JOBS Act Creates Opportunities

By Gregory Lynch, Porter Martin and Jeff Barrett | August 06, 2012

The Jumpstart Our Business Startups Act, the JOBS Act, which was passed by Congress and signed into law by President Obama earlier this year, could have a significant impact on how many traditionally farmer-owned biofuels companies are structured. 

Many of the biofuels companies formed in the Upper Midwest in the late 1990s and early 2000s were started by local agricultural producers and investors. While this distinctive structure had many advantages, including a natural hedge against commodity prices and access to a large base of knowledgeable investors, securities and tax laws created compliance burdens for companies conducting their equity drives. Companies responded in one of two ways: they either formed a limited liability company (LLC) and registered their equity offering with the Securities and Exchange Commission, or a cooperative, which was exempt from initial SEC registration.

Companies that organized as LLCs and publicly registered their securities realized the benefits of being able to conduct a public offering to a large number of investors. After a successful equity drive, however, these companies were subject to the costs of being a publicly reporting company, which included hundreds of thousands of dollars annually in compliance costs, in addition to greater management distraction, increased liability and a loss of confidentiality. Companies that organized as cooperatives were able to avoid most of the SEC compliance costs, but at the substantial cost of significantly limiting their flexibility in obtaining corn supplies without incurring significant tax burdens. As a result of these challenges, many LLCs with SEC-registered equity securities decided to reorganize and deregister from SEC registration, or “go dark.” Similarly, many cooperatives decided to convert to an LLC structure to avoid tax and operating restrictions. 

The process for both was similar. Companies formed multiple classes of LLC equity securities with different voting and/or economic rights and then reorganized their members into these various classes so that no class of equity securities had more than 500 record holders (300 record holders for any class of equity securities that was previously registered with the SEC). In order for this to be effective, the differences in equity securities needed to be significant. For example, a company could grant different voting rights to members based on voting versus nonvoting units, the right to elect directors, the right to amend charter documents such as operating agreements or the right to approve fundamental transactions such as dissolution, merger or conversion.

While this type of reorganization is successful in deregistering a class of equity securities with the SEC, it has the cost of taking away voting rights that members previously held. Many companies and their shareholders voted in favor of deregistering with the SEC, however, because the benefits outweighed these costs. 

The recently passed JOBS Act makes it easier for biofuels companies to experience the tax benefits of operating as an LLC without the compliance costs associated with going public. The act raises the threshold for mandatory registration under the Securities Exchange Act of 1934, as amended, from 500 shareholders to the lesser of 2,000 total shareholders or 500 shareholders who are nonaccredited investors. As a result, the necessity of forming multiple classes of LLC equity securities in order to avoid registering with the SEC has been minimized. It is important to note, however, that the JOBS Act did not affect the threshold of 300 shareholders of record for nonbank holding companies. Thus, biofuels companies that are currently publicly reporting companies must get below 300 record holders of a class of full voting equity securities to “go dark,” but may have up to 2,000 shareholders of record (or up to 500 unaccredited investors) for other classes of equity securities that have not been previously registered. 

The JOBS Act makes it easier for biofuels companies that are currently subject to SEC reporting to “go dark” or deregister with the SEC. Further, for biofuels cooperatives looking for a more flexible organizational structure, the JOBS Act makes it easier to convert to an LLC without being subject to SEC reporting. As a result of these changes, now may be a good time to consult your legal, tax and accounting advisors to determine whether your current organizational structure is still the optimal one.

Authors: Gregory Lynch
Attorney, Michael Best & Friedrich LLP

Porter Martin
Attorney, Michael Best & Friedrich LLP
(608) 283-0116

Jeff  Barrett
Attorney, Michael Best & Friedrich LLP