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Becoming an Emerging Growth Company: A Tool for Reducing the Burdens of an IPO

by | Sep 8, 2020 | Securities

“Emerging growth company” is sometimes used generically in the business community and media to describe an early-stage company–usually in a startup-heavy sector like technology or life sciences.

Yet an emerging growth company, or EGC, is actually a very specific and well-defined category under federal securities laws. Companies from any industry — not just high tech—that meet the definition may be able to take advantage of their EGC status to significantly reduce their regulatory burdens when raising capital via an initial public offering. “Emerging growth,” is in itself, a bit of a misnomer. The law requires the company to be neither emerging or growing.

According to the U.S. Securities and Exchange Commission, a company may qualify as an emerging growth company if it has annual gross revenue of less than $1.07 billion during its most recently completed fiscal year and, as of December 8, 2011, had not sold common equity securities under a registration statement.

A company continues to be an emerging growth company for the first five fiscal years after it completes an IPO, unless one of the following occurs: 1) its total annual gross revenues are $1.07 billion or more; 2) it has issued more than $1 billion in non-convertible debt in the past three years; 3) it becomes a “large accelerated filer,” as defined under Exchange Act Rule 12b-2.

Regulatory Benefits

Emerging growth companies, according to the SEC, are permitted:

  • to include less extensive narrative disclosure than required of other reporting companies, particularly in the description of executive compensation.
  • to provide audited financial statements for two fiscal years, in contrast to other reporting companies, which must provide audited financial statements for three fiscal years.
  • not to provide an auditor attestation of internal control over financial reporting under Sarbanes-Oxley Act Section 404(b).
  • to defer complying with certain changes in accounting standards.
  • to use test-the-waters communications with qualified institutional buyers and institutional accredited investors.

An IPO “On Ramp”

The emerging growth company status was created as part of the Jumpstart Our Business Startups (JOBS) Act of 2012. A centerpiece of the legislation, EGC status was designed to provide an on-ramp that allows companies to adjust to the registration requirements associated with becoming a publicly traded company. (The JOBS Act also expanded other capital raising tools for businesses, including Regulation A.)

A company from any industry is eligible to become an EGC if it meets the criteria. Small startups and larger, more established companies can take part. Companies based in the United States can qualify, as can those from outside the country. Most companies mounting IPOs now qualify as emerging growth, and EGC offerings have occurred on the OTC markets, and the NASDAQ and New York Stock Exchange. (Among the well-known companies that have taken advantage of EGC status to complete their IPOs in recent years are Wayfair, Inc., the online furniture store; Restoration Hardware, the home furnishings company; and Manchester United, the English soccer team.)

Since the rules were initially implemented, the SEC has revised the rules to increase the gross revenue cap from $1 billion to $1.07 billion to account for inflation, something the law requires every five years. Another inflation-related increase is expected in 2022. In addition, the agency added the “test the waters” provision last year in an attempt to “make the IPO markets less turbulent” by allowing EGCs “to feel out institutional investors about potential public offerings before filing registration statements,” The Wall Street Journal reported.

To learn more about how your company may qualify as an EGC, contact us for a consultation.