Robert Rasmus and James Whipkey didn’t have a problem in July 2012; they had a wrinkle. The founders of private-equity firm Red Oak Capital Management had formed Hi-Crush Proppants LLC (HCLP), a producer of highly sought-after Northern White sand for hydraulic fracturing, in 2010. Hi-Crush was about to go public, and it had plenty of things going well for it: a rail line that bisected its Wyeville, Wisconsin, plant; plenty of the aforementioned sand; and long-term contracts that produced seemingly dependable income streams. Hi-Crush’s wrinkle was that it sought to go public as a master limited partnership.

MLPs in the energy sector normally base their yield to investors on pipeline or drilling production, but Hi-Crush was basing its dividends on sand contracts. The company’s rationale for breaking from a traditional “C” corporation structure and going public as an MLP was clear from its registration statement: “We sell substantially all of the frac sand we produce under long-term, take-or-pay contracts that significantly reduce our exposure to short-term fluctuations in the price of and demand for frac sand.”

Other MLPs hitting the market around the same time were featuring gas-station and coal-mining revenue, meeting the requirement for an MLP to derive most of its revenue from natural resources, real estate or commodities. Hi-Crush chose to negotiate the IPO minefield by declaring itself an emerging growth company (EGC) which, among other things, enabled it to communicate confidentially with the SEC leading up to its offering. This was beneficial because public discourse en route to an IPO can be misinterpreted by investors. Hi-Crush’s IPO in August 2012 was well received and raised nearly $200 million.

The EGC designation owes its status to a piece of legislation that could have far-reaching effects for the energy industry. The Jumpstart Our Business Startups (JOBS) Act’s scope is ambitious. It cobbled together six separate pieces of legislation and was signed into law with bipartisan support in April 2012. The law’s premise is simple: provide entrepreneurs and small businesses with access to capital, allow them to grow, and they will then hire and be the catalyst for economic recovery.

Two aspects of the JOBS Act have received a lot of attention but aren’t particularly important for oil and gas companies: equity-based crowdfunding and general solicitation. Crowdfunding investing is capped at $1 million per year, making its raises too small to materially affect energy companies.

General solicitation for private investments, provided all investors are accredited, may be of some import to companies in the energy industry eventually, but it’s unclear how pervasive advertising will be or how successfully it will reach investors. As of this writing, the SEC had not issued rules for general solicitation, punting a July 2012 deadline. Perhaps more telling will be the Financial Industry Regulatory Authority’s subsequent guidance on general solicitation to its members.

As with any piece of bipartisan legislation, the JOBS Act has ancillary attributes that stand outside the purview of its stated aim. But for operators seeking capital to grow, the law provides opportunities through both public (EGCs) and private (private placement) channels.

Public markets

A cursory analysis shows that over two-thirds of U.S. IPOs in 2011 could have qualified as EGCs if the designation existed then. The sole qualification listed in the law is that an aspiring EGC must receive less than $1 billion in revenue in its latest fiscal year. That’s it.

To determine how that threshold would have affected the energy industry in the past, see IPO graphic (left). One of the expiration conditions for EGCs is to become a large accelerated filer, which requires, among other conditions, floating more than $700 million publicly to nonaffiliates. Looking back through 10 years and 800 energy IPOs, only four companies would have floated more than $700 million in North America, all of them E&Ps and one of them listed in Canada. The EGC classification can be used by most new public issuers in energy.

The EGC designation is meant to be temporary. An EGC loses its status when the first of these criteria is met: the end of the fiscal year of the fifth anniversary of its IPO, the end of the fiscal year that revenues exceed $1 billion, the date more than $1 billion in nonconvertible debt is issued over a three-year period, or the date the EGC becomes a large accelerated filer.

The benefits to issuers who use the EGC tag are substantial. In addition to the ability to communicate confidentially with the SEC, an EGC may test the waters with potential investors before filing its offering, be exempt from auditor attestations to internal controls, provide two years of audited financials (the previous requirement was five), be exempt from the requirement to present “selected financial data” in the registration statement, and be exempt from pre- and post-IPO quiet periods with regard to research report publishing.

There are more provisions about research analyst conduct and executive compensation disclosure, but the implication for companies looking to go public is clear: The barriers have been reduced somewhat.

The JOBS Act rolls back some of the investor protections established in laws like the Sarbanes-Oxley and Dodd-Frank acts. No better example of how reticent players are to embrace the law exists than the case of the SEC’s implementation of the law’s general solicitation provision. The SEC was given a July 4 deadline to publish solicitation rules and began receiving public comments on April 10. The commission has received extensive negative feedback from investor advocacy groups and state regulators, forcing the SEC to postpone its ruling twice and seek public comment a second time. As of this writing, the SEC still hasn’t delivered its guidance on the provision.

Issuers have also been cautious in offering shares since the act’s passage. Comparing the first three quarters of 2012 to the same period in 2011 and excluding Facebook’s offering, IPO transaction values are down 47% for the year. This could be due to issuers becoming accustomed to the ramifications of EGC classification, or it could be wholly unrelated. Many EGCs are listing their designation as an investment risk in registration documents, as that classification alone may affect demand for their offerings and subsequent share prices. Regardless, EGCs comprised 89% of the IPOs in third-quarter 2012, signaling some acceptance by issuers to use the designation.

Private capital

The effects of the JOBS Act on private capital raises are just as profound as they are on their public counterparts, and are more easily understood. Private placements are transactions that allow issuers and investors to pair in transactions where the securities offered may be of any type and combination. Previously, the flexibility of private placements was limited both by the size of the offerings and the number of investors allowed to participate in them.

Regulation A transactions have historically been small, seldom-issued offerings. They are not subject to Blue Sky laws, state investor protection laws designed to prevent fraud. Additionally, securities in Reg A offerings cannot be restricted post-issue. The JOBS Act increases the size of Reg A transactions from $5 million to $50 million annually, where smaller companies, and particularly service companies, may put the provision to use.

Regulation D transactions are the most commonly seen private placements, and also had size and investor limitations. Whereas before, if an offering raised more than $10 million and had more than 500 investors it had to register with the SEC, the JOBS Act raises the investor number to 2,000, provided they’re all accredited. Additionally, investors’ interests may be bundled within those 2,000 slots.

The increase in the limit of Reg D investors can have significant benefits to issuers. As drilling and completion costs continue to rise, operators have been forced to solicit investors with more investible wealth in order to stay under the 500-investor cap and meet large funding goals. This is particularly true for issuers that use fund structures like private equity and hedge funds. The new investor limit may allow some issuers to look to more diverse groups of investors at lower amounts.

The shift in capital formation paradigms in both public and private markets from the JOBS Act has been seismic. Companies on the verge of going public can reap the benefits of EGC designation. Companies intent on remaining private have greater flexibility to raise capital through Reg A and D transactions. Regardless, the law couldn’t come at a better time for energy companies with burgeoning opportunities challenged by rising costs.

Scott Cockerham is a partner at Parkman Whaling LLC, an energy investment and merchant bank in Houston. Previously, he worked in investment management at Deutsche Bank and Goldman Sachs.