JOBS Act can spur small business growth, but there are some risks

MADISON – President Obama endorsed it. The Senate passed it by a 3-to-1 margin. The margin of victory in the House of Representatives was even higher. Interest groups such as the National Venture Capital Association and the Biotechnology Industry Organization have praised it.

“It” is the Jumpstart Our Business Startups Act, or JOBS, which now appears poised to become federal law.

If all these politicians and industry leaders support the JOBS Act, why are some skeptics still jittery about the bill’s long-term implications?

Perhaps it’s because they still hear their mothers whispering: “Things that look too good to be true sometimes aren’t.”

The JOBS Act represents a good-faith effort by Congress to make it easier for startups of all descriptions, from Main Street retailers to biotechnology companies, to raise money. Because startups account for the lion’s share of all net job creation in the United States, Republicans and Democrats alike want to increase the odds those new businesses will succeed. The JOBS Act proposes to help startups in two major ways:

• It allows entrepreneurs to solicit funds from middle-income individuals without having to adhere to existing Securities and Exchange Commission regulations, which generally limit such fundraising to relatively wealthy “angel” investors.
• It takes some of the cost, regulation and risk out of preparing a startup company for an “initial public offering” of stock. And, for those startups that don’t want to go public, it quadruples the number of individual investors who are allowed before an IPO is required.

The first trend is often called “crowd funding” because, as the name suggests, it allows startups to raise money from a crowd of small investors. Currently, the law says only “accredited investors” may invest in private offerings. Accredited investors in the United States must have a net worth of at least $1million exclusive of their primary residence or meet other income tests.

Under JOBS, anyone may invest up to $10,000 a year, or up to 10 percent of their net income if they earn less than $100,000 a year, in private companies. This means most working Americans could invest in a startup. Advocates say this will lead to more startup funding and, in time, more jobs. It’s a phenomenon driven by the explosion in social media, which makes it easier to pitch ideas – and to have those ideas vetted by an online crowd, regardless of geography.

The knock on crowd funding is that not everyone can handle the risk of investing in startups that often fail. Angel investors can afford to lose money on a deal because they often spread their risk over multiple deals – and sometimes get huge returns that wipe out any losses. Joe and Jane Average usually cannot afford to spread their bets, and that means they must pick “The One Sure Deal” or lose their investment.

The second goal of the JOBS Act is to establish a regulatory “on ramp” for young companies that aspire to go public. After a decade in which American IPOs became increasingly rare while the rest of the world forged ahead, policymakers decided to recast some of the more onerous provisions of the Sarbanes-Oxley Act. Passed in response to the Enron and Worldcom accounting scandals, Sarbanes-Oxley clamped down on startups, as well.

The JOBS Act would give startups five years after going public to focus on research, product development and company building before becoming subject to the provisions of Sarbanes Oxley. That’s especially important in the biotech industry, where companies often need years to gain regulatory approvals for new drugs and medical devices.

The act also boosts the number of shareholders a private company is allowed to have (from 500 to 2,000) before the company must publically disclose certain financial information.

Some institutional investors are worried about the on-ramp changes, however, because they see existing rules as protecting against fraud and mismanagement. On-ramp companies will be allowed to raise tens of millions of dollars on public markets without making regular reports to the SEC or giving investors audited financial statements. Previously, companies had to show three years of audited financial statements to go public. The JOBS Act cuts it to two years.

Former SEC Chief Accountant Lynn Turner testified in Congress last year on the risks to the financial markets if investor safeguards are substantially weakened.

“More jobs and a larger number of qualified IPOs is something we all strive for,” Turner said, “but IPOs have to be successful for not only those selling stock, but also for those buying shares.”

Politicos and industry leaders believe the JOBS Act will fuel startups, boost IPOs and help rekindle the economy. They’re probably right, but let’s hope Mom keeps a close watch on the unintended consequences.

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