Daniel Gorfine
Adjunct Fellow; Vice President, External Affairs and Associate General Counsel, OnDeck
Capital Access and Capital Markets and Demographics and FinTech and Global Economy and Public Policy
Daniel Gorfine is an adjunct fellow at the Milken Institute and vice president, external affairs and associate general counsel at OnDeck, a technology-based company focused on transforming small business lending.
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Developing a small company mini-IPO market

By: Daniel Gorfine
March 19, 2014

Despite a recent upsurge in U.S. IPO activity, including the high-profile Facebook and Twitter public offerings, IPO activity has been on the decline over the past decade. In fact, between 2001 and 2011 fewer than 100 companies went public each year, compared to an average of 311 annual IPOs between 1980 and 2000.

The decline has been even more dramatic for small companies valued at less than $50 million. According to Jay Ritter, Professor of Finance at the University of Florida, in his testimony before the Senate Banking Committee in March 2012, an average of 165 companies valued at less than $50 million went public each year between 1980 and 2000. Over the last decade, that number has fallen to fewer than 30. Stated differently, a recent article in The Wall Street Journal notes that companies valued at less than $50 million made up nearly 80% of the IPO market in the 1990s, while today they account for less than 20% of initial public offerings.

One potential avenue for increasing public participation in small company securities offerings is found in Title IV of the Jumpstart Our Business Startups Act (JOBS Act), which was signed into law on April 5, 2012. The Securities and Exchange Commission (SEC) has been tasked with implementing this title of the law, which, if properly tailored, could stimulate a mini-IPO market and provide small companies with additional avenues to raise capital.

Title IV of the JOBS Act builds upon an existing securities law exemption, Regulation A, which provides for a mini-IPO registration with the SEC for offerings of up to $5 million. This provision, however, has rarely been used despite its intended benefit to small companies. A Government Accountability Office (GAO) report published in 2012 cited, among other reasons, the cost and complexity of having to register an offering in each state where investment is solicited as one of the reasons for the lack of interest in a Reg A offering.

The SEC released its proposed rules implementing Title IV of the JOBS Act on December 18, 2013. The proposed rules create a two-tiered exemption. A Tier 1 offering consists of securities offerings of up to $5 million in a twelve-month period, while a Tier 2 offering consists of securities offerings of up to $50 million. Importantly, a Tier 2 offering is exempt from state registration, but unlike Tier 1, requires ongoing reporting and an audit of financial statements. The proposed rules permit companies under both tiers to submit confidentially a filing for SEC review, and they permit an issuer to "test the waters" in order to determine whether there is sufficient investor interest in the offering being contemplated. Overall, we believe that the SEC has done an admirable job in drafting its Proposals to create a potentially viable exemption. In our comment letter submitted to the SEC on March 19, 2014, we offered a number of observations and guiding principles, as well as concrete recommendations that would enhance the viability of the new Reg A+ exemption. Key takeaways include that: &bull A broad range of industries and sectors will consider utilizing the updated exemption as a capital access mechanism. The ability for small companies to raise up to $50 million in a twelve-month period, coupled with the exemption from state securities registration under a Tier 2 offering, could prove attractive to biotech/life sciences, community and regional banks, real estate, technology, and local brick-and-mortar businesses. &bull The ultimate success of a Tier 2 offering hinges on the development of robust secondary markets. In order to facilitate this development, the Commission should simplify the process for an issuer to list securities on an exchange and eliminate investor-count limits that could trigger Exchange Act reporting. &bull A right-sized Tier 1 exemption is an important capital-raising tool for small businesses. The audit and ongoing reporting requirements of a Tier 2 offering will likely preclude the participation of offerings falling under a certain size. At the same time, Regulation Crowdfunding only permits an issuer to raise up to $1 million in a twelve-month period. Accordingly, a Tier 1 offering of up to $5 million could bridge the gap between a crowd-raise and Tier 2, but only if costs to issuers are decreased by preempting state registration requirements or creating a streamlined, efficient, and predictable multi-state review process. The comment period on the proposed regulations closes on Monday, March 24 and final regulations from the SEC on Title IV arenaEUR(TM)t expected until later this year. It remains to be seen whether a robust market can develop around Tier 1 and Tier 2 offerings as there are outstanding issues, as cited in our comment letter, that could hinder the development of these markets. Stay tuned. See our letter here.