Five Years Later: Did the Jobs Act Change the IPO Market (or Did the IPO Market Change the Jobs Act)?

The Jumpstart Our Business Startups Act, or JOBS Act, will be celebrating its fifth anniversary in April. When it was passed in 2012, the hopes were that streamlining the financial disclosure process and opening crowd funding platforms for capital raising would encourage more companies to go public.
The Financial Executives Research Foundation, in partnership with Donnelly Financial Solutions, is working on a research project focusing on the Jobs Act and the impact on Emerging Growth Companies born out of the legislation.
In this issue of the podcast, we speak with Joseph Hall, a partner at the law firm of Davis Polk. Mr. Hall is head of the firm’s corporate governance practice and is a former Managing Executive for Policy at the U.S Securities and Exchange Commission. Today, he often advises companies on the disclosure relief embedded in the Jobs Act.

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Below is an edited transcript of the discussion (listen to the full podcast using the player at the top of this page):

Financial Executive Research Foundation: How has the Emerging Growth Company status changed the IPO market?
Joseph Hall: I don't think that the JOBS Act changed the IPO market.
It changed the way IPOs are marketed and it provided some real benefits to the companies that meet the EGC standard. But I think the IPO market is more demand-driven than it is supply-driven. Or, at least, I would think demand is a much more important factor than supply. And so, if you've got frothy markets at high valuations, I think you're more likely to see people trying to take advantage of that.
But that said, it's certainly a benefit to be able to file confidentially, which I think is an easier step for a lot of companies to take. So at the margin there may be some companies that will go ahead and take that step when they would not have done a public filing off the bat. Whether that company is the company that's going to make it all the way through the process is harder to know.
Clearly the ability to defer your audit, your 404 attestation for the EGC period, is a great benefit to companies in terms of cost savings — at least right at the beginning. There’s  obviously a lot of transaction costs associated with going through an IPO. And if you have to immediately upon finishing the IPO begin planning for that 404 attestation on essentially your second 10K, that's just an awful lot of front-end-loaded costs. It's been very beneficial to companies to be able to delay that for a period of time.
And then some of the other things with the JOBS Act that I think help the process or make the process better. It allows you to get more information out of the process than you have before, things like the testing-the-waters communications, which have been very popular. And I think just about every company able to do a regular IPO process is going to have some conversations. I think that probably helps companies get a more realistic view earlier on in the process about what the valuation is likely to be, what the investor reception is likely to be, because otherwise the only people they can talk to are their underwriters and their underwriters' analysts. It's not the same thing as talking to an actual investor.
I think those elements of the JOBS Act have changed the process for the better. I think back five years ago when the JOBS Act was passed in 2012, you read a lot about the JOBS Act encouraging companies to go ahead and go public that wouldn't have gone public otherwise. I don't think that we've seen that.
FERF: So, is your argument that the JOBS Act made it easier but it didn't necessarily change the market?
Hall:  What I mean to say is that if there was a company that was planning to go public or that wanted to go public, I just don't think that the passage of the JOBS Act was the trigger that got them to go public. I think if a company was ready to go public, they were a good candidate for going public and felt that it was time for them to access that capital market. I think the company was going to do it and the fact that the JOBS Act came along made that a little bit easier, but I don't know that there are that many companies that would not have gone public but for the JOBS Act.
FERF: How about those companies that file for ECG status and made it all the way to the end, went into a financial reporting company? How has that transition been for those companies?
Hall: Other than the 404, the SOX 404 attestation, once you're a public company, the changes are not all that significant from where things stood before 2012. The entry requirements are a lot easier, or somewhat easier under the JOBS Act, with two years of financials instead of three years of financials, reduced executive compensation disclosures, factors like that.
But a company that makes it through the confidential review process, makes it through the road show and prices and starts trading, and is now a regular public company. The big-ticket item is the 404 relief. Other than that it's a company, it's out there, it's followed by analysts hopefully. It's got quarterly reports to file. It's got earnings to release and it's got market expectations to manage and to meet. So I think if you talk to a CEO and a CFO of an emerging growth company versus a CEO of a company maybe 10 years earlier that was not an emerging growth company, only because law hadn't been enacted, I doubt you would find their experience was too different.
FERF: You mentioned 404 as being the biggest-ticket item for those companies making the transition. In your experience has there been any companies that 404 was too much of a burden?
Hall: I think companies realize that that was an expense that they were going to have to bear and they go out and hire one of these consultants to help them get their internal controls in line. But if you're thinking about going public and you're thinking about exposing yourself to public shareholders, you're trying to raise, call it anywhere from $50 million to a billion dollars in capital, the incremental expense of that SOX 404 requirement, I don't think was keeping companies from going public. I think there was a lot of chatter like that five years ago, six years ago, but it sorts of makes a nicer story.
In the market -- certainly since the financial crisis but even going back to the post-dot-com crash -- there were lots of other things going on in the market that were causing companies to delay their plans to go public. I would submit that the most important factor was companies afraid that they weren't going to get the valuations that they wanted.
FERF: How would you describe the demand dynamic today compared to what it was when the JOBS Act was initially passed?
Hall: Well I think that the simplest metric is just to look at the S&P 500 from what it was then to where it is now. We're obviously in record territory. There's a lot of excitement in the market right now. And we're hearing the bankers talk about a very robust IPO pipeline because of it.
Obviously, things can turn very quickly. And the IPO market is probably the most volatile of capital markets. Things can turn on a dime, and it's very susceptible to external shocks, but we're hearing that in the tech sector and in the energy sector, the bankers that we've been talking to are quite optimistic now about the prospects for a good IPO year. And that, to my way of thinking, has got to be directly tied to where you see the stock market indices right now.
FERF: Do you think the pipeline companies will be adopting ECG status going forward or they have already?
Hall:  I don't think there are any companies that turn it down. I think the statistics are something like 98% of IPO companies meet the EGC criteria. And if a company will qualify for the ECG, there doesn't seem to be any investor pushback for them to take advantage of the EGC rules.
If the market is not going to punish you in terms of valuation for delaying that 404 attestation report, or the market's not going to punish you for taking advantage of things like testing the waters — yeah, you're going to do it.
There's no hit for it. There's one section of the JOBS Act that, for example, would have allowed companies not to adopt new accounting standards that are proposed. And by and large companies have opted out of that, so that people have not been taking advantage of all of the benefits that were there in the JOBS Act. They've been thoughtful about which ones they're going to adopt, but the ones that they do adopt there doesn't seem to be any market penalty for adopting them.
FERF: Why don't you think they took advantage of that option? Is it because they think the market would push back on them too hard?
Hall: Let's say you're in an industry with 25 different comps in your industry and the other 24 comps are following the new guidance, but you're not. People are going to look at your numbers and they're going to be like, “okay well we see this is what you're reporting but now can you please tell us what you would have reported if you played by the same rules as everybody else.”
I think that's the main reason why that little gift in the JOBS Act, when companies thought about it, they realized that it didn't make a lot of sense.
FERF: Reg A+ was approved in 2015 and the crowdfunding rule in 2016. What are the trends from issues that you're seeing for using these capital-raising mechanisms?
Hall: They're insignificant. I think this is the word for it.
The people who drafted the JOBS Act had a lot higher hopes for Reg A+ and for crowdfunding, and I think what you saw in both instances was the SEC doing what they could to push back a little bit on that. It was clear during the Congressional hearings after the JOBS Act that the SEC was quite concerned about it, quite skeptical about a lot of the provisions in it.
And they were clearly skeptical about expanding Reg A+ or expanding Reg A into Reg A+. They were skeptical about crowdfunding and so I think when the SEC finally adopted rules implementing those provisions the reaction from the people that were pushing them was that the SEC stifled what we were trying to accomplish here.
If you look at Reg A+, there's tier one and tier two offerings.
A tier one offering is up to $20 million per year and a tier two offering is up to $50 million per year. But with the tier one offering you don't get state blue sky preemption so in addition to registering in the SEC you basically have to go out and register in every state that you want to offer and sell.
With the tier two offering you do get the blue sky preemption, but you also become subject to ongoing reporting requirements. They're not as stringent as the ones that apply to a regular reporting company, but I’ve got to tell you they're not that relaxed either. So we didn't think when the final Reg A+ rules came out that they were going to be terribly attractive for a lot of companies. And I've seen some statistics about how many regulations A+ offer, how much capital has been raised in regulation A+ offerings in the year and a half since the rules became final, and it's kind of a drop in the bucket.
I think the total amount is around the size of one good-sized IPO for a regular company. I don't think it's that attractive. I think if companies want to raise capital, even equity capital and not enter the SEC reporting regime, they're probably better off just doing a traditional private placement. On that score, the Jobs Act provided some very valuable flexibility there as well by removing the so-called general solicitation requirement from Reg D offerings, for 144 A offerings. I think that, just removing that general solicitation requirements of prohibition, moving the general prohibition, which is basically a prohibition on advertising, had more of an impact than anything that Congress did pushing the SEC to expand the regulation A exemption.
They made regular private placements easier to conduct and probably easier to more successfully conduct. And looking forward, if I had three wishes that I could get out of the SEC in the coming administration, certainly one of them would be do more relaxation of the very strict rules around communicating. Allow companies to advertise their offerings more broadly, let them talk more about what they're trying to accomplish. Don't maintain the 80-year old gag rule that we've had under the federal securities laws. I think that's frankly a lot more effective way to ease the restrictions on capital raising, than lowering the regulatory burden.
At the end of the day, nobody likes regulatory reporting requirements but without them, without that constant flow of communication to the market, the market doesn't know how to value you. So, it is a burden, it is a pain to have to report your earnings every three months, but the market needs that information and people to have interest in buying your stock, so that's kind of the bargain you make with the public market. You want public capital, you got to let the public know how you're doing.
I wouldn't focus so much on those rules if I were going to start figuring out which rules to throw out in line with the President's edict that you must get rid of two rules for every one rule that you make.
I'd be much more worried about s the ease with which people can go about raising capital and that's where I'd focus my energies if I were the new SEC.
FERF: Do you feel it’s worth trying to come up with a solution on the crowdfunding issue? Or is it just the fact that you make it easier for private placements and other mechanisms?
Hall: Well I tell you what, on crowdfunding, maybe I'm just too old and I've seen too much. My fear with crowdfunding is that you are going to take a lot of money for un-vetted ideas from people who really can't afford to lose it. I'm just not sure what the problem is out there that crowdfunding was designed to fix. These are companies that are taking peoples’ equity capital and who are they getting that equity capital from — they’re getting it from mom and pop investors. Maybe there’s a reason why these companies aren’t being able to get funding from certain more traditional VC sources. Maybe the problem is that the idea isn’t actually that good.
I’m just a natural skeptic about crowdfunding. I mean it sounds nice, it sounds like it has some sort of popular appeal. You know everybody thinks Kickstarter’s a great thing, but if a company hasn’t got an idea that’s good enough to interest the more traditional sources of private capital out there like the VC community, then I really question whether we ought to be making it all that easy for them to tap into retail investors who, by definition, don't really know what they're getting into. And then at the same time provide a venue where, or a mechanism for them to invest in offerings where they're getting less information.
The SEC tried to set up a system that would have some gatekeepers in it. They tried to set up a system where these funding portals would have some basic due diligence obligations. But to me, I'm very concerned that small investors are going to be burned by it. And the amount of money they can raise through a crowdfunding portal is not big enough to really launch a business of any kind of scale. Maybe it's going to be good for the local brewery or that kind of thing.
But again, if the idea is to help the local brewery raise more money from the local community, I'd rather do that by things like making it easier for them to advertise their securities offerings rather than put them in this crowdfunding portal. I don't ever see it becoming an outrageous source of capital for anybody.
FERF: If a private company comes to you right now and is looking for capital-raising options, what do you tell them?
Hall: The first question will be whether they are ready to become a public company or what’s the investor base they’re targeting. If they’ve got a great idea and they’ve already talked to a couple of venture capitalists and they’ve got VCs or even just angel investors that are willing to put some money in. You work with them on that basis.
But if they’ve matured beyond that and their VCs are looking for an exit, we tell them let's go ahead and go public. I can't see us ever saying to somebody go the Reg A+ round. In the first place, it's really not a legal judgment, It's clearly a business judgment whether to go that route, but I think if I asked you to name me five companies that went public through the Reg A+ process, maybe you could if you just looked it up, but I couldn't name one.
I think if a company wants to go public, they're going to want to do it the traditional way. They're going to want to do it with underwriters, using a regular underwritten process, listing on a national stock exchange, filing quarterly reports, holding investor calls, holding analyst calls. The traditional way I think is still the paradigm.
FERF: Do you see any changes happening on the IPO or capital-raising issues for companies as far as regulatory concerns are going right now?
Hall: To the point that I made earlier about liberalizing the communication rules I think would be something that the incoming administration could look at. Make it easier for companies to actually conduct the offerings. And then I think once a company is public, the SEC has for a while been engaged in the process of asking themselves how to modernize the disclosure regime and Congress in both the JOBS Act and the Fast Act give a pretty clear direction to the SEC look through their disclosure mandates, and see where they can be simplified or eliminating duplicative disclosures and things like that.
There's a lot there, the SEC's rule book tends to grow, they don't go back in and prune it very often. Congress has told them to go in and prune it. So, I think there are things there that the SEC could do to make it easier for a company