17. What is an “Emerging Growth Company” and why is it important?
An emerging growth company (EGC) is any company that meets the following requirements:
• the company has less that $1billion or more of total gross revenue in a consecutive 12-month period;
• is within 5 years of its original IPO;
• the company cannot have issued more than $1 billion in non-convertible bonds within the last 3 years, and
• the company does not qualify as a “large accelerated filer”, meaning a public float of over $700 million.
Status as an emerging growth company provides a number of benefits to the company with regard to security laws and regulation.
• Confidentiality – An EGC may make confidential submission to SEC of a preliminary prospectus prior to the public filing with SEC. This gives the SEC an opportunity to review the prospectus and maintains confidentiality about the securities issuance.
⁃ Note: Eventually this draft and all amendments must be filed public with the SEC at least 21 days prior to underwriters commencing a road show.
• Unregulated Communications – An EGC may have unregulated oral or written communications with qualified institutional buyers and accredited investors. This effectively allows the EGC to “test the waters” before the preliminary prospectus is filed with SEC.
⁃ Note: This is a big difference from non-EGC companies that must file the preliminary prospectus with the SEC before discussions/selling efforts could begin.
• Audited Financial Statements – The EGC must produce 2 years of audited financial statements with the registration statement.
⁃ Note: Non-EGC companies are required to submit 3 years of audited statements.
• Security Analyst Reports – Securities analysts will be permitted to freely publish research reports about companies about to issue securities.
⁃ Note: Securities analysts generally do not have access to information from non-public company. Disclosing this information to the public could be seen as conditioning the market for the issuance, which is prohibited for non-EGC companies. This benefit is so broad as to allows companies participating in underwriting process to publish an analyst report.
• Accounting Standards – Exemption from new or revised accounting standards.
⁃ Note: This can reduce the cost of updating disclosures of financial documents based upon new or revised accounting procedures.
• Auditor Exemptions – The EGC is exempt from compliance with PCAOB rules requiring mandatory rotation of external firms auditing the company. Further, the company executives are not required to produce an auditor attestation of internal controls under section 404(b) of SOX of 2002.
⁃ Note: Smaller companies generally do not have the funds or resources to rotate auditing firms or verify compliance with SOX.
• Executive Compensation Rights – EGC companies are exempt from many requirements to disclose executive compensation. Also, EGC companies are exempt from “say-on-pay” vote requirements placed on non-EGC companies by securities laws. Say-on-pay rights allow shareholders to vote to approve the compensation of executives of the business.
Given the benefits associated with EGC status, companies are apt to monitor their growth and plan for the effects of losing EGC status.
• Discussion: Why do you think Congress established the category of Emerging Growth Company and provided the above-referenced benefits? Can you think of any other factors that should be considered in categorizing a company as an EGC? Which of the state exemptions do you see as the greatest benefit to EGCs?
• Practice Question: What are the requirements to qualify as an emerging growth company? What advantages does this designation provide to the company?