“Emerging Growth Companies”(EGCs) are businesses that meet certain government criteria that allow them to follow different rules when they file with the Securities Exchange Commission (SEC) to go public. This status gives some smaller companies the ability to compete with larger companies for the capital that’s available through an initial public offering (IPO).
The government began recognizing “emerging growth companies” in 2012 as part of the Jumpstart Our Business Startups (JOBS) Act. Enterprises that qualify can keep their “emerging growth company” status for up to five years.
Emerging Growth Company Definition
Emerging growth companies are defined by Section 2(a)(19) of the Securities Act . Companies that qualify under these rules may choose to follow simplified disclosure requirements.
To go through an emerging growth IPO, a business must meet the following criteria:
• Their total gross revenue — all of the money generated by the business — must be less than $1.07 billion in its most recently completed fiscal year.
• The business cannot have sold common equity securities, shares of a class of stocks of the company, under a registration statement.
Emerging Growth Company Status Benefit
When a company goes public, it must follow strict guidelines issued by the SEC. Meeting these requirements can be costly, time consuming, and complicated. Once a business qualifies as an emerging growth company, it may choose to follow a scaled-down set of guidelines created for smaller companies.
These include:
• Less detailed narrative disclosures from management.
• Two years (rather than three) of audited financial statements.
• No third-party auditor attestation for financial reporting.
• Test-the-waters communications with certain investors.
How Long Does Emerging Growth Company Status Last?
Once an emerging growth company goes public and starts offering stocks on the open market, it can maintain its status for five years unless one of the following events occurs:
• Its gross revenues exceed $1.07 billion.
• It issues $1 billion or more in non-convertible debt — unsecured bonds that cannot be converted into company stock — over three years.
• It becomes a large, accelerated filer, which according to SEC rules has at least $700 million in publicly issued stocks held by non-affiliates.
JOBS Act Explained
The disclosure and regulatory requirements for emerging growth companies began as part of the Jumpstart Our Business Startups (JOBS) Act to counteract a belief that smaller companies were being discouraged from entering the public market, largely due to the cost of compliance with government regulations. Proponents of the act believed that allowing smaller businesses the opportunity to go public would create more jobs and lead to broader economic growth.
The act loosened SEC regulations for smaller companies in an effort to make it easier for companies to raise capital. It also made it easier for retail investors to invest in startups, and for startups to access crowdfunding.
Some opponents to the bill worried that decreased SEC regulation would expose investors to undue risk.
Pros and Cons of the JOBS Act
There are both benefits and drawbacks to the JOBS Act and ability for some startups to apply for Emerging Growth Company status.
Pros of the JOBS Act
The main advantage of the JOBS Act is that it gives small companies more access to raising money to invest in research and development, growth, and hiring. Other benefits include an opportunity for retail investors to purchase equity in startups through their brokerage account and enhanced liquidity for founders and existing shareholders.
Cons of the JOBS Act
The lack of regulation is a potential disadvantage to the JOBS Act. Less government oversight could mean a greater risk for fraud.
Summary of Pros and Cons of the JOBS Act
Here’s a look at the pros and cons of the JOBS Act at a glance:
| Pros | Cons |
|---|---|
| Less regulation, which lowers the barrier to entry for companies looking to raise capital. | Decreased regulation means less government oversight. |
| Easier to reach out to potential investors through test-the-waters communications and advertising. | Less government oversight may mean a greater risk for fraud. |
| Increased communication, such as advertising online, makes it easier to find investors across geographical boundaries. | A lower bar for entry into the public markets could mean a higher failure rate. |
| Easier for retail investors to invest in startups. |
Going Public Process
The JOBS Act made it easier for smaller companies to go public and offer shares of stocks on the open market. Companies commonly go public by making an IPO. Prior to that, they are private.
Before going public, companies can not sell shares to the general public, and they don’t have to disclose financial information to the public. Once a company decides to offer shares on open exchanges, it must follow a lengthy IPO process.
The IPO Process
First, the company must choose an IPO underwriter, often an investment bank, who will help determine the IPO price and facilitate the sale between the company issuing stock for the first time and investors.
The underwriting team will also begin the process of registering the company with the SEC by filing the S-1 Registration Statement. The SEC then reviews the documents submitted by the underwriter. Meanwhile the underwriting team contacts institutional investors to gauge their interest in the IPO.
When the SEC has approved the IPO, it’s time to choose the initial share price based on company valuations, market conditions, how much capital the company hopes to raise, and general interest.
With a share price set, the IPO is ready to launch on the open market and an IPO date is announced.
After launch, the underwriter has a 25-day period to stabilize share prices by executing trades that influence price. Once that period ends, the market will determine the share price going forward. Investors look at things like earnings reports to determine whether or not the stock is a good value.
The Takeaway
An IPO offers companies some potentially huge advantages, including raising money to help a company grow, increasing liquidity, providing an exit strategy for early investors who can sell shares, and a big boost in publicity. Emerging growth companies get access to those advantages with a slightly easier IPO process.
Investors interested in IPOs can buy shares inside a brokerage account or retirement accounts, such as an IRA. One way to get started is via the SoFi Invest® online brokerage account, which allows you to build a portfolio that includes IPOs as well as stocks and exchange-traded funds.
FAQ
What qualifies as an emerging growth company?
Emerging growth companies must have a total gross revenue of less than $1.07 billion in the most recently completed fiscal year, and they cannot have sold common equity securities under a previous registration statement.
How do you lose emerging growth company status?
Companies retain their emerging growth company status for five years or until their gross revenue exceeds $1.07 billion, the company issues $1 billion or more in non-convertible debt, or it becomes what is known as an accelerated filer.
Is an emerging growth company a smaller reporting company?
Smaller reporting companies are defined differently than emerging growth companies. They must have a public float of $250 million or less. Or if they have revenue of less than $100 million they may have no public float or a public float of less than $700 million. A public float the number of shares held by non-affiliates multiplied by the market price.
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Investing in an Initial Public Offering (IPO) involves substantial risk, including the risk of loss. Further, there are a variety of risk factors to consider when investing in an IPO, including but not limited to, unproven management, significant debt, and lack of operating history. For a comprehensive discussion of these risks please refer to SoFi Securities’ IPO Risk Disclosure Statement. IPOs offered through SoFi Securities are not a recommendation and investors should carefully read the offering prospectus to determine whether an offering is consistent with their investment objectives, risk tolerance, and financial situation.
New offerings generally have high demand and there are a limited number of shares available for distribution to participants. Many customers may not be allocated shares and share allocations may be significantly smaller than the shares requested in the customer’s initial offer (Indication of Interest). For SoFi’s allocation procedures please refer to IPO Allocation Procedures.
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