How Will the JOBS Act Affect Tech IPOs?
President Obama will today sign the JOBS Act, which eases securities regulations in a whole bunch of ways for small businesses, including allowing organizing “crowdfunding” from unaccredited investors. There are a few significant ways this will impact how tech companies go public.
The bill makes it easier for some elite companies to stay private, but it also makes it easier for companies to go public by reducing regulatory burdens associated with U.S. IPOs. I spent some time this week asking venture capitalists, secondary market organizers and CEOs how they think it will affect their business.
First of all, the bill says companies with less than $1 billion in revenue — called “emerging growth companies” — don’t have to make Sarbanes-Oxley audited financial reports for up to five years, don’t have to make Dodd-Frank compensation disclosures, can meet with investors before filing to test the waters, and have other rules relaxed.
There are a slew of rule changes, but the consensus from everyone I talked to is that the JOBS Act is more a reducer of friction than a significant change to the incentives around going public.
The JOBS Act is “more of a perception gain,” said Benchmark Capital partner Bill Gurley, speaking on a panel on IPOs organized by Wealthfront at the Rosewood Sand Hill last night. “It’s marginal, it’s not a revolution.”
Still, the IPO costs today are pretty major, and anything that reduces them could be good for would-be public companies. If it costs $3 million to $5 million today for a company with $80 million in revenue and 10 percent operating margins to go public, “that’s half of your profit right there,” Gurley said.
Multiple speakers at the event griped about the cost of Sarbanes-Oxley as well as the industry of consultants and advisers that has arisen around it. They praised the JOBS Act’s move to give young companies more time to comply so they can push back on the “bullshit overhead” surrounding compliance, as Aruba Networks CEO Dominic Orr put it bluntly.
Some companies anticipate a more dramatic and material effect. Speaking from Washington, D.C., where he’d flown in for the JOBS Act signing, Rally Software CEO Tim Miller told me, “If [the JOBS Act] had passed a year ago we’d probably be a public company today. Right now, it’s so expensive to go public as a small-to-midcap company that it would have taken all our potential profits and then some — and sharing that information publicly would have been a competitive threat to our business.”
On the other hand, another part of the JOBS Act makes it easier for some private companies to stay private. It raises the shareholder limit before companies are required to make public disclosures to 2,000 from 500. And that 2,000 doesn’t include employees.
The consensus I heard is that the infamous 500-shareholder limit has gotten a lot of publicity for the way it affected Google and Facebook, but the reality is that it doesn’t impact very many companies.
Still, raising the limit could, for example, take pressure off Twitter.
A byproduct of the 500-shareholder limit has been the use of restricted stock units, rather than regular stock options, by companies like Facebook, Zynga and Twitter so they can keep hiring without passing the mark. RSUs have become common enough that the SEC released general guidelines for them earlier this year.
RSUs are non-transferable and have no strike price — they’re activated only when a company is sold or goes public. So it’s possible that, post-JOBS Act, companies will go back to providing a more traditional equity upside with stock options.
But some VCs pointed out that the other benefit of RSUs is that they help companies avoid reporting “409A valuations,” which are the tax code’s requirement for a publicly disclosed fair market valuation associated with stock option grants. Private companies like to avoid telling people how much they’re worth.
The coincidence of the JOBS Act and the impending Facebook IPO seems to be prompting the industry to consider the state of secondary markets for private company stock — and perhaps turning away from them.
One of the secondary trading leaders, SecondMarket, last week laid off 10 percent of its staff, while referencing the Facebook IPO.
SecondMarket SVP Jeff Thomas told me this week he thought the major impact of the JOBS Act will be a movement away from RSUs as companies revisit their compensation incentives for employees. Of course, that would be in his interest — because RSUs are non-transferable, they can’t be traded on secondary markets.
Even if going public gets a little bit easier, public markets still come with the problems of “casino investors and quarterly reporting demands” that companies would rather avoid, Thomas argued.
But Gurley and other VCs were dismissive of organized secondary markets. They prefer that their private companies figure out more controlled ways to manage late-stage liquidity for early investors and employees.
Sequoia Capital tells its portfolio companies to include a “right of first refusal” in all their stock options so they can buy them back instead of allowing outside transactions, said long-time partner Doug Leone at the Wealthfront event last night. “Within Sequoia companies, that door is getting shut,” he said.