Three years after the JOBS Act was passed, making it easier for small ventures to raise capital, Congress is tackling the issue of secondary trading. The House Financial Services Committee last week floated a draft bill that would allow the creation of “venture exchanges” tailored to the needs of small companies.
In many ways, the success of the JOBS Act hinges upon the creation of such markets. A healthy secondary market created liquidity that is critical to building investor confidence and creating a robust alternative to the global markets that today are dominated by enormous corporations.
Venture exchanges could also help boost the broader economy. The number of IPOs and listed companies has been in steep decline for decades. The U.S. has averaged 150 IPOs a year since 2000, compared to 500 annually before that, says David Weild, CEO of Weild & Co. and the former vice chairman of NASDAQ. He argues that if IPOs had kept pace, they would average 950 a year today and newly public companies would have generated up to 9 million in additional jobs. (Factoring in the multiplier effect, the number of jobs created could have been double that).
The bill, called the Main Street Growth Act, “has the potential to go down as one of the most important Acts to come out of this, or any, Congress by creating essential infrastructure in support of U.S. economic growth,” said Weild in a statement.
A New Asset Class
The idea behind the JOBS Act was to get capital into the hands of promising ventures by making it easier for them to raise money from the public. The law’s various provisions— Regulation A+, Title II accredited investor crowdfunding and, eventually, mainstream crowdfunding under Title III—create a new hybrid class of “private” companies that are publicly held. (For more on the JOBS Act and its status, click here.)
The problem is, these quasi-public companies are illiquid. There is no easy way to sell their shares on a central market, the way you can buy or sell the shares of publicly traded companies on the New York Stock Exchange or NASDAQ. Without a way to sell shares, investors would have to wait for an “exit”—an acquisition of the company or, in some cases, an IPO.
The Main Street Growth Act, which was authored by the House Financial Services Committee, would allow the creation of exchanges that could facilitate buying and selling of shares in companies that have raised money under exemptions from federal securities laws. Under the proposed bill, for a company’s shares to be eligible for listing on a venture exchange, it must have assets under $2 billion and have not conducted an initial public offering, or be defined as an “emerging growth company” under the JOBS Act.
Venture exchanges would operate on a national scale yet be exempted from federal National Market System (NMS) and Alternative Trading System (ATS) rules, making them less expensive to operate than a full blown exchange.
However, in its current form, the bill requires venture exchanges to register as a national exchange if they are not
one already, and elect to be treated as a venture exchange. “This is exchange-lite,” says Chris Tyrrell, CEO of OfferBoard Group and chairman of CrowdFund Intermediary Regulatory Advocates (CFIRA).
That approach is in contrast to efforts by states such as Michigan to create stock markets that operate at the state or local level.
The Main Street Growth Act has some notable features:
Trades would be quoted in increments of at least 5 cents, compared to the decimal points of modern markets. The return to fatter margins is meant to addresses a key shortcoming and unintended consequence of decimalization: in the old days, bigger margins supported a healthy ecosystem of brokers and researchers who supported smaller companies. When those margins disappeared, so too did the economic incentive to support any but the largest companies. Weild argues that decimalization helped destroyed the micro cap market—and along with it jobs.
Auction: In addition, the venture exchanges would be allowed to hold periodic auctions of shares, rather than continuous trading. That’s a tacit acknowledgement that trading in smaller ventures may be much less frequent than Fortune 500-type shares.
The Main Street Growth Act must now be formally introduced and make its from the committee into the full House, and then through the Senate. Ideally, said Tyrrell, the Senate would take up a similar bill in parallel. Otherwise the issue risks getting derailed by the presidential campaign.
The notion of a venture exchange has been gaining traction. Canada and Australia have successful small venture exchanges, and the Securities & Exchange Commission has been talking about them for at least two years.
In recent Senate testimony, Stephen Luparello, Director, Division of Trading and Markets at the agency, had this to say:
“The SEC is considering innovative approaches that appropriately balance the needs of smaller companies for efficient secondary markets and the interests of investors in smaller companies. Venture exchanges potentially could achieve such a balance by providing the investors a transparent and well-regulated environment for trading the stocks of smaller companies that offers both enhanced liquidity and strong investor protections. As such, they could strengthen capital formation and secondary market liquidity for smaller companies and expand the ability of all investors to participate through well-regulated platforms in the potential growth opportunities offered by such companies.”
The House bill follows similar efforts at the state level to create local stock markets. For example, Michigan last year passed a law that allows for the creation of Michigan-only stock markets. Texas recently introduced a similar bill into its legislature. The two states are among a total of 19 that have passed intrastate exemptions that allow investment crowdfunding within their state borders.