In Latest Jobs Bill, a Billion-Dollar Business Is Now Small
Bipartisanship returned, however briefly, to Capitol Hill on Thursday, when the House passed, by an overwhelming margin, a bill ostensibly intended to make it easier for start-up companies to raise capital. “What this bill does is, it provides a real shot in the arm to entrepreneurs, small-business men and women, removes red tape, allows small businesses an easier time to go about starting up, as well as retaining and creating jobs,” Eric Cantor, the House majority leader, said after the Jump-Start Our Business Start-Ups Act sailed through the House on a 390-to-23 vote. (All 23 opponents were Democrats.)
The House bill, which is supported by Senate Democrats and in many respects mirrors a proposal from President Obama, has been almost universally hailed in terms similar to those Mr. Cantor used, and it does contain measures aimed at improving small companies’ access to capital markets. But some investors, analysts and securities law experts say the bill, more than helping small companies, will in fact free most companies, including very large corporations, from important oversight and disclosure requirements for several years after going public.
Much of the concern arises from Title I of the bill, which defines certain kinds of companies that go public as emerging growth companies. These companies would no longer have to provide some information that investors have come to expect in a prospectus. For instance, they will have to supply only two years of audited financial data rather than three. The bill would also effectively repeal Securities and Exchange Commission regulations and the financial industry’s own rules that separate the activities of securities analysts from those of their investment banking colleagues at companies that underwrite initial public offerings for these emerging growth companies. Once its stock is publicly traded, an emerging growth company would be exempted from disclosure and shareholder approval rules on executive compensation passed as part of Dodd-Frank and auditing standards imposed by the Sarbanes-Oxley Act.
And what precisely is an emerging growth company? It is any company with annual revenue of less than $1 billion. (That’s “billion,” with a “b.”) “It’s just too broad a definition — every company winds up being an emerging growth company,” said John C. Coffee Jr., a securities law professor at Columbia. Kathleen Smith, chairwoman of Renaissance Capital, a firm based in Greenwich, Conn., that analyzes, tracks and invests in initial public offerings, told the Senate Banking Committee at a hearing last Tuesday, “By this definition, we would be giving relief to over 90 percent of the companies going public,” including “companies with very large market capitalizations.” Lynn Turner, a forensic accounting consultant with the California-based firm LitiNomics, testified at the same hearing that 98 percent of all initial public offerings since 1970 would have qualified as emerging growth companies.
In an interview, Ms. Smith said that the definition of an emerging growth company should be limited to relatively small companies, with public offerings of about $50 million and total market capitalizations, including shares held by insiders, of about $250 million. But Mr. Coffee said the market for offerings of $100 million or less is disappearing, and “it’s beyond the reach of legislation to change that.” The institutional investors who are the main players in the I.P.O. market, he said, demand high liquidity — and “in their judgment they only get high liquidity when the market capitalization is about $300 or $500 million.”
Moreover, he added, small I.P.O.’s are relatively expensive. “If all you want is money, it’s much cheaper to do a private placement.”
A separate provision in the bill aims to cut I.P.O. costs for smaller companies by increasing the limit on public offerings that do not have to be registered with the S.E.C. to $50 million, from $5 million. Other measures in the bill truly directed at small companies would allow them to advertise a private stock offering (that would not require registration) and to “crowd-fund” up to $2 million a year, depending on how much financial information the corporation provides investors. The crowd-funding proposal in particular has won strong support from some entrepreneurs, but it raises questions — about what kinds of businesses might benefit from this type of fund-raising and whether investors would suffer — that will receive further scrutiny from The Agenda soon.
Meanwhile, others warned that the Title I provisions could dampen enthusiasm for larger I.P.O.’s, too. Some of the rules that would be curbed for emerging growth companies “are in part designed to strengthen investor confidence in those companies,” said Jeff Mahoney, general counsel to the Council of Institutional Investors, a trade association. Jay Ritter, a finance professor at the University of Florida who specializes in I.P.O.’s, added: “Taking rights away from minority investors is not a way to give minority investors a willingness to pay a higher price.”
Under Title I, a corporation could retain emerging growth status until five years after its I.P.O., or until it achieves $1 billion in revenue, or until its publicly traded equity — known as the public float — exceeds $700 million, whichever comes first. Once it loses emerging status, it would no longer be exempt from the reporting rules and other corporate governance requirements.
However, Mr. Coffee said that yet another section of the bill might ultimately encourage companies to skip regular reporting altogether. Title V raises the number of shareholders of record that prompt a company to have to register with the S.E.C. to 2,000, from 500. While that change might seem innocuous, Mr. Coffee said, most individual stockholders are not shareholders of record but beneficial owners whose shares are held by a brokerage firm, which is the owner of record. As a result, companies worth billions of dollars and with thousands of beneficial owners — but fewer than 2,000 holders of record — could decline to register at all with the S.E.C. and then choose to trade on private networks rather than the major exchanges.
“This represents a major retreat — the largest in the history of securities law — from the principle of transparency,” Mr. Coffee said. “Stocks will trade in the dark because the only disclosures that a company will make will be voluntary disclosures when it wants to say something.
“The real question is whether the federal securities laws can survive election years.”