When legislation dubbed the JOBS Act was signed into law by President Barack Obama in 2012, it was heralded as a faster on-ramp to an initial public offering. Instead, the act has added to the cascade of factors helping tech companies stay private longer.
The Jumpstart Our Business Startups Act was a grand compilation of many different bills that had been attempted in congress, designed to make it easier for young companies, especially tech startups, go public. With less stringent reporting requirements, the bill’s intent was to reduce much of the regulatory burden and some of the cost of going public.
The actual impact of the JOBS Act is much different, despite some recovery in the IPO market. This year, IPOs, especially in technology, increased, with a total of 160 deals filed in the U.S. in 2017, according to Renaissance Capital, which provides pre-IPO research, up from 105 last year. And as data shows, during the first two years after the JOBS Act passed, the numbers of IPOs increased.
The 2017 upswing, though, is relative. In 2016, the IPO market sunk to a low it had not seen since the 2008-2009 financial crises, the drought that was one of many factors that ultimately led to the JOBS Act. And the spike in the wake of the JOBS Act’s passage likely has much more to do with the dearth of offerings during the financial crisis than the legislation.
Meanwhile, the downside of the JOBS Act could be weakening demand for IPOs while doing little to increase supply. The JOBS Act cut disclosure requirements by letting companies confidentially file their initial intent to go public with the Securities and Exchange Commission, report two years of financial statements instead of three, and disclose executive compensation for just three top executives. So investors are given far less information on companies than in the past to make an investment decision, which a recent study has shown is making investors more wary to buy into IPOs.
“What we do know is that the number of IPOs has not really taken off. … It took away investor protections, but didn’t generate an increase in IPOs,” said Lynn Turner, who was chief accountant of the SEC from 1998 to 2001. “From that perspective, it was a failure.”
The avoidance of IPOs has been blatant among the “unicorn” tech startups, companies like Uber Technologies, Airbnb Inc., Palantir Technologies and Pinterest, all of which have stayed private as long as possible. For these companies, money has been easily accessible, thanks in part to the elimination of the 500-shareholder rule in the JOBS Act, combined with an explosion in private funding sources.
“They are able to fund in a way they have never been able to before,” said Susan Chaplinsky, a professor at the Darden Graduate School of Business at the University of Virginia, and a co-author of a study that found the JOBS Act did not lower the cost of going public for companies. “The first and foremost reason for going public is because they needed to raise capital. And the amount of money in the private sector has taken that off the table.”
The new SEC rules raised the requirement to 2,000 shareholders before a company is required to disclose its financial statements. While Google GOOGL, -0.28% GOOG, -0.32% and Facebook Inc. FB, -0.68% were the only companies pushed into an IPO under the previous rules, the new requirement is helping many companies stay private while still adding investors.
“The 500 shareholder rule only impacted two companies, ever, Google and Facebook,” said Barrett Daniels, Chief Executive and managing partner of Nextstep Advisory Services, which helps companies with IPOs, technical accounting, and regulatory reporting. “Was it really necessary to change [that rule] to create this crazy environment that we are in?”
The IPO market in 2017 has mostly been made up of smaller, lesser known companies, which have had mixed results in the market. The best known companies were consumer-focused startups such as Blue Apron Holdings APRN, +2.48% a developer of meal kits; Snapchat creator Snap Inc. SNAP, -0.92% ; and the streaming platform company Roku Inc. ROKU, +6.30% ROKU, +6.30% More esoteric corporate software and cloud companies such as MongoDB Inc. MDB, +1.23% an open source, subscription-based rival to Oracle Corp., and Cloudera Inc. CLDR, -3.84% CLDR, -3.84% were among the lesser-known in the deal ranks this year. None of these deals, with the possible exception of Snap, was greatly anticipated by investors on the same level as the big unicorns like Uber and the others with billion-dollar valuations.
The JOBS Act has made going public easier for these companies in some ways, especially by allowing any early correspondence between companies and the SEC to be done in private. The SEC adopted new crowdfunding provisions as additions to the JOBS Act, the last piece of the act to pass, which went into effect in 2016. Those rules let crowdfunding platforms continue without having to register with the SEC, giving small companies access to capital at a far lower cost.
There is a downside to these rules, though. In 2011, investors got wind of Groupon Inc.’s GRPN, +0.00% aggressive accounting shenanigans before its IPO, and were alerted to it via the exchange of correspondence with the SEC. Groupon dropped the controversial accounting measure before its IPO in 2011. In crowdfunding, consumers often fund companies with the intent of buying a product in advance but they can end up being guinea pigs for early versions of products that don’t work as advertised or never arrive.
And in another area where the JOBS Act has not really helped is in the cost of going public. Three business professors at different universities, Chaplinsky, Kathleen Weiss Hanley and S. Katie Moon, found that in its first three years, the JOBS Act did not lower the costs of going public for emerging growth companies. Their study called, “The JOBS Act and the Costs of Going Public,” concluded there was “little evidence that the act in its first three years has reduced the measurable costs of going public.”
“Although there are benefits of the act that issuers appear to value, they should be balanced against the higher costs of capital that can occur after its enactment,” the researchers wrote.
Meanwhile, factors outside the JOBS Act are providing many reasons to stay private. In the past year and a half, more alternatives to going public have emerged, such as the proposed Long Term Stock Exchange, and a special purpose acquisition vehicle called Social Capital Hedosophia Holdings Corp. IPOA, +0.30% IPOA, +0.30% which raised $600 million in its own IPO earlier this year.
Proponents of some of the recent alternative listing options believe that the IPO market is basically broken. In an interview with the New York Times, James Freeman, the founder of Blue Bottle Coffee, said that going public seemed like “a way of living in hell without dying” when explaining the company’s decision to selling a majority interest to Nestlé SA NESN, +0.72% for $500 million this past September. Before Uber’s former CEO Travis Kalanick stepped down amid the mess of scandals he said he would hold out as long as possible before going public.
The creators of the Long Term Stock Exchange believe that the short term mentality rules on Wall Street and they have designed a potential exchange with a so-called tenured voting system, in which the voting rights increase the longer investors own the stock. But this concept is also controversial because it will eliminate executive compensation being tied to short term results.
“They are making the claim that the IPO market is broken and one reason it is broken is founders are reluctant to have to deal with anxious shareholders. That is the heart of capitalism,” said Stephen Diamond, associate professor of law at Santa Clara University School of Law. “Mark Zuckerberg was an idea-rich, cash-poor guy and he has balked and screamed about it every step of the way.”
While Zuckerberg may have kicked and screamed about going public before the company’s 2012 deal, though, Facebook’s looming IPO enabled him to cut a deal to buy Instagram for $1 billion in cash and stock just weeks before Facebook’s IPO.
“To buy an Instagram, you need stock,” Diamond said, adding that the deal could very likely not have been done if Facebook only had illiquid stock.
The bigger trend in the last two decades, said IPO expert Jay Ritter, professor at the University of Florida, is to be acquired. He noted that IPOs in the U.S. have been on the decline since the dot-com boom and bust of 2000. From 1980 to 2000, an average of 310 firms went public every year, but from 2001 to 2016, the average sunk to 108 a year.
“In tech, getting big fast is more important than it once was, and staying organic isn’t what it used to be,” said Ritter, who blames the “winner take all” phenomenon on the drop in the number of IPOs and preference to be bought. “Companies are waiting and focusing on growth to be the winner, rather than going public early when it’s not clear that the business model is going to successful. The availability of private capital has helped them wait long.”
The biggest evidence of how the evolution of the IPO market will play out will arrive in the next year or two. If the backlog of unicorn companies sitting on the sidelines finally breaks, sending important companies like Uber and Airbnb to Wall Street, we could start to see what the new normal will be. But it is completely possible that we are already in that time, with huge funds like the one wielded currently by SoftBank Group pouring money into long-in-the-tooth “startups” that communicate privately with the SEC while continuing to avoid going public.
This is the world that congress created, and it could be permanent.
“You can have nearly unlimited private investors, they can raise huge amounts of money, ergo the birth of the unicorn,” said Lise Buyer, founder and principal of Class V Group, which advises young companies on the IPO process. “In a convoluted way, the JOBS act is directly responsible for the rise of the unicorn and the depression of the IPO market.”