What Is an Emerging Growth Company?
An emerging growth company (EGC) is a specific classification of issuer under U.S. securities law, established to provide scaled-back regulatory requirements for certain newer, smaller companies in the realm of corporate finance. This designation aims to reduce the burden and compliance costs associated with becoming a public company, thereby encouraging more businesses to access public capital markets through an initial public offering (IPO). The criteria for qualifying as an emerging growth company primarily revolve around a company's annual gross revenue and its history of public sales of equity securities.
History and Origin
The concept of the emerging growth company was introduced as part of the Jumpstart Our Business Startups (JOBS) Act, which was signed into law on April 5, 2012.8 The legislation was enacted with the intention of stimulating job creation and economic growth by easing the regulatory landscape for smaller businesses seeking to go public. Prior to the JOBS Act, many private companies faced significant expenses and complex disclosure requirements when attempting an IPO, which was perceived as a deterrent. The JOBS Act sought to create an "IPO on-ramp" by offering a temporary period of reduced regulatory burdens for qualifying emerging growth companies, allowing them to gradually adapt to the full scope of public company obligations.7
Key Takeaways
- An emerging growth company (EGC) is a classification created by the JOBS Act to streamline the path to public markets for smaller companies.
- EGCs benefit from reduced regulatory and filings requirements, particularly concerning financial disclosures and internal control attestations.
- A company typically qualifies as an EGC if its total annual gross revenues are below a certain threshold (currently $1.235 billion) and it hasn't sold common equity securities under a registration statement as of a specific date in 2011.6
- The EGC status is temporary, lasting up to five fiscal years after an IPO or until certain disqualifying conditions are met.
- The relaxed rules aim to lower the cost and complexity of going public, encouraging equity financing and potentially fostering more growth companies.
Interpreting the Emerging Growth Company
The designation of an emerging growth company is primarily a regulatory one, affecting how a company interacts with the Securities and Exchange Commission (SEC) and the types of disclosures it must provide to investors. For a company, attaining EGC status means it can take advantage of certain exemptions for a period, such as presenting two years of audited financial statements in an IPO registration statement instead of three, and delaying compliance with new accounting standards until they are required for private companies.5 This can significantly lower initial compliance costs and administrative burdens, making an IPO a more attractive option for a developing business that might otherwise be deterred by the complexities and expenses of a traditional public offering. Investors, in turn, should understand that an emerging growth company will provide less extensive disclosures than larger, more seasoned public companies.
Hypothetical Example
Imagine a fictional technology startup, "InnovateTech Inc.," that has developed a groundbreaking artificial intelligence software. The company has been successful in securing initial funding from venture capital firms and has grown its annual revenues steadily. In its most recently completed fiscal year, InnovateTech reported total annual gross revenues of $500 million. As of December 8, 2011, InnovateTech had not sold common equity securities under a registration statement. Given these facts, InnovateTech Inc. would qualify as an emerging growth company under the current SEC rules.
As an EGC, InnovateTech could confidently submit a draft registration statement for its planned initial public offering to the SEC for confidential review. This allows the company to engage in preliminary discussions with potential investors and receive feedback from the SEC without immediately making sensitive financial information public. They would also be able to provide two years of audited financial statements in their IPO prospectus, rather than three, and would not be required to obtain an auditor attestation of internal control over financial reporting for a certain period.
Practical Applications
The emerging growth company classification has several practical applications across the financial industry and regulatory landscape:
- Initial Public Offerings (IPOs): The most direct application is in simplifying the IPO process. EGCs can submit draft registration statements confidentially, "test the waters" with qualified institutional buyers, and benefit from scaled disclosure requirements, which can reduce the time and cost involved in going public.4
- Reduced Reporting Burden: For companies that qualify, EGC status means less extensive reporting requirements, particularly regarding executive compensation disclosures and the auditor attestation requirement of Section 404(b) of the Sarbanes-Oxley Act.3
- Accounting Standards Adoption: EGCs can opt to delay the adoption of new or revised accounting standards until they are required for non-public entities, providing more time to implement changes.
- Analyst Coverage: The JOBS Act also made changes to rules regarding research reports, aiming to facilitate analyst coverage of emerging growth companies, which can improve market awareness and liquidity for their shares.
Limitations and Criticisms
While the emerging growth company designation was designed to foster capital formation, it has faced some limitations and criticisms. One concern raised by some studies is that the reduced disclosure requirements for EGCs might lead to lower-quality IPOs and increased risk for individual investors, as there may be less financial information available for thorough due diligence.2 This lack of comprehensive data could potentially create information asymmetry, where insiders and institutional investors have access to more information than the general public.
Additionally, while the intent was to encourage more small companies to go public, some critics argue that the actual impact on the overall number of IPOs has been modest or that the benefits primarily accrue to companies that might have gone public anyway. There is also the potential for companies to strategically manage their revenue to maintain EGC status for as long as possible, even if their market capitalization suggests they are no longer truly "emerging." The temporary nature of the status means that companies eventually transition to full public company reporting requirements, which can still represent a significant jump in compliance burden.
Emerging Growth Company vs. Small Reporting Company
The terms "emerging growth company" (EGC) and "small reporting company" (SRC) are both classifications used by the SEC that offer certain regulatory relief, but they are distinct.
An Emerging Growth Company is defined primarily by its total annual gross revenues (less than $1.235 billion currently, and no public sale of common equity securities before December 8, 2011) and is generally applicable for the first five fiscal years after its IPO. The benefits for an EGC are tied to the JOBS Act and focus on easing the transition to public markets, including confidential IPO filings and scaled financial reporting and executive compensation disclosures.
A Small Reporting Company, on the other hand, is defined by either its public float (less than $250 million) or, if no public float, by its annual revenues (less than $100 million). SRC status is ongoing as long as the company meets the criteria, not limited to a post-IPO period. The scaled disclosures for SRCs are broad and apply to various SEC filings, providing continuous relief from certain reporting requirements for genuinely smaller public entities.
While a company can be both an EGC and an SRC simultaneously, the EGC designation is temporary and specifically designed for the IPO "on-ramp," whereas SRC status is a more enduring classification for smaller public entities based on their size metrics.
FAQs
How long does a company retain emerging growth company status?
An emerging growth company generally retains its status for the first five fiscal years after its initial public offering. However, this status terminates earlier if the company's total annual gross revenues exceed $1.235 billion, it issues more than $1 billion in non-convertible debt over a three-year period, or it becomes a "large accelerated filer" (a company with a public float of $700 million or more).1
What are the main benefits for an emerging growth company?
The primary benefits for an emerging growth company include reduced disclosure requirements in IPO registration statements (such as only two years of audited financial statements instead of three), confidential submission of draft registration statements to the SEC, delayed adoption of new accounting standards, and an exemption from the auditor attestation requirement on internal controls. These measures are intended to lower the cost and complexity of going public.
Can a company lose its emerging growth company status?
Yes, a company can lose its emerging growth company status before the five-year period is up. This occurs if its total annual gross revenue reaches or exceeds $1.235 billion, it issues over $1 billion in non-convertible debt during a three-year period, or it achieves the status of a large accelerated filer. Once these thresholds are crossed, the company must comply with the more comprehensive reporting requirements applicable to other public companies.
Are all small public companies considered emerging growth companies?
No, not all small public companies are considered emerging growth companies. The emerging growth company (EGC) designation is specific to companies that recently went public and meet certain revenue criteria, lasting a maximum of five years post-IPO. Many small public companies may instead qualify as small reporting companies (SRCs), a separate classification that provides ongoing scaled disclosure based on public float or revenue thresholds, independent of their IPO date.