President Obama is expected to sign the JOBS Act shortly. Congratulations to us all! It was passed quickly and with full bipartisan support in an election year. Of the many provisions in the bill, one that the venture capital industry worked very hard on was the IPO On Ramp. Many thanks to Kate Mitchell of Scale Partners for her leadership on this matter.
Because I am frequently asked, let me tell you the story behind the IPO On Ramp?
In the 2000s, after the Stock Market bubble popped, there were three substantial changes to the business of taking a company public. One was the Sarbanes-Oxley 2002 law. Second was the Spitzer’s work to break out research. And third was the decimalization of Wall Street trading. While one of these could have caused issues, all three at once just crushed young company prospects of going public. But why?
Sarbanes-Oxley, or SOX, put an never before existing and enormous burden of accounting, internal controls and measurements on newly IPO’d companies as well as all public companies. This was well intended and overall a good thing. But, this costs money and took important management time away from running the business. SOX might cost perhaps $5 million per year to implement in a normal company. It’s a whole different economic picture if this $5 million is 5% of sales, or 0.5% of sales. You can see the little $100 million company needs to get big, like $1 billion or so, in order to afford it in order to get public, thus delaying when a company can go public. This put the brakes on small company. They are not created as giants!
New York Attorney General Eliot Spitzer decided that the run up in the stock market values in 1999 and 2000 before the crash was attributable largely in part to the coziness of Wall Street research and underwriting. While there are obvious conflicts and certainly some abuses to the way it was structured, it was not hidden from the buyers in any way. You see, for a public buyer to purchase new issues, they need information. Research was the only economic way to distribute company information in a fair way for all potential buyers. And the researches whose firms were taking a company public had the most interest to research the company. Makes sense. Without research for the smaller companies paid for by the bankers who take them public, the economics of a deal meant that only big IPOs could get done since research is not free. Again, the little company was pushed out of the market as a result of the Spritzer‘s actions.
Finally, as computer trading systems evolved, Wall Street decimalization was implemented. I’ve read some stories that indicate that the influx of mathematicians and physicists from the shut down SuperCollider in Texas flooded Wall Street with “Quant Jocks” who figured out to take advantage of this new trading world. As the market from drill bits, e.g. $3/8 or $¾ to $0.01 to even $0.001 spreads, the economics of trading went out of the business, too. Small IPOs don’t have a lot of float, so this impact also cut the economics out of small company’s going public making investment banks go for the larger deals.
All these things essentially cut the economics out of going public and the banks moved to larger deals, bigger companies, and left a gapping hole in the market between the pink sheets and Large Cap deals. This is the gap exactly where fast growing tech companies come to market. You might say, many were left at the alter.
So what? First, the IPO On Ramp is an attempt to provide a gradual conformance to the SOX laws passed in the early 2000s. These laws are important. Unfortunately, the original law was a big paintbrush. The IPO On Ramp is an attempt to repaint things starting with smaller brushes so that small companies can “grow into” the greater important SOX requirements. The law is still there, but the time to comply is expanded based on time in the public market or scale of the company. This is part of the JOBS Act. The NVCA and many other organizations that care about small companies going public and ultimately becoming big companies worked very hard on this new law.
As to the Spritzer regulation change and the Decimalization? The trading and underwriting world adjusted to the Spritzer Decree. Research is flowing again, but still limited. Companies still need to be larger so the research is economic, but it’s getting better. As for decimalization – chalk that up to progress. This will never go back. In fact, as a result of this and High Frequency Trading, the process of buying and selling a stock is now lightning fast. This isn’t changing.