JOBS Act 3.0 Expanding Pre-IPO Talks with Potential Investors
When a private company decides to “go public”, it does so through an Initial Public Offering (IPO). An IPO is the private company’s first sale of stock on the public market. Benefits of going public can include a permanent and liquid source of capital for the company, and the company can increase their brand and name recognition through broadcasting their corporate narratives, which suggests legitimacy and stability. (Joe Bou-Saba, Forbes). Although the number of domestic companies listed on U.S. stock exchanges increased in the mid-1990’s, that number has since dropped by nearly half. (Editorial Board, Bloomberg; Michael Wursthorn and Gregory Zuckerman, Wall Street Journal). A study by the Center for Research in Security Prices at University of Chicago’s Booth School of Business reported in the Wall Street Journal showed that in 1996 there were over 7,400 companies listed on U.S. stock exchanges, and today that number is less than half. (Michael Wursthorn and Gregory Zuckerman, Wall Street Journal).
In an effort to encourage more private companies to go public, Congress is working on a bill amending the Securities Act of 1933 (Securities Act) to allow companies to engage in “pre-IPO” talks with potential investors. (Glenn Pollner et. al., Harvard Law School Forum on Corporate Governance and Financial Regulation).
Currently, the Securities Act permits an “emerging growth company” (EGC) to engage in “testing-the-waters” when considering an IPO. To qualify as an EGC, a company’s total annual gross revenues must be less than $1.07 billion during its most recently completed fiscal year and it must not have sold common equity securities under a registration statement. (SEC, Emerging Growth Companies). EGCs may “test the waters” by engaging in oral or written communications with potential accredited investors or qualified institutional buyers to gauge investor interest prior to filing a registration statement with the Securities and Exchange Commission (SEC). (SEC, JOBS Act FAQ).
In July 2018, the U.S. House of Representatives passed the “JOBS and Investor Confidence Act of 2018,” frequently referred to as JOBS Act 3.0, with a vote of 406-4. The JOBS Act 3.0 expands upon the 2012 Jumpstart Our Business Startups (JOBS) Act. While the JOBS Act 3.0 overwhelmingly passed in the House, the U.S. Senate must still approve the legislation. This legislation will expand the Securities Act to allow all companies to test-the-waters, rather than just EGCs. (Glenn Pollner et. al., Harvard Law School Forum on Corporate Governance and Financial Regulation).
A 2011 study by the SEC IPO Task Force estimated that the average cost for a company in pre-IPO regulatory compliance is $2.5 million, followed by an ongoing $1.5 million in compliance costs once public. (SEC, IPO Task Force Report). These high costs can deter a company from initiating the IPO process especially if they are uncertain about investor interest. Allowing all companies to “test the waters” will allow companies (regardless of size) to gauge investor interest and can take the guesswork out of the IPO process and whether it will be successful. (Jacob Rund, Bloomberg).
The purpose behind the expansion of this policy is to encourage more IPOs. (Sinéad Carew and Michelle Price, Reuters). SEC Chairman, Jay Clayton, is worried that main street investors are missing out on the growth part of development of emerging companies and is pushing for IPOs as a result. (Ted Knutson, Forbes). Similarly, proponents of the JOBs Act expansion believe the expansion will encourage more IPOs, which will help diversify U.S. markets. (Jacob Rund, Bloomberg). The IPO process can be long and expensive as a result of current regulatory compliance, but the expansion of this policy should ease some of those burdens. (Joe Bou-Saba, Forbes).
If the JOBs Act 3.0 expansion of testing-the-waters passes in the U.S. Senate, it will encourage more private companies to consider going public. This amendment to the Securities Act will allow private companies to gauge the interest of public investors without having to incur the pre-regulatory expenses of an IPO.