The new JOBS Act gives fast-growers a streamlined path to capital.
Capital is the lifeblood of a growing tech company, and today access to that capital in the U.S. is improving thanks to recent regulatory and legislative initiatives. Growing tech companies now have an array of new alternatives to consider. In a rare show of bipartisan congressional support, the Jumpstart Our Business Startups (JOBS) Act was signed into law in April by President Obama. This new law is the culmination of a legislative process that began a number of years ago, when policymakers and industry leaders contemplated the effects of over-regulation on the IPO process in the United States.
The law includes provisions that reduce the regulatory burdens on capital formation and improve public market access for growing companies. The JOBS Act also acknowledges that, for many emerging technology companies, the “traditional” life cycle has changed—rarely do companies proceed with multiple venture rounds and then head straight to an IPO. Many tech companies now choose to stay private longer, rely on many more private financing rounds, make private secondary markets available in their securities, and defer IPOs. In addition, the JOBS Act recognizes that in a world where social media is ubiquitous, prohibitions against “general advertising” and “general solicitation” may be anachronistic.
So, by relaxing regulatory burdens on companies, can the JOBS Act fulfill its promise of reviving the IPO market, and therefore the economy? “The new law provides many attractive opportunities for emerging companies and existing public companies of all sizes,” says New York-based Morrison & Foerster securities partner Anna Pinedo. “Expectations are riding high, but with rulemaking subject to SEC action, its true impact will not be measurable until at least 2013.”
Fostering innovation and growth for emerging companies is a critical element of an economic turnaround, say supporters of the new law, pointing to the historic role played by publicly owned companies in powering job creation, revenue generation, and other economic stimuli. In the present regulatory climate, however, startups need help to get going.
“Current [IPO] pricing dynamics disfavor smaller firms,” says investment banker Bill Hambrecht, a champion of IPO innovation since the late 1960s (see “A Fair Shake for the Little Guy” below). “The truth is, realistic capital requirements for many promising companies are comfortably in the $20 million to $50 million range, but the system, calibrated to deals above $100 million, shuts them out of the game.”
Among the JOBS Act’s most ardent supporters, Hambrecht notes, “Like the capital markets, the economy needs stability and sustainability. If promising growth companies are not even seeing the light of day or are being acquired by competitively minded big companies, then by definition you are not creating jobs.”
For the national economy, startups are proven workforce engines that need refueling. Recognizing this, the U.S. Treasury Department convened the “Access to Capital: Fostering Growth and Innovation for Small Companies” conference in March 2011, a gathering that produced the IPO Task Force, itself a driving force behind seeing the JOBS Act signed into law.
Among the reforms incorporated in the JOBS Act is an amendment to the Securities Act, which would permit companies to raise up to $50 million through a less burdensome “mini-registration” process. “Informally called Regulation A+, the new regulation would provide an exemption from SEC registration similar to the current Regulation A, which is currently capped at $5 million,” explains David Lynn, a Washington D.C.-based Morrison & Foerster securities partner who co-chairs the firm’s Public Companies Group and also writes the firm’s JOBS Act blog. “This significantly eases the process for the many companies seeking to raise smaller amounts of capital and pursue a route other than the traditional IPO.”
Another is Title 1, the provision that formally gives growing companies their own issuer class, designated as EGCs, or emerging growth companies. Among several requirements for qualifying for and maintaining EGC status, an issuer must have total gross revenues of less than $1 billion during its most recently completed fiscal year. For qualifying companies, which can include foreign entities, the law provides a less-taxing transitional “on-ramp” period to adjust to life as a public company.
“For qualified EGCs, the new on-ramp is a phased approach that eases regulatory standards in areas including financial reporting, Dodd-Frank compensation disclosures, and the auditor attestation requirements of Sarbanes-Oxley,” Lynn says, noting that, “while streamlining is the objective, companies should not expect a true linear path to funding or an exit.” With roadblocks and all manner of twists and curves, he adds, “the process has its nuances and pitfalls.” (For a look at some of the on-ramps, off-ramps, and perils along the way, see the illustration above.)
Other egalitarian reforms under the JOBS Act include:
“Testing the waters,” which permits companies to solicit institutional investor feedback prior to publicly filing an offering.
Greater flexibility for companies in communicating offers, including advertising to potential investors.
A “crowdfunding” exemption, which allows investors to invest relatively small amounts of money in startups.
While there is enthusiastic support for the crowdfunding opportunity in some quarters, Washington D.C.-based Morrison & Foerster securities partner Dan Nathan takes a more cautionary view. “This seems to skew to millennials,” he says, “and while crowdsourcing techniques are effective in other fields, its unprecedented introduction into the securities world seems fraught with risk.” Lynn agrees, calling crowdfunding “a bit of a sideshow, and not necessarily where the action is going to be with the JOBS Act.”
How the new law will ultimately play out in practice remains in question, pending further SEC rulemaking. Final regulations must be adopted in order for several key provisions to be implemented—and a shakeout period, eclipsed by distractions, including the November elections and the Eurozone crisis. “While developing and unfolding in a time of global uncertainty,” says Pinedo, “hope remains high that the JOBS Act will help kick-start the initial public offering market and facilitate capital formation for companies of all sizes.”
A Fair Shake for the Little Guy
In 1968, Bill Hambrecht co-founded Hambrecht & Quist, an investment banking firm that specialized in emerging high-growth technology companies. By the early 1990s, Hambrecht had become synonymous with the big IPO: he was a leading oarsman on floats including Apple, Adobe Systems, Amazon, Genentech, MP3.com, and Netscape.
At the forefront of IPO innovation throughout his career, he established San Francisco-based WR Hambrecht + Co. in 1998 to disrupt what he had come to see as imbalance and disadvantage in the IPO system. Seeking to “level the playing field for investors and issuers,” he has since become a champion of capital access reform, including the JOBS Act.
“I am all for making research reports, offering circulars, and other investmentrelated material available on the Internet under the new law,” Hambrecht says. “In my mind, that sanitizes the process completely—let the marketplace be the judge of a company’s value, not traders who are indistinguishable from investors or insiders with an agenda.”
Helping change the path of capital formation from exclusionary to egalitarian is Hambrecht’s pioneering use of the Dutch auction process, which uses open bidding to find the optimal market price for a stock. Based on a 17th century Dutch method of selling tulips, it’s how Hambrecht helped Google go public in 2004—via the Internet.
“By finding the clearing price where supply meets demand, auctions are the most effective and fair way to price a company,” Hambrecht says. “Anybody can participate, and no big institution has an advantage over the individual investor. This is an essential theme of the JOBS Act, and of restoring trust in the system.”
JOBS: No Free Passes
Critics of the JOBS Act are concerned that it strips away investor protection safeguards instituted after a decade’s worth of corporate scandals. But regulators will still be on the job.
“While easing the path to capital formation and the public markets, the relaxed rules will surely not come with relaxed scrutiny from the SEC, DOJ, and other agencies,” says Eugene Illovsky, a securities litigation partner in Morrison & Foerster’s Palo Alto office. “The JOBS Act establishes new territory in securities law, and everybody will be watching closely to see how market practice unfolds.”
Unchanged is the fundamental nature of the business relationship. “Private companies are still interacting with investors and taking their money,” continues Illovsky, adding that, “the relaxed requirements under Title 1 and other provisions of the JOBS Act in no way give issuers or financial intermediaries a free pass on disclosure or compliance matters.” For companies seeking funding, Illovsky says, “the best advice is to institutionalize best practices for disclosure and internal controls, accounting, and reporting.”