The IPO Bill Hits Crosswinds, Which Might Be a Good Thing

The so-called Jobs Act, which steamed through the House earlier this month, has run into crosswinds.

The bill has President Obama’s support and is likely to pass the Senate. But a The New York Times editorial took aim at it, a critical statement from Securities and Exchange Commission Chairman Mary Schapiro argues it will chip away at objective investment analysis, and former SEC chair Arthur Levitt has described it as “investor unfriendly.”

The Council of Institutional Investors called for a re-evaluation. Even the consistently conservative U.S. Chamber of Commerce worries about the provision allowing Wall Street analysts to write research reports prior to a startup’s IPO.

There are good reasons to raise questions. I, too, have a quarrel with a minor piece of it that runs counter to the Reg FD reforms of a decade ago.

Clearly there is need for IPO reform. Over the past 11 years, an average of only 48 venture-funded companies sold shares to the public each year, compared with 197 from 1991 to 2000, according to data from the National Venture Capital Association and Thomson Reuters, publisher of this blog. There are numerous reasons for this, including several expensive reporting requirements in Sarbanes-Oxley. Relief is appropriate.

In the crosshairs of the criticism is a clause designed to do this by easing compliance with accounting regulations for up to five years for companies with less than $1 billion in annual revenue. Critics say too many companies will be permitted under its umbrella. Some suggest lowering the threshold by half or more.

The NVCA points out that between 13% and 15% of listed companies would qualify for the provision at any one time, which would include a majority of new venture-backed issuers, but hardly a lion’s share of the public company universe. A conversation with Kate Mitchell, a managing director at Scale Venture Partners and a member of a task force providing recommendations to legislators, leads to another useful observation.

Mitchell acknowledges that the intent is to “encourage IPOs.” “You see a big dearth,” she says. So exclusion is not a bad goal and lowering the cap might have the unintended consequence of drawing out companies too early in their development instead of closer to the $1 billion mark.

A second clause drawing fire is the one permitting Wall Street research prior to an IPO. Clearly the lack of research hurts young companies trying to expand their investor base. One fear is research coverage “will be the way investment banks compete to win the IPO mandate,” says Lise Buyer, principal at Class V Group, an IPO consultant.

Mitchell says several safeguards are designed to keep this from happening. For instance, a research analyst can’t be paid by investment banking departments, can’t be supervised by an investment banker and has to certify independence. “We wanted to have quality independent research,” she says.

But it is hard to know how the provision will play out in practice.

The legislation also authorizes the crowd-funding of startups, the confidential filing of S-1s, which then must be released publicly at least 21 days before a roadshow begins, and a “test the waters” provision enabling companies planning IPOs to speak with investors during what at present is a blackout period. The goal of this last clause is to allow startups to determine if there is demand for their stocks. The downside is that transparency disappears as individual investors obtain information the general public doesn’t have, exactly what Reg FD hoped to prevent.

Supporters point out that similar conversations take place during stock transactions on the secondary market today. And if a company finds out it isn’t yet ready to go public, it can divert resources back to building its business instead of pressing ahead.

I find the argument falls short. After all, the secondary market is not a paradigm of transparency today, with information on its exchanges often in short supply. And when information becomes selectively disclosed, the investing public as a whole loses.

NVCA President Mark Heesen says the Senate is likely to vote and pass the legislation within a couple weeks. Whether it will change in the process and go to conference is unclear.

I hope it will. Tweaks will likely improve it. The reason is as Buyer said in an e-mail: “The bill was clearly designed by those anxious to make selling companies to the public easier, but it looks much more questionable when viewed from the buy side.” She is right.

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