This post will detail the two panels from last Friday’s 2013 BCLBE and BBLJ JOBS Act Symposium: 1) The IPO On-Ramp and 2) Crowdfunding.
Panel 1: The IPO On-Ramp
Moderator: Ian Peck
Robert Bartlett, Professor, UC Berkeley, School of Law
Reza Dibadj, Visiting Professor, UC Berkeley, School of Law
Martin Zwilling, Startup Professionals
Background: Title I of the JOBS Act
Title I of the JOBS Act was originally pitched as a job creation vehicle. Title I seeks to accomplishes this through its two provisions: (1) providing an “on-ramp” to going public for emerging growth companies (“EGCs”), a company within five years of going public, using existing principles of scaled down regulation; and (2) improving the availability and flow of information for investors before and after an IPO.
There are four major changes that were discussed during the panel:
1) Creation of the “Emerging Growth Company” as a new category of issuer
2) EGCs eligible for IPO On-Ramp enjoy significant benefits, including:
- A reduced two-year requirement of audited financials needed in registration statements versus the standard three to five years
- Allows communication between EGCs and qualified institutional buyers prior to filing registration statement (although there is an SEC Rule that does not allow solicitation of filing)
- Research reports can be filed even while the EGC is making an offer
3) EGCs have less extensive financial reporting/audit obligations (exempt from SOX)
4) EGCs have limited executive compensation disclosures
Moderated Q&A
When questioned about what problems exist in the IPO market and how the JOBS Act approached these problems, there was a general consensus that the worry stemmed from the dramatic decline in IPOs in the market over the past decade. IPOs going overseas, problems that came with the economic downturn, and the choice of M&A as the preferred exit strategy. Zwilling spoke beyond the general market on how entrepreneurs, in general, want control of their company, and when they are ready to exit, M&A serves as a better exit strategy due to its lower costs and fewer regulations.
Zwilling makes the point that essentially, M&A provides private transactions where, in some cases, equity holders are being paid premiums that give entrepreneurs the freedom to exit and start new companies. The JOBS Act addresses some of these IPO concerns by lowering accounting costs, only requiring two years of audited financials in registration statements, and allowing EGCs to essentially test the waters by communicating with institutional buyers prior to filing a registration statement.
A concern was raised: The JOBS Act’s less extensive financial reporting and auditing obligations for EGCs may reduce information communicated to potential investors. This lack of information, especially for companies whose revenue source is either unknown or not fully developed, can create problems similar to the dot-com bubble. The panel discussed Facebook as an example of the information gap where Facebook’s pricing was way off and the investors not understanding exactly how Facebook makes revenue (e.g. when the phone application is used, Facebook is not making money).
Finally, the panelists were asked to look at whether crowdfunding would cut into the IPO market. The panelists mostly agreed that it is unclear how these Title I (the IPO On-Ramp) and Title III (the JOBS Act’s crowdfunding exemption) will interact. Professor Bartlett speculated that there will not be an inconsistency because the way the laws are set up will not a company to go public until they are ready. Title I allows EGCs to delay going public while crowdfunding allows them to raise funds with greater ease. When the company and the market decide that the company should go public, it will.
Panel 2: Crowdfunding
Moderator: Natalia Katunkina
Robert Bartlett, Professor, UC Berkeley, School of Law
Mary Dent, Silicon Valley Bank
Jerome Engel, Adjunct Professor, UC Berkeley, Haas School of Business
Eric Brooks, Securities and Exchange Commission, San Francisco
Reza Dibadj, Visiting Professor, UC Berkeley, School of Law
Martin Zwilling, Startup Professionals
Background: Title III of the JOBS Act
Prior to Title III of the JOBS Act, the only way to connect small companies with small investors was through a long, costly securities process. Title III’s crowdfunding provision allows a platform whereby funding can be registered and advertised in exchange for equity. There are concerns, however, that small investors will be taken advantage of.
Moderated Q&A
Crowdfunding’s main goal is to allow small investors to pool funding in support of a common cause. Prior to Title III, crowdfunding could occur so long as the funding was not considered a security (e.g. rewards and donations). Congress was likely motivated to pass crowdfunding legislation (in part) by the perception that small companies create jobs, but may have difficultly receiving funding. Dent described this as the technology being available to connect these investors with these companies and Congress just “unleashed the technology.”
There has clearly been an interest to participate in these smaller businesses given the money that is being raised outside of securities and the evidentiary success that has been witnessed in both non-profits and third world countries. Also, it is seen as a way of “democratizing finance” so that it is not just the “rich” who can access securities.
These goals, however, also generate concern. The first is outright fraud due to the gap between the investor and the small company. The second concern, which may be more widespread than the fraud risk, is that the inexperienced people drawing into making these investments fundamentally do not understand securities. Dent poses the question as to whether the people who are making these investments truly understand what equity is and what value can be gained from these investments. The question she posed, was: “WHAT DO YOU GET IF YOU OWN THIS?” The securities that Congress enacted work against the second concern because instead of protecting against this lack of understanding, it is providing a sense of false security. It does so by baiting investors to feel protected given the safeguards that Congress instituted, however these are retroactive safeguards that do not prevent investors from investing in companies in which they cannot receive a monetary return. For example: what does it mean to own $200 in your local bakery? This bakery will most likely not be going public or merging, and therefore investors will likely not have an opportunity to cash out on their investment.
The panel agreed that crowdfunding has its place, but it likely is not well-suited to raise capital in exchange for equity. Crowdfunding can be used for building stronger communities and cases in which emotion is a factor (e.g. doing good). Without the sentimental value being added, equity crowdfunding does not make sense. The reasoning being that once an investment is made, the investor is tied to that investment because investors will have a difficult time receiving a return on their investment since the company will most likely not go public. The panel did not recommend equity crowdfunding because getting a second round of funding will pose a problem (e.g. venture capitalists tend to avoid crowdfunding deal). Part of the reason that second round funding becomes a problem is because even making simple changes end up to be more difficult and less efficient given the amount of company owners.
Highlights from Audience Q&A
When asked as to whether notification could remedy the concern that investors do not understand the difficulties that will come with equity crowdfunding, the panelists were in agreement that equity crowdfunding is difficult, complicated, or involves many risks that make notification impractical. The reason being that too strong of notification will deter funding (scare people away) while too weak of notification, such as a boilerplate, will just be ignored. A mere warning cannot solve understanding crowdfunding. Also, there is debate as to how much of a duty is owed to protecting investors from equity crowdfunding. Investors are free to make their own investment decisions, but at what point should this be regulated to protect people from getting into investments that they do not fully understand.
Crowdfunded companies have a hard time exiting the market through an IPO because crowdfunding signals to investors a lack of credibility. Having venture capitalist backing is a signal to investors that the company is credible and there is a lower risk associated with these companies over those that could not receive this type of funding. Crowdfunded companies will most likely not go public and even if they did getting the funding prior to an IPO and actually selling stocks will be much harder.
When questioned on the role of corporate governance and the impact these deregulations will have on startups and EGCs, the panel responded in general agreement that corporate governances will not be weaker do to the deregulation of startups and EGCs. The reason being that startups, generally, have higher incentives and are not subject to venture capitalists peering over their shoulders. Also, corporate governance is not really going to be affected by Title I or Title III or the JOBS Act.
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