More than a year ago, Congress passed legislation that its supporters said would help revive new company offerings. Now, the market for initial public offerings is starting to heati up, but the law, the Jump-Start Our Business Startups Act, or the JOBS Act, has had little to do with it.
You need only to look at the recent I.P.O. of the upscale grocer Fairway Group Holding Corporation. It’s an illustration of the forces that drive the market for offerings and why the JOBS Act was a missed opportunity to truly spur more I.P.O.’s.
Founded in the 1930s, Fairway caters to Manhattanites — and those who want to be like them — offering lots of olives, cheese and other fine foods and produce. Sterling Investment Partners acquired control of the company in 2007 and invested hundreds of millions of dollars in the concept. Today, Fairway has 12 stores and wide eyes for a nationwide expansion.
These plans were seeded with a successful I.P.O. in April that raised $158.8 million. More eye-popping than its expansion plans was the stratospheric valuation the stock market has given the chain. Fairway’s stock price is up more than 60 percent since its I.P.O., giving the company a market capitalization of around $825 million.
If you do the math, each Fairway store is now valued at about $71 million. That’s a lot of cheese and olives.
Fairway is classified as an emerging growth company and therefore arguably benefited from the relief offered by the JOBS Act. But the question is, did its I.P.O. success have anything to do with the legislation?
Probably not. In fact, the law may have even harmed investors in this case.
To understand why, let’s walk through what the JOBS Act did for Fairway.
The first thing is that the company was able to obtain confidential review of its I.P.O. documents with the Securities and Exchange Commission. In the first year of the JOBS Act, this was one of the more attractive provisions of the legislation. A study by Ernst & Young found that 63 percent of emerging growth companies elected confidential review.
Companies like this provision because their numbers are reviewed and revised by the S.E.C. without the public’s knowing the agency’s focus. But this also puts investors in the dark about possible problems. We saw the value of this review in the offerings of Zynga and Groupon, when aggressive accounting tactics exposed by an S.E.C. review alerted investors to problems at both companies.
Another significant advantage provided to Fairway by the JOBS Act was the ability to avoid for up to five years making extensive disclosure on its executive compensation or holding a “say on pay” vote. Not surprisingly, this is popular among emerging growth companies. Ernst & Young counted that 82 percent of them took advantage of this provision.
Fairway also took advantage of the law to avoid disclosing the full compensation of its executives, but it did disclose its full financial information. The JOBS Act allows companies to disclose only two years of financial information instead of three.
Here, Fairway was again in the majority, as some 66 percent of the companies in the Ernst & Young study chose the same route.
Fairway’s selective use of the JOBS Act shows that it is being used to avoid disclosure of information that may cause embarrassment to the company or alert investors of problems. But at the same time, it shows that the law may have allowed companies to get away with not disclosing financial information that investors value.
None of this has anything to do with whether Fairway would have gone public. Investors bought the offering because they viewed it as the next Whole Foods and not the next Pets.com. The fantastic pricing is a bet that the company will continue to expand. The JOBS Act had nothing to do with this.
The lack of an impact of the legislation is seen in the number of I.P.O.’s before and after its passage. Dealogic recorded an average of 33 I.P.O.’s per quarter in the year before the JOBS Act versus 31 I.P.O.’s per quarter in the year after.
The act was intended to help spur a moribund market in small I.P.O.’s. But for offerings that raised less than $100 million, there were actually fewer after the JOBS Act. According to Dealogic, there were an average of 15 such I.P.O.’s per quarter in the year before the new law versus an average of 13 per quarter the year after.
So what does spur I.P.O.’s? Advantages that the Fairway offering had, like a robust stock market and a reviving economy in addition to a growth story that investors wanted to buy. Investors want to minimize risk and invest in the new thing, with economic factors dominating. This is why the United States I.P.O. market is down only 12 percent in the last 12 months, compared with a decline of 41 percent in the rest of the world, according to Dealogic.
None of this is a surprise to critics of the JOBS Act. The act was passed hastily, viewed as a cheap way for a Congress to be seen as doing something — anything! — on the economy. But the act’s critics, including the S.E.C., opposed the legislation as deregulating public companies and perhaps encouraging fraud without doing much to spur I.P.O.’s.
Judging by the companies that have used the act to hide things that might have raised uncomfortable questions, the critics have a point. The JOBs Act does make it easier for companies to go public in some ways, relaxing the prohibitions on analysts covering companies after an I.P.O., for example, but the law so far does not appear to be having its intended effect: creating jobs by spurring I.P.O.’s. This is not to say that the changes established by the law will not be of some use, because they got rid of needless regulation, but they aren’t going to do much for the I.P.O. market.
This is a shame because small I.P.O.’s have virtually disappeared. In 1997, 477 companies raised $100 million or less in an offering, for a total of $15.8 billion, according to Dealogic. In the year after the JOBS Act, only 53 small companies went public, raising $3.3 billion.
We aren’t even sure what caused the death of the small I.P.O. Some say it was decimalization, when share prices were no longer priced in fractions and brokers lost profits; others point to overregulation in the form of the Sarbanes-Oxley Act. But neither argument seems compelling, because offerings fell off the cliff in 1997, before either of those events happened.
It may instead be a result of larger structural shifts in the market and investors who are no longer willing to take the risk on smaller I.P.O.’s.
Congress would have done better to have taken time to look at the market to see what was actually wrong. It may well be that in today’s economy, this market cannot be revived. Or perhaps Congress should have allowed for the creation of a true small-issuer market like the Alternative Investment Market in London.
This will not happen now. The passage of the JOBS Act sucked any remaining will out of Congress to legislate innovatively. The S.E.C. is engaged in a rear-guard action to minimize the harm from provisions in the act that it opposed, like crowdsourcing. As for Fairway, it would have gone public regardless, but did so without disclosing information that investors might value. It’s too bad that Congress wasted a good crisis.
Steven M. Davidoff, a professor at the Michael E. Moritz College of Law at Ohio State University, is the author of “Gods at War: Shotgun Takeovers, Government by Deal and the Private Equity Implosion.” E-mail: email@example.com | Twitter: @StevenDavidoff