The JOBS Act has been on a long journey since it was originally signed into law in 2012 as the SEC has gone through the lengthy process of rulemaking. And, as we near the end of at least this first stretch of road, it appears as though the equity crowdfunding that had many market watchers eagerly anticipating a sea change in private markets may ultimately prove too burdensome for most companies to undergo.
This is not to say, though, that small private companies raising capital won’t have an abundance of new options and strategies when it comes to raising the cash they need to grow. One such option comes through the changes to Reg A contained in Title IV of the bill. Now, private companies using the exemption have seen the maximum amount they can raise in a year boosted tenfold.
Tuesday October 21 brings Reviving the small cap IPO of yesteryear with Reg A Crowdfinanced Offerings, a cocktail event organized by www.equities.com contributor Dara Albright in Manhattan. Among the notable speakers at the event will be David Weild, the man known as the “Father of the JOBS Act” and the Founder, Chairman, and CEO of IssuWorks.
David took the time to talk to www.equities.com about how Reg A and the JOBS Act should work to open up capital formation and help the mega-cap companies of tomorrow find footing today while they’re still sporting downsized valuations.
EQ: Is it possible, at this point, to see any material impacts from the changes in the JOBS Act? Are there any issues that it’s exposed and what pressing issues in the market do you see moving forward?
David Weild: While the JOBS Act has helped improve the IPO market, the IPO market is still a shadow of its former self. We need to cut the costs of accessing public capital and improve the aftermarket support model if we’re going to ever get the number of small IPOs back up to the levels that existed before the Dot Com Bubble.
Most of the shrinkage in the IPO market occurred in small IPOs – what we defined as a sub $50 million IPO back in 1991. Adjusting for inflation, that $50 million IPO would be the equivalent of an $84 million IPO today. Back in the 90’s, 80% of all IPOs were small IPOs, then it dropped to about 20-30 percent of all IPOs. This year, the small IPO rebounded to 50% of all IPOs – largely, in our view, due to the JOBS Act and two provisions: “Testing the Waters” and “Confidential Filings.”
The big problem is how we grow back the infrastructure in support of small-cap companies. Small-cap stocks are what academics call “Asymmetrical order book” stocks – they are not naturally liquid – they require someone to step in and provide liquidity. In today’s markets, where the minimum price increment (MPI) is only 1 cent per share, market makers can’t make money committing capital to support institutional liquidity, so they don’t. At the same time, retail broker commissions were effectively gutted by the self-directed retail model. So, brokers can’t make money marketing stocks any longer. Combined, we’ve taken all of the marketing support out from under small-cap stocks, and companies need it back.
That’s what my company, IssuWorks, does. We use technology to help corporate issuers (public companies and companies tracking to IPO) to significantly increase the number of impressions with highly qualified institutional investors. We work with their investment banks and investor relations professionals to reach the long-tail of the institutional investor marketplace – the highly fragmented, long-term investor universe that is uneconomical for Wall Street to reach. We provided a disciplined and systematic approach to reaching these investors in a way that all parties can have confidence in. But, we also think that the government should put greater economics into market making to increase liquidity which will attract more institutional capital, increase valuations, improve returns to investors and decrease the cost of capital for entrepreneurs.
EQ: A lot of the early excitement around the JOBS Act was focused on Title III and crowdfunding, but it really does seem like people are now focusing in on Title IV. Why do you think the changes to Reg A are going to be such a big deal and why do you think they’re important?
David Weild: Reg A-Plus is really IPO-light. What it should do in theory is cut the cost of accessing public markets for up to $50 million in equity capital through a simpler disclosure regime. This is appropriate because small companies can bear less cost than large companies. In addition small companies pose no systemic risk to our market: The corporate governance scandals in the wake of the Dot Com Bubble that led to Sarbanes Oxley were driven by the failures of extremely large cap companies – Enron, Worldcom, Tyco, to name a few. When a large-cap company fails, it creates an enormous amount of damage to pension funds and individual investors. Large cap failures undermine investor confidence on a large scale. We suffer no such risk from small cap companies.
In fact, you can total the value of all listed nanocap (sub $100 million market value) stocks in the market and they don’t add up to value of one Apple ($AAPL). So, while small public companies create a lot of investor protection friction, are generally riskier than large companies and regulators obsess about them, the fact of the matter is that all companies start small and regulators must “right size” expense and tolerate that “friction” or they will inhibit economic growth, jobs, and eventually undermine national security.
Tragically, it was the small IPO that made our stock market the envy of stock markets across the globe. We have lost that edge: Both the Brookings Institute and the Small Business Administration have documented a decline in start-ups and small business. We think this is related in part to the decline in the small IPO. More small IPOs would increase returns to private company investors which in turn would increase capital available to start-ups and eventually the number of start-ups.
Small IPOs used to represent 80 percent of all IPOs. Then, with the dawn of electronic markets in 1998 through direct ATS, it dropped to about 20 percent of all IPOs. More importantly, we went from doing 500 IPOs a year in the early 1990s to less than 135 IPOs a year from 2001 to present. On a GDP-weighted basis, we should be doing over 900 a year. That difference between our potential and our actual has burned a 10 million plus job hole in the U.S. economy.
Applying large-cap structure to today’s small-caps stocks is also the wrong answer, and it is inhibiting the capital formation. Reg A-Plus is an attempt to get the costs right-sized to the companies and to give smaller companies an option to access public markets in a way where there are disclosure requirements as opposed to being in the dark markets, where there are no information standards.
There’s always been an interest, going back to the days when Stanley Sporkin was our head of enforcement at the SEC, in getting companies to disclose publically and do things in the full light of day. Just as Supreme Court Justice Louis Brandeis once said, “Sunlight is the greatest disinfectant.” Heavy-handed regulation has helped drive us in the opposite direction and as we have documented – the US has gone from 9,000 listed companies in the 90’s down to about 5,000 today. If we hadn’t changed market structure, we believe that the US would enjoy 13,000 listed companies and 10 million more jobs.
So, the hope is that Reg. A+ will create a lower cost and highly effective option to allow companies to access public capital. Right now, everyone is praying that the state securities administrators (NASAA) will not try and assert jurisdiction since they will only add another layer of regulation (State and SEC) cost and uncertainty of Reg. A for small public companies when large companies have only one (the SEC).
EQ: A lot of the focus seems to be on how everything is changing from the company’s side, but I think it’s also important to look at the investor side. How do you think the investment landscape is going to change for retail investors as a result of all of these new options for small companies?
David Weild: I think they’ll have more choice and they’ll see companies at earlier stages of development than they may otherwise have been able to. And I think that’s healthy. I think it’s healthy for the U.S. economy to have a broad range of options for the retail investor. It’s very healthy for the public to be talking about, and engaged in, entrepreneurship.
I think crowdfunding under Title II (It repealed the prohibition against general solicitation) has caused people to talk about very early stage companies. Now, it doesn’t matter if you’re accredited or not, you can still hear the stories of private companies which you couldn’t before the JOBS Act. So, people will see earlier stage stories and talk about entrepreneurship and that’s very healthy for the US economy overall.
People will aspire to take companies public or to be an entrepreneur. That dialog spurs innovation. Together, it creates a virtuous circle that will be incredibly beneficial to job formation and economic growth which ultimately accrues to the benefit of investors. It doesn’t mean that a lot of investors won’t lose money on early-stage companies, but, in the aggregate, we’re going to drive economic growth rates as a result of this and America will be better off. Investment returns are ultimately tied to long-term economic growth. Innovation will find cures to cancers, global warming and renewable energy.
Ultimately, investors will be better off. This doesn’t mean that some investors won’t lose money on businesses that go bad. Small businesses fail at faster rates than larger businesses, but some of them succeed. I think that what people lose sight of is that all businesses start small. Intel ($INTC) went public in 1971. It was only a 3-year-old company. It wasn’t profitable on an operating basis, and it missed delivery on its first product. That $8 million IPO? The company’s stock price was cut in half – talk about risk! It took a while to turn it around. The rest is history. It’s a major employer that’s contributed technologies to our economy that have precipitated everything from genomics to the wireless industry.
So, I think that you can’t underestimate the value of planting more and more of these seeds of hope. Which is what they are, because some subset of these companies are going to ultimately find the cure to cancer or a solution to global warming or sources of renewable energy. These are the things that will transform and improve the quality of life for the next generation. So, I can’t tell you how significant these improvements to capital markets are for the good of the nation.
EQ: How concerned should we be about the way Reg-A could potentially exempt more companies from state Blue Sky laws?
David Weild: One of the things that’s holding up Reg A right now is this whole controversy between state’s rights and federal preemption of Blue Sky, or “merit review.”
Merit review by the states is just an unnecessary tax on small companies. I think the irony is that usually the states’ rights advocates are the Republicans, but, in this particular case, it’s the Democrats that are trying to assert jurisdiction. It’s the Democratic states, mostly, that are trying assert jurisdiction over Reg. A offerings.
The irony here is that many of the Democratic states are likely to be the biggest beneficiaries of Reg A-Plus. The states of New York, Massachusetts, and California have some of the biggest entrepreneurial economies. Or, in the case of New York, New York is one of the biggest beneficiaries from the securities industry. So, I find it rather ironic that Democratic members of congress support something that makes cost higher for smaller companies, inhibits capital formation that will ultimately benefit some of the major Democratic states. This is absolutely the wrong way to go.
We really need federal preemption of merit review for Reg A companies just to keep the cost reasonable and to keep the risks reasonable. It’s not just the cost of the merit review directly, it’s the lack of predictability of what states that you’re going to pass and be able to market in. For example, if California wakes up one morning and decides that they are going to put in 35 different comments, you may find that you, all of a sudden, have to go ahead with your public offering without the state of California.
So, behind closed doors this issue been burning very brightly. I know that the SEC has wanted to preempt state regulation, and my view is that this is a classic case of state regulators behaving badly. I hope that they ultimately will acquiesce and give up that jurisdiction for the benefit of the country, but the cynics believe that NASAA’s members are more concerned about losing their state filing fees and running for state office than doing what is best for the economy. In my view, it is very important that we not saddle smaller companies with higher costs, which state regulation creates.
States still have the anti-fraud statutes, right? So, no company gets a free pass. I really hope the SEC wins on this issue. The SEC has this one right.