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Why some companies are including the law itself as a risk factor in their IPO filings.
Sarah Johnson, CFO Magazine
June 15, 2012
In the aftermath of Facebook's initial public offering in May, smaller, lesser-known companies are preparing for their own debuts on U.S. stock exchanges. Naturally, they are alerting investors in public filings that their small stature and lack of public-company experience can make investing in their stocks a risky endeavor. But some are going even further, listing the Jumpstart Our Business Startups (JOBS) Act itself as a risk factor.
During one week last month, at least 13 companies, including HomeTrust Bancshares, Plesk, and LegalZoom.com, warned investors in their Securities and Exchange Commission prospectuses that the regulatory relief provided by the JOBS Act could actually be a turnoff. "We cannot be certain if the reduced disclosure requirements applicable to emerging-growth companies will make our common stock less attractive to investors," Cimarron Software wrote in its S-1 form last month.
The trend may reflect an unintended consequence of the act, says Michael Stocker, a partner at law firm Labaton Sucharow who represents institutional investors. In their filings, notes Stocker, companies are saying that because they "are willing to take advantage of the related standards for disclosures under the JOBS Act, one real risk is that they will be punished by investors, since investors won't be getting as much information and they may have less confidence in how the companies are doing."
So-called emerging-growth companies — those that take in less than $1 billion a year in revenue — can wait up to five years after their IPOs before following all of the rules that larger listed businesses do. They can submit two audited financial statements to the Securities and Exchange Commission instead of three; they can avoid holding
say-on-pay votes; and, most significant, they are not required to get their auditors' sign-offs on internal controls over financial reporting.
These companies spell out their exemptions under the JOBS Act in the new risk-factor disclosures. At the same time, they note that they will lose their emerging-growth status before five years if their revenue increases beyond $1 billion, their market cap exceeds $700 billion, or they issue more than $1 billion in nonconvertible debt.
Not all emerging-growth companies preparing for an IPO have included the law as a risk factor, but they may want to consider it, says Thomas J. Murphy, a partner at law firm McDermott Will & Emery who helps companies with their public offerings. "It's cheap insurance and good disclosure to call out for people [the] places where you differ from other public companies," he says.
The additional disclosure implies the company using it is trying to be comprehensive, says Murphy. Moreover, the lines of text may help the company later on if it runs into trouble. "If an emerging-growth company has a failure of its controls and has to restate its financial statements, the disclosure is going to be a plus when that company defends itself against a lawsuit," says Murphy. "The business can respond by saying, 'We warned you that there weren't auditors looking independently at this.'"
But the plaintiffs' bar may have a retort, suggests attorney Stocker. "All the disclosure says is that because of the JOBS Act, the company's stock may not trade [at] as high a volume or [for as] good a price as you may hope," he says. "It's not saying because of the JOBS Act you may get a nasty surprise at the end of five years."