IN 1980, Massachusetts banned a new technology company from selling shares to the public there, worried that gullible residents would get swept up by the hype surrounding the venture. In retrospect, that proved a regrettable decision for Bay Staters: the firm in question, Apple, is now the single most valuable public company in the world. Future generations of startups seeking to raise money by selling equity should be given a smoother ride under new rules soon to come into force.
For all of America’s perceived openness to innovation and finance, regulators have energetically restricted the ways corporate tiddlers can raise money. The general public has been banned from risky, early-stage investment opportunities, all in the name of consumer protection. That will largely be reversed from May when rules approved by the Securities and Exchange Commission (SEC) on March 25th come into force. These will overhaul the process of raising equity in ways that will make it far easier for firms to finance themselves, even if consumers will have to keep their wits about them.
Under one of the (long-delayed) provisions of the JOBS Act, a compendium of enterprise-boosting laws passed in 2012, companies will be able to raise up to $50m in what is commonly referred to as a “Mini IPO”, or initial public offering. Although SEC agreement will still be required, many of the intrusive constraints found in garden-variety IPOs will be waived.
The most controversial aspect of the rules is tied to who may invest in such offerings. Typically access to anything out of the ordinary requires an investor to be “qualified”, meaning those with a net worth of $1m or an annual income in excess of $200,000. Now anyone will be able to invest up to 10% of their income in early-stage ventures, a type of investment that makes stockmarket gyrations look dull.
The new rules will galvanise crowdfunding, websites that allow the general public to invest in promising companies. The likes of Kickstarter and Indiegogo already allow people to back small firms, but punters typically get rewarded with early-release versions of their products. Now they could get shares, too.
Plenty of other barriers will be lifted for small firms. Pernickety state watchdogs of the sort that kept Apple out of Massachusetts will lose their say. Companies will no longer have to list on an SEC-accredited exchange, which often comes with onerous disclosure standards. Financial results will have to be filed twice a year, rather than quarterly. And firms can forgo an “independent” audit committee of board members, a costly requirement under the Sarbanes-Oxley Act, which was passed in the wake of Enron’s implosion in 2001.
Taken together, observes Sam Guzik, an attorney who represents companies going public, the reforms will make it cheaper for firms to raise money. That should enable faster growth and an easier path to a conventional stockmarket listing.
Sceptics worry that crowdfunding venues will become a playpen for fraudsters targeting the poor and credulous. Much the bigger worry is that startups have a tendency to go bust. In Britain, where equity crowdfunding is already thriving, regulators have warned investors it is “very likely” they will get wiped out. For every Apple, in other words, there will be many, many more lemons. That will still sound like a reasonable trade-off to lots of American investors.
© The Economist Newspaper Limited, London (April 11th 2015)