"All booms end up busts. Then comes the sad refrain of regret: How could we have been so foolish?"- Dallas Fed Annual Report
Once in a while a piece of legislation comes along that you just know is more likely to do harm than good to the investing world; the JOBS Act is that piece of legislation.
So what does the legislation do?
The big breakthrough is that it creates a new securities classification called the "emerging growth company". This is a company that has less than $1 billion in annual revenues before an IPO. Once an emerging growth company goes public they retain their status until they pass $1 billion in annual revenues or five years have elapsed.
What are the benefits of being an emerging growth company?
1) You only need two years of audited financials before your IPO instead of the current 3 year requirement. This is just a plain and simple speed up of the IPO process provision.
2) You are exempt from Sarbanes-Oxley Section 404b which requires engaging an external audit firm to review the adequacy of your internal financial controls. This provision is madness if you ask me as it just about guarantees that there will be plenty of outright fraud going on. I would think logic dictates instilling the best practices on small firms from the start, but i guess that is not the case.
3) You can conduct an IPO with research reports coming out immediately before or after the so called 'quiet period '. I call this the promoter provision as it is going to lead to an avalanche of sell-side deal related research from small investment banks. I can't decide whether or not I like it yet as I felt the old rule was kind of silly. At least now there will be no pretending going on. If you don't know the analyst working for the bank underwriting the deal is conflicted, you should probably not be investing.
4) You are exempt from 'Say on Pay' rules. This actually makes sense to me.
Those are the emerging growth company rule exceptions. But the bill doesn't stop there.
- It also raises the mandatory trigger for becoming an SEC reporting company to 2000 shareholders or 500 non-accredited investors.
- It raises the limit on mini REG offerings from $5 million to $50 million
- It ends the ban on general solicitation or advertising in REG D rule 506 offerings if all the participants are accredited investors.(should make you private equity guys on here very happy)
Then there are the crowdfunding rules.
1) A company can raise $1million over a 12 month period.-This seems like a good cap for this though I do wonder how this is going to be enforced.
2) Two tiers of investor caps basically of 5k or 10k, depending on whether you are below or above 100k, in annual income or net worth. People will be circumventing this rule left and right.
3) Disclosure requirements for 100k or less are simply having an officer sign a piece of paper saying these financials are true, between 100k-500k you need a CPA to have reviewed your financials, and over 500k you need audited statements. How many companies can start to raise up to 100k in a year? That is what scam artists sitting at home are trying to figure out right now.
So as you can see, the JOBS Act is going to prove to be a very interesting development for the securities industry. Here is what I expect in markets going forward once Obama signs this act tomorrow.
- We should see IPO mania in tech as this legislation makes raising equity on a smaller scale a lot easier. So, go long everything - that is trading on Sharepost - because odds are they make it to market very soon.
- Expect underwriters to do very well, especially the smaller guys as deal flow really picks up.
- Expect faster exits from VCs.
- Expect foreign markets to fall further behind in tech as accelerated exits and rolled back regulations make the US market tough to compete with when it comes to cashing out at a high valuation.
- Expect more financial spam and definitely more fraud.
Those are some of my core expectations, but the big one here is that you should expect a massive opportunity to short a lot of companies that will be promoted, marketed, listed, and eventually bankrupt. The US market is not exactly a tough market to list in under current regulations.
If Yelp (NYSE:YELP), Angie's List (NASDAQ:ANGI), Zipcar (ZIP), Tudo (NASDAQ:TUDO), Renren (NYSE:RENN), and Vringo (VRNG) can IPO then I can only imagine what this is going to lead to. If Bernanke doesn't start draining the swamp, we are going to find ourselves looking back five years from now and pointing to this legislation as the cause of another market debacle.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.