Why the JOBS Act does, and doesn’t, matter.
The Senate right now is debating the JOBS Act, with a full vote expected later this afternoon. Champions of the legislation, including a large number of venture capitalists, argue that it will increase capital access for emerging businesses. Critics believe it is a dangerous rollback of investor protections, including some put in place following the Enron and Worldcom accounting scandals.
So who’s right? From my perspective, they both are. The JOBS Act is a mishmash of several different initiatives that, ironically, don’t directly address employment. Here’s a quick breakdown:
Kills the ‘500 shareholder’ rule: The current legislation would expand from 500 to 2,000 the number of shareholders a private company can have without also having to publicly disclose certain financial information (which is different than having to become publicly-listed, by the way). We first reported on this last June. Probably a welcome development, since private companies should be able to determine their own future. That said, the 2,000 figure is just as arbitrary as 500.
Enable crowd-funding: Consider this the Kickstarter-for-equity provision, allowing companies to issue shares in exchange for crowd-funded capital. This basically is for companies that either are too small for traditional angel/VC funding, or companies that are unable to secure such capital. In other words, we’re probably talking about a proliferation of thousands of lousy companies. But if just one or two become the next Facebook, then the trade-off is worth it.
Permits general solicitation: Right now, any issuer under Regulation D is prohibited from general solicitation of investors. This includes many private companies, plus certain types of investment funds (including venture capital and private equity funds). The JOBS Act eliminates that prohibition, although it would continue to only allow accredited investors to invest in Reg D offerings. The fear is that unscrupulous boiler room operators would run late-night TV ads enticing senior citizens to buy shares of bogus start-ups. Then again, we’re talking about unscrupulous people, which means that acts of Congress are unlikely to encourage or discourage them. So I think this provision’s only real impact would be to make my job easier, since VC/PE firms would now be permitted to publicly discuss fundraising efforts. My overall opinion is extreme ambivalence.
Emerging growth companies: Okay, this is where I move from ambivalence to opposition. The idea here is to make it easier for small private companies to go public, by reducing the costs associated with such an action. It does so by reducing certain existing investor protections, including one that prevents investment banking analysts from offering pre-IPO research on their firm’s own clients. Here is what I wrote on the subject, back in January:
Going public is not supposed to be a cakewalk. We’ve already been through an IPO environment where all you needed was a clever URL and a fuzzy mascot, and the results weren’t pretty. I’m not suggesting that last year’s issuers are all future members of the Fortune 500, but shouldn’t a successful listing signal to retail investors that experienced institutions took a hard look at the issuer and considered it worthy of consideration? How can that still be true if those institutions get to see only two years of audited financial statements instead of three? Or if analysts working for a company’s underwriting bank can publish pre-IPO research (albeit with a disclaimer)?
This isn’t to suggest that small issuers are trying to pull the wool over investor eyes, or that the disappearance of small, boutique investment banks hasn’t had a real impact on the abilities of small companies to go public. But just like I believe the 500-shareholder rule should be abolished in the name of private company freedom, I believe that relevant rules governing public companies should remain in place, in the name of public shareholder protection. Moreover, these changes are being proposed to cure an IPO crisis that simply does not exist. Seriously, look at the numbers and then tell me private companies — including ones that are pre-revenue and/or unprofitable — can’t go public.
That said, I’d expect the JOBS Act to pass today — possibly with some amendments — before getting signed into law by President Obama. We’ll learn about its consequences later.
Update I: An amendment offered by by Sens. Merkley (D-OR) and Brown (R-MA) has passed. It would require companies raising up to $1 million to provide prospective investors with certain underlying financial information. It also would restrict investors with less than $100,000 in annual income from plugging more than 5% of their income into a crowd-funded offering.
Update II: An amendment offered by Sen. Jack Reed (D-RI) failed. It would have tightened certain shareholder definitions, and prevented public companies from “going dark” if their shareholder number falls below a certain threshold.
Update III: The JOBS Act has passed, 73-26.
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