JOBS Act Risk Disclosures IPOs

The new law, which loosens reporting requirements for smaller businesses, has prompted some companies to actually add information to their regulatory filings.

CFO Magazine
Sarah Johnson

In the run-up to Facebook’s initial public offering, which is expected to happen within days, smaller, lesser-known companies are preparing for their own foray onto U.S. stock exchanges as well. Naturally, they are alerting investors in public filings that their small stature and lack of public-company experience can make investing in their stock a risky endeavor. Some are going even further and emphasizing that the Jumpstart Our Business Startups (JOBS) Act is itself a risk factor.




Seal of the U.S. Securities and Exchange Commission. (Photo credit: Wikipedia)

Over the past week, at least 13 companies … have warned investors in their prospectuses filed with the Securities and Exchange Commission that the JOBS Act’s breaks on SEC rules could actually be a turnoff. “We cannot be certain if the reduced disclosure requirements applicable to emerging growth companies will make our common stock less attractive to investors,” reads a statement in boldface type by Cimarron Software in an S-1 form submitted to the SEC yesterday.

The trend may reflect an unintended consequence of the JOBS Act, which lawmakers hope will lead to a more active IPO market, according to Michael Stocker, a partner at law firm Labaton Sucharow, who represents institutional investors. The filings are saying “that because the companies are willing to take advantage of the related standards for disclosures under the JOBS Act, one real risk is that they will be punished by investors, since investors won’t be getting as much information and they may have less confidence in how the companies are doing,” says Stocker.




What investors want (Photo credit: tjohansmeyer)

Indeed, so-called emerging-growth companies — those that take in less than $1 billion a year in revenue — can wait up to five years after their IPO before following all of the rules that larger listed businesses have to follow. They can submit two audited financial statements with the SEC instead of three, they can avoid holding say-on-pay votes, and, most significantly, they are not required to get their auditors’ signoffs on internal controls over financial reporting.

… Not all companies preparing for an IPO that qualify as emerging-growth companies have included the law as a risk factor.




Logo og McDermott Will & Emery (Photo credit: Wikipedia)

However, they may want to consider doing so, according to Thomas J. Murphy, a partner at law firm McDermott Will & Emery who helps companies with their public offerings. “It’s cheap insurance and good disclosure to call out for people places where you differ from other public companies,” he says.
The additional disclosure implies the company using it is trying to be comprehensive. Moreover, the lines of text may help it later on if it runs into trouble. “If an emerging-growth company has a failure of its controls and has to restate its financial statements, the disclosure is going to be a plus when that company defends itself against a lawsuit,” Murphy says. The business can respond by saying, “We warned you that there weren’t auditors looking independently at this.”

The plaintiffs’ bar could have a retort, however, Stocker suggests. “All the disclosure says is that because of the JOBS Act, the company’s stock may not trade as high a volume or [for as] good a price as you may hope,” he says. “It’s not saying because of the JOBS Act you may get a nasty surprise at the end of five years.”

Related articles

• The New Landscape for Business Startups and Their Investors (toddballenger.typepad.com)
• Going Public In Private: The Boom In Secret IPOs (forbes.com)
• Much Ado About the JOBS Act: Fear Mongering vs. Idealism Cloud (pandodaily.com)

A Look at Obama's JOBS Act

The Network Journal:

By: ANN BROWN

Wednesday, April 25, 2012

• Business

On the surface, President's Obama's recently signed the JOBS Act, for Jump-Start Our Business Start-Ups, which will roll back restrictions on the way start-up companies can raise money from individual investors, seems like a win-win for small businesses. But says management, strategy and branding consultant Steven Mason, president of the Brand Mason, there is more to it.

"The JOBS Act is a boon to private companies, which drive job creation and the GDP. The most significant impact of the recently passed JOBS Act is that private companies will be able to raise money from individuals who are not "accredited". This means that investors who have not been considered wealthy enough by the SEC to be designated an accredited investor will now be able to make direct equity investments in private companies,” says Brian Hamilton, CEO of financial information company Sageworks and a noted expert on privately-held companies. “It would be hard to overstate the implications of this legislation as it allows small investors access to a market that previously didn't exist to them. Additionally, it gives private companies access to millions of dollars they couldn't previously tap into. It introduces some risk for a new class of investors, but it is very positive for private companies."

BEA logo (Photo credit: willida)

Small businesses can throw a wider net for investors, says Mason. "If you are good at getting hundreds of people to invest small amounts of money, you can potentially raise a large amount of money," he says. Potentially, the bill gives more freedom to startups—and investors. “Small investors can direct investments to their community,” explains  David M. Williams, founding director of professional consultant firm Business Enhancement Associates. “It allows small businesses to go public without SEC filing. It also exempts small businesses from Sarbanes-Oxley audit requirements for five years.”

Among other things, it would allow them to raise small sums from investors via the Internet. According to Obama,  websites will be closely monitored by the Securities and Exchange Commission. Some critics say this component of the bill may leave people vulnerable to fraudulent online schemes. “The abundance of online options for connecting unaccredited investors with private companies presents an inherent potential for fraud and misrepresentation and may draw in undiscerning investors,” notes Hamilton.

There are other cons, he points out. “Comparatively riskier investment opportunities will become available to unaccredited investors since new companies are always the least well known and many young companies fail,” he says. “As far as IPO investing is concerned, private conversations with the SEC about disclosures are not released immediately, and while the company may benefit, it's hard on investors seeking transparent information.”

Also, “crowd-funding platforms and this type of investing are so new that there is likely to be additional fraud. The risk factors of these investments should be made clear. Maximum amounts that individuals can invest based on their income is at a minimum now,” says Hamilton.

David M. Williams, founding director of professional consultant firm Business Enhancement Associates, agrees. “Crowdfunding investors would have no control in management decisions, and no guarantee that their interests would be represented. Small investors add liability, investors who would normally not be qualified or accredited. And the lack of SEC oversight or Sarbanes-Oxley guidelines make fraud or mismanagement more likely,” he says. There are other drawbacks to the bill he says. “It adds the burden of up to 200 shareholders to management used to closely-held ownership. It also complicates future equity raises, debt financing or recapitalization,” says Williams.

Among the other negatives, says Mason, are "you can raise a maximum of $1,000,000 in any 12-month period and individuals can't invest whatever they want. They are limited to investing percentages of their income and net worth and there's only so much they can invest in one year, across all crowdfunded companies." There are restrictions that may also hinder small businesses seeking funding under the new bill. "Funding Portals have to be registered with the SEC and the SEC hasn't even written all the regulations for them yet, so if the regulations are onerous enough, the entire point of this crowdfunding could be a chimera. Basically, the SEC and the government have the power to make this a complete boondoggle, because these Funding Portals are subject to so many restrictions that it's going to cost issuing companies real money just to comply," Mason points out. "There are significant accounting fees companies will have to incur, and if they are raising more than $500K, they'll need audited financial statements, which are very expensive."

Occupy the Jobs Act (Photo credit: DonkeyHotey)

Adds Mason, “What's happening is that a new surge of available capital will enter the market, making possible a far greater diversity of startups otherwise unable to get funding through other sources, at least in their early stage. At the same time, those funding these businesses will not be professional investors, and there are intriguing issues associated with their different expectations as well as with the ultimate success or failure of their endeavors. Last, while President Obama signed the bill, I would not characterize the bill as an "Obama policy" as the impetus for the main features of the bill did not come from the President. Further, the JOBS bill imposes a number of SEC reporting requirements on those seeking crowdsourced funding: it's not as easy as it sounds, but it certainly sounds great politically.”

The bill was supported by bipartisan lawmakers and entrepreneurs.

Related articles

• Crowdfunding. Who's In? Who's Not? (isellerfinance.wordpress.com)
• The Effect of the JOBS Act on Small Businesses and Investors (beamemphis.blogspot.com)
• More on the JOBS Act: Crowdfund Your Next Round (siliconbayounews.com)

The Effect of the JOBS Act on Small Businesses and Investors

Business Enhancement Associates AHA! Moments Blog
April 20, 2011
by David M. Williams

Job Act (Photo credit: Sasha Y. Kimel)

The Jumpstart Our Business Startups Act (JOBS Act) signed into law in early April is designed to create jobs by letting small companies raise capital without being required to meet all of the existing legislation. It allows a small company to offer public stock, to “go public” or make an Initial Public Offering, without having to file with the Securities and Exchange Commission. Allowing a small company to go public has broad implications for both the company and the investor.

For the Small Business

A small business must consider under what form of entity it wants to operate. Taxation, liquidity, control, and liability are all affected by a company’s form. Very small companies, the “Mom-and-Pop” shops, usually start as sole proprietorships. This form is the simplest to operate—the owner/operator and the operating entity are considered one and the same.

At the other end of the spectrum is a C Corporation. A C Corporation is generally considered a separate entity from any of its owners. Fractional ownership, “shares”, can be held by multiple individuals or entities and they can be conveyed for value (bought and sold) without disturbing the entity’s existence. It has its own income tax and tax rate table, which can exceed the marginal tax rates of any shareholders.

SEC (Photo credit: Wikipedia)

There are certain advantages to the C Corporation entity, and there are certain disadvantages. A business founder needs to weigh both of these to determine whether a C Corporation would be advantageous to the business. Nonetheless, a company must be a C Corporation to benefit from the provisions of the JOBS Act.

The JOBS Act permits a company to sell public shares under certain circumstances without filing with the SEC. It can advertise the sale of shares, and it can sell shares to individuals who make less than $200,000 annually or have less than $1 million in assets excluding home and personal assets (an accredited investor). The Company is exempt from meeting Sarbanes-Oxley requirements for 5 years or until its revenue reaches $1 billion.

The provision of crowdfunding, a capital-raising strategy in which investors buy stakes in closely held companies over the Internet, appears to be a good thing at first blush. However, first off, each shareholder is limited to investing $10,000 (or 10% of income if lesser). The most a Company can raise is $1 million ($2 million if they file with the SEC) by means of crowdfunding. That means that raising $1 million would add 100 owners to the business.

While the language of the JOBS Act is not clear on the matter, it appears that any subsequent equity raise would require filing with the SEC and meet all of the reporting requirements, since the company is now a Public Company.

Michael Oxley , U.S. Senator from Maryland. (Photo credit: Wikipedia)

From the business standpoint, the JOBS Act simplifies the process of going public for a small company. However, a small company would be required to switch to a C Corporation, with its additional complexity and tax cost. A business could end up with a large number of shareholders who would be considered unsuitable to own stock of a start-up company if it weren’t for the JOBS Act. While the business wouldn’t have to meet Sarbanes-Oxley requirements, the shareholders will still hold the CEO, CFO and Board of Directors liable. Overall, the burdens may not be offset with the limited amount that can be raised.

Additionally, the business would not get the benefit of investment banking professionals as the business owners try to raise capital on their own. The potential for issues is great, which could make the JOBS Act a very expensive way to raise capital.

For the Investor

Number of the High Net Worth Individuals (HNWIs) hold at least US$1 million in financial assets, excluding collectibles, consumables, consumer durables and primary residences. Utra-High Net Worth Individuals (Ultra-HNWIs) hold at least US$30 million. (Photo credit: Wikipedia)

The provisions of the JOBS Act offer small investors the chance to invest into opportunities that were only available to High Net Worth individuals and institutions. It also lets them to direct their investment dollars into their own geographic area.

There are many drawbacks to the opportunities made available. First off, a small investor would be investing in a very risky enterprise. An institutional investor knows that some of their portfolio companies will fold up. A few others will be “walking wounded,” able to continue operating but not profitable enough to return capital to the institutional investor. They count on one out of seven portfolios to provide them with a risk adjusted return. Unless a small investor can invest in 7 or 8 small companies, the odds are that their investment will either fail or be “walking wounded.”

Although the JOBS Act gives the investor public stock, there is no market for it. The investor can’t trade it on any stock market. They can only hold the stock until the company buys them out or it goes bust.

Sarbanes-Oxley was put into place because of accounting abuses epitomized by Enron. These small companies won’t have to have the degree of auditing that Sarbanes-Oxley requires. Therefore, the small company could fail by accident or imprudent management that wouldn’t be caught. This does not even consider unethical individuals who form false companies to collect capital, and then disappear.

The small investor would have no control. Most likely, the 100 shares (from crowdfunding) would represent no more than 49% of the company. The small investor would therefore own 0.49% of the company. They would have no say in company governance, short of suing the company.

The JOBS Act removes many of the safeguards that have been put in place to protect the small investor. These safeguards were enacted because of the risk of abuse or loss. Small investors need these protections more than ever. It would appear, then, that the JOBS Act opens risks and problems for both the offering company and the small investor.

Related articles

• Much Ado About the JOBS Act: Fear Mongering vs. Idealism Cloud (pandodaily.com)
• JOBS Act: 5 things to look forward to (and 5 to dread) (news.cnet.com)
• The JOBS Act, Groupon, and Gullible Investors (blogs.hbr.org)