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Smoothing the IPO Path

A new SEC committee wants to help smaller companies find less costly ways to raise capital.
Alix Stuart, CFO Magazine
December 1, 2011

This year showed yet again how volatile the initial-public-offering market can be, the Securities and Exchange Commission kicked off its latest effort to open up funding options for private companies with an all-day meeting of its new advisory committee on small and emerging business in late October.

"People have woken up to the fact that funding innovation is a problem we should do something about," says committee co-chair Stephen Graham, an attorney with Fenwick & West who represents growth companies in financing deals and IPOs. He says the group will be making ongoing recommendations to the SEC during its two-year lifespan, with the first recommendation possibly coming before the end of the year.

The group was formed this past summer in response to concerns that the IPO process is too high a hurdle for growth companies, that Sarbanes-Oxley compliance may be too costly for them, and that smaller companies need other means for raising capital from private investors. The biggest issue the group confronts: coming up with alternatives that lift the burden on companies while still offering investor protections that the SEC would deem adequate.

The idea of an "IPO Lite" is one of the more alluring options the committee is considering. "How do we make it so that it's not either on or off; one day you're a private company and the next you're a public
company. . .spending $3 million on compliance?" muses Graham. He points to some alternative models, like a phased series of compliance hurdles that independent group IPO Task Force has proposed, as avenues of exploration for the committee.

Others are looking to work within the current boundaries of the SEC's Regulation A process, a modified IPO in which companies can register shares without producing a full set of audited financials. Reg A is rarely used, because companies can raise only up to $5 million and must comply with a variety of state securities laws. At the meeting, SEC officials explored how they could make the process more useful. Congress is also looking at Reg A, with the House of Representatives passing a bill to raise the limit from $5 million to $50 million in the week following the meeting. However, the efforts in Congress and at the SEC are not dependent on one another. Says Graham: "We're focused on making recommendations the SEC could implement without an act of Congress."

If the Reg A cap were raised to $50 million, and if the state compliance burden were reduced, the process "would be worth looking into for my company," said Kathleen A. McGowan, vice president of finance for Tobira Therapeutics, at the meeting. Tobira is a venture-backed biopharmaceutical company focusing on HIV treatments that raised a B round of funding in September 2010.

Debating Sarbox, Again
Indeed, some investors seem very open to something less than a full-blown SEC reporting regime from the companies in which they invest. "Why couldn't the SEC come up with a one-page reporting [format] that a company could post on the web?" asked Milton Chang, managing director of Incubic Venture Fund.

On the flip side, Richard L. Leza, chairman of Exar, a company that makes specialized silicon and software products, suggested the cost of complying with reporting structures like Sarbanes-Oxley might not be as great as some people supposed, particularly as corporate executives learn the process over time. Exar, a Nasdaq-traded company with close to $150 million in revenue, saw its audit and compliance costs double, from $1.5 million to $3 million, when it initially began hewing to Sarbox rules. Now, those costs are back down to $1.5 million, Leza said.

Frustration with some of the current SEC rules emerged at the meeting when the topic of crowd-funding was discussed. While most crowd-funding raises are now outside the purview of the SEC, since they involve a company offering a product rather than securities in exchange for money, some companies would like to raise more money through such platforms and offer debt or equity.

While that is technically possible now, investor-protection laws often hamstring them. The rules limit how and to whom the deals can be marketed, making it difficult for companies to reach a critical mass of investors.

Many argue, in fact, that attempts to confine the marketing of such deals to the traditional "friends and family" is unrealistic in the world of Facebook, LinkedIn, and other web-based networks. "The SEC cannot lock down everything," said Shannon L. Greene, CFO of Tandy Leather Factory, a small-cap company traded on Nasdaq. "If someone wants to put something stupid out there, you can't protect every $100 investor. Some of the onus of investor protection has to be on the individual investor."

Meanwhile, Paul Maeder, general partner with Highland Venture Partners, pooh-poohed the whole notion of crowd-funding. "What problem are you trying to solve?" he shot at SEC officials, suggesting that qualified investors such as his firm are very easy to find. "If you don't have an angel network, it's because you don't know how to use a browser, which arguably means you shouldn't start a business," said Maeder. For small companies, he argued, "access to capital is not a problem."

But access to capital often varies greatly by region, other panelists countered, and asking a large group of people for investments doesn't always mean a company is too weak to get funded by traditional means. Sean Greene, the Small Business Administration's special adviser for innovation, said: "There are a lot of smart, interesting people looking at this, not just people with wacky ideas."


The next steps largely revolve around narrowing the mission and the audience for the committee's inquiry, questions that SEC staff readily admit they are still trying to answer. The group will have future meetings; the SEC also seemed likely to address the issue at its annual forum on small-business capital formation, held late last month (just as this issue of CFO went to press).

Alix Stuart is senior editor for growth companies at CFO.




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