In this hyper-partisan era, the one thing Republicans and Democrats seem to agree on is the need to enable entrepreneurs and small businesses to gain access to capital in order to fuel job growth. To that end, the Jumpstart Our Business Startups (JOBS) Act, signed into law by President Obama on April 5, 2012, represented a rare point of consensus in Washington that startups and emerging growth companies should not be showered with burdensome mandates like those faced by larger companies in the Dow Jones Industrial Average.
In the years since the JOBS Act passed, access to capital has gradually improved thanks in significant part to the law. But many of the provisions have taken a very long time for the Securities and Exchange Commission (SEC) to implement. Title III, for instance, intended to enable equity crowdfunding for very small firms, just went into effect on May 16, 2016.
The good news is there is a thorough effort in Congress to expand upon the JOBS Act’s liberalization of access to capital for small entrepreneurs. The Fix Crowdfunding Act (H.R. 4855), sponsored by JOBS Act architect Rep. Patrick McHenry (R-N.C.), would raise the threshold for an equity crowdfunding campaign from $1 million to $5 million per year, in line with that of other countries, including Great Britain, and allow firms to communicate with potential investors. The bill is expected to get some bipartisan support, like the original JOBS Act, when it is likely voted on in the House Financial Services Committee this week.
These reforms are sorely needed, not just to give entrepreneurs access to capital, but to provide ordinary investors with “access to wealth creation,” as entrepreneur and crowdfunding advocate D.J. Paul noted at the recent “Fundit” conference on JOBS Act opportunities in Las Vegas. Excessive regulations have not only made it much more difficult for small businesses to raise capital, but for middle class investors to grow wealthy through investing in companies at their early stages of growth.
Mounds of red tape from securities laws have created a vicious cycle in which entrepreneurs can’t take their small firms public to access capital, and ordinary investors can’t access wealth creation through buying shares in these promising firms.
As Scott Purcell, CEO of the equity crowdfunding consulting firm FundAmerica, noted at the Fundit conference that he co-organized, it wasn’t that long ago when startups and smaller firms often went public on the same stock exchanges as large firms to “raise capital to grow.” In an interview a few days after the conference, he gave the example of his father, David Purcell, now 78, who launched an initial public offering for the computer printer manufacturer Encad in 1993.
When it went public on the NASDAQ stock market, Encad’s IPO raise was only $7.5 million—in contrast to the average of $300 million for today’s IPOs. When Encad was acquired by Eastman Kodak in 2001, many public investors made five times the amount of their initial investment. But now, “the costs of regulations and compliance make it literally impossible for a company like that to go public,” said Scott Purcell.
A major cause of the IPO decline is the Sarbanes-Oxley Act in 2002, known as “Sarbox” for short. Signed by President George W. Bush in responses to scandals at Enron and WorldCom, it requires extensive audits of broadly defined “internal controls.” Auditing costs quadrupled for many public companies.
Piling on to the costs is the Dodd-Frank Act, signed by President Obama in 2010. It requires public companies to spend valuable resources to document things that are not even tangentially related to preventing financial fraud, and instead are designed to advance certain social or political agendas. For example, Dodd-Frank’s “conflict minerals” provision requires public companies to disclose if any gold, tin, or tungsten used in their products may have come from war-torn regions of the Congo.
As a result of these burdens, investing in new companies at their early stages of growth has largely been an option available only to wealthy venture capitalists or angel investors. Under the SEC’s Regulation D, companies do not have to comply with many mandates such as Sarbox and Dodd-Frank if they restrict their shareholders to “accredited investors.” The SEC defines “accredited investors” as individuals with a net worth, excluding personal residences, of at least $1 million or annual income of at least $200,000, or married couples who have an annual income of at least $300,000.
While millionaires constitute a small minority of the U.S. population, there are still literally millions of them who could be potential investors. It used to be illegal for entrepreneurs to market or advertise their firms in search of accredited investors, so only the well-connected could reach them. Title II of the JOBS Act changed all this for the better, by repealing the SEC’s 80-year-old ban on “general solicitation” of private securities. Now, websites like OurCrowd.com allow startup firms to make their pitches. But while these potential deals are now visible to everyone, the investors who sign up still have to be deemed “accredited” by the SEC.
But that may change ever so slightly for the better. The JOBS Act’s Title IV “mini-IPO” provisions, implemented last year as Regulation A+, allow companies to launch special stocks offerings of $50 million or less in which shares can be sold to all types of investors. Although these offerings still must be approved at the SEC and contain audited financials, they do not have to comply with other mandates, such as those in Sarbanes-Oxley and Dodd-Frank. A DC Circuit Court of Appeals ruling issued July 14 will likely further bolster Regulation A+, as it gave the green light to the SEC’s preemption of state-level red tape for some of the offerings
Regulation A+ and the potential expansion of the JOBS Act’s equity crowdfunding provisions in the Fix Crowdfunding Act may enable ordinary investors to again grow wealthy with a company headed by the likes of David Purcell. Scott Purcell has suggested that his serial entrepreneur dad’s new firm, ProtoStar, which makes an upright medical walker called the LifeWalker, look into utilizing JOBS Act provisions to raise capital from the public.
The elder Purcell has good relationships with wealthy “accredited investors,” but is excited about the JOBS Act and the potential of the Fix Crowdfunding Act to give him the option to go directly to the investing public. “VCs always think they are the smartest guys in the room,” he says. “They are not, for many reasons.”
David and Scott Purcell and the Fundit conference participants are just some of the growing number of entrepreneurs who believe it’s time to open “the room” to Joe and Jane Investor to let them once again partner with budding entrepreneurs. It’s the shot in the arm that job growth and wealth creation for all sorely need.
Disclosure – I spoke on two panels at the Fundit conference, which reimbursed me for some travel expenses.
Originally posted to Forbes.