS Act will be an interesting development to watch this year. Until its potential passage, startups and emerging companies should continue to proceed with caution when announcing a pending financing round during their demo day pitches.

This post was written by Daniel J. Gawronski and Brad R. Jacobsen.