The Jumpstart Our Business Startups Act (the JOBS Act) which was recently passed by Congress and signed into law by President Obama 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 to these regulatory challenges in primarily one of two ways: they either formed (i) a limited liability company (LLC) and registered their equity offering with the Securities and Exchange Commission (SEC), or (ii) a cooperative which was exempt from initial SEC registration.
Companies who organized themselves as LLCs and publicly registered their securities realized the benefits of being able to conduct a public offering to a large number of investors. However, after a successful equity drive, these companies were subject to the costs of being a publicly reporting company, which included hundreds of thousands of dollars annually being spent on compliance costs, in addition to greater management distraction, increased liability and a loss of confidentiality. Companies who organized themselves as cooperatives were able to avoid most of the SEC compliance costs. However, this benefit came at the substantial cost of significantly limiting their flexibility in obtaining their corn supply without incurring significant tax burdens.
As a result of these challenges, many LLCs who had equity securities registered with the SEC decided to reorganize and deregister from SEC registration, or “go dark.” Similarly, many cooperatives decided to convert to an LLC structure to avoid the tax and operating restrictions of being a cooperative.
The process for both of these steps was similar. Companies formed multiple classes of LLC equity securities that had 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 the following:
- Voting vs. non-voting units
- Right to elect directors
- Right to amend charter documents (e.g. Operating Agreement)
- Right to approve fundamental transactions (e.g. dissolution, merger, conversion)
While this type of reorganization can be successful in deregistering a class of equity securities with the SEC, it has the cost of taking away some rights that members previously held. However, many companies and their shareholders voted in favor of deregistering with the SEC because the benefits of deregistration outweighed these costs.
Greater Flexibility Under the JOBS Act
The recently passed JOBS Act makes it easier for biofuels companies to experience the tax benefits of operating as an LLC without being subject to the compliance costs associated with a public reporting company. The JOBS Act raises the threshold for mandatory registration under the Securities Exchange Act of 1934, as amended, from 500 shareholders to the lesser of (i) 2,000 total shareholders or (ii) 500 shareholders who are non-accredited investors. As a result, the necessity of forming multiple classes of LLC equity securities with differing voting and/or economic rights 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 non-bank holding companies. Thus, biofuels companies who are currently public 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.© MICHAEL BEST & FRIEDRICH LLP