CEI's John Berlau today writes on Openmarket.org about Twitter's IPO, the JOBS Act, and the return to pre-Sarbanes Oxley "normalcy" of companies going public to raise capital before they are profitable. (See below.) I thought you might be interested in his analysis.
Pointing out the debut of Amazon in 1997, years before the firm made a profit, Berlau documents that IPOs before profitability were the norm rather than the exception before Sarbanes-Oxley and Dodd-Frank. Berlau argues that middle-class investors now have more opportunities to get in and build wealth with firms like Twitter at their growth stages thanks to the regulatory relief of the Jumpstart Our Business Startups (JOBS) Act of 2012."
Twitter, the JOBS Act, and the Return to IPO Normalcy
The headline read that the company's initial public offering price is "high," and "so is its valuation" The accompanying story explained that the latest tech sensation had yet to show a profit, and had in fact been losing millions per year.
An analyst attributed what the article called the stock's "high valuation" to "Internet inhalant." Hesaid, "Some people smoke Internet inhalant and their judgment gets bizarre."
Think this is an article about the Twitter IPO debuting today? Wrong! It's a piece from Wired in 1997 on the new IPO of Amazon.com.
Like Twitter, Amazon was losing money when it went public. In fact, investors would have to wait more than four years after its IPO for the firm to turn its first profit.
Yet investors who bought Amazon at its IPO price sure have turned a profit. According to GeekWire, $1000 invested in Amazon back then would have turned into $239,045 today!
My organization, The Competitive Enterprise Institute, of course, is not in the business of making stock market predictions. Twitter's IPO may soar or it may pop, and whichever result should make no difference for public policy.
What should concern policymakers, however, is whether middle-class retail investors, informed of the risks, have the opportunities to build wealth through investing in firms at their growth stages. The soaring regulatory costs of "reforms" such as the Sarbanes-Oxley Act of 2002 and the Dodd-Frank Act of 2010 caused companies to delay going public as long as possible, denying ordinary investors such opportunities.
New companies formed in the post-Sarbox era, such as Facebook, would seek funding from "accredited" investors such as hedge funds and venture capital firms to avoid the red tape. When they went public, as Facebook did last year in its disastrous IPO, much of the growth had already occurred. The main objective of such IPOs was not capital for growth, but for existing owners to realize value of their shares.
Facebook's stock is doing well now and above its IPO price. But the real "scandal," if any, is that ordinary shareholders couldn't get a piece of it while it was growing thanks to the red tape.
The good news is that the Jumpstart Our Business Startups (JOBS) Act, signed by President Obama last year, has started a partial reversal of this trend. Because small and midsize companies can now get relief from some of the most onerous provisions of Sarbox and Dodd-Frank for five years after the launching their IPOs, hundreds more firms have gone public during their growth stages.
As I have written previously, and others have noted, Twitter likely went public earlier than expected due to the JOBS Act's regulatory relief provisions. In the “Form S-1” Twitter filed to launch its IPO, the company declares, “We are an emerging growth company, and … we may choose to take advantage of exemptions from various reporting requirements under the JOBS Act.”
Yet companies that go public before making their first profit are not products of the so-called radicalism of the JOBS Act, nor were they aberrations of the go-go '90s era in which Amazon listed.
Going public before profitability was in fact the historical norm before Sarbox. Xerox, which went public in the 1930s, struggled with meager revenues for decades until its revolutionary photocopier debuted in 1959, causing sales, profits, and its stock price to skyrocket over the next decade.
Ironically, Twitter's eligibility for JOBS Act relief may end as early as today if its stock price rises high enough to put it outside of the law's threshold of $700 million in market valuation. The only JOBS Act provisions the company then would have benefited from would be the pre-IPO reg relief.
Such things could also happens to firms such as biotechnology companies, many of which have utilized JOBS Act reg relief, when there is sudden interest in a new drug they are developing. The company may still be small, but investor demand will cause its market cap to be too large. The firms would then have to spend much more time dealing with the minutiae of Sarbox "internal controls" rather than growth for investors by developing new products.
Such issues should be addressed in a "JOBS Act 2.0," outlines of are reportedly under discussion. In the meantime, we should celebrate the JOBS Act's bipartisan success in increasing opportunities for smaller entrepreneurs and investors to snap up growth and build wealth.
Disclosure: John Berlau owns shares in Facebook, but is still not on Facebook. His Twitter handle is @jberlau.