Up Front

Give the JOBS Act the Benefit of Any Doubts

Martin Neil Baily and Robert E. Litan

One of the more remarkable recent findings about the U.S. economy is that from 1980 until the recession, firms five years or younger accounted for the creation of essentially all net new private sector jobs. If the future is anything like the past, and there is no reason to think differently, a healthy rate of firm formation and growth therefore are keys to a sustained recovery.

Yet firms cannot launch and certainly cannot grow without capital. And though technology — the Internet and the growth of cloud computing in particular — has dramatically lowered the costs of entering many lines of business, firms in a variety of sectors still require money to get started and grow. The examples of biotechnology, energy, and franchises in multiple sectors, immediately come to mind.

One of the casualties of the recession is that money for newer ventures is much harder come by. Banks have cut credit card and home equity lines of credit. Venture capital firms have essentially been out of “seed” stage financing since the bursting of the Internet bubble in 2000. And even wealthy angel investors seem interested only in “quick exit” opportunities in the tech sector.

The JOBS Act, passed overwhelmingly by the House and, with some amendments, by a smaller but significant majority in the Senate, should help change this environment after it is signed by the president (whose administration also supported the bill). The act’s “crowd-funding” provisions should make it easier for some new firms to raise equity over the internet, and other more established firms to raise additional funds without going public. And for those companies that do want to access the public markets, the act makes it cheaper to do so by exempting companies in their first five years after an initial public offering (IPO) from complying with much of the Sarbanes Oxley Act, especially the costly rules mandating audits of companies’ “internal controls.” At roughly $1 million a year in additional audit fees, it is uncertain at best whether the benefits of this audit requirement outweigh the costs for smaller public companies. Even for larger ones, we can’t resist observing that SOX did little to prevent the excessive risk-taking by major banks and other financial institutions that helped lead to the financial crisis of 2008.

The only other real controversy about the bill is whether the investor protections for crowd-funding that were added by the Senate are adequate to prevent fraudsters from separating unwitting investors from their money. Among the most important: a requirement that issuers have audited financial statements if they are trying to raise any more than $500,000 in a single year; that issuers only make their offerings on platforms, such as Facebook, Kickstarter, and Kiva, that are registered with the SEC; and civil liability for misrepresentation in any offering documents or oral communications about the offering. In addition, investors would be subject to reasonable limits on how much they can put into any crowd-funded issuer: the greater of $2,000 or 5 percent of the investor’s annual income or net worth if the investor’s earnings or net worth is less than $100,000, or up to $100,000 for other investors.

Taken together, we believe these are reasonable protections and strike the right balance between being too onerous and sufficiently light touch to let the crowd-funding market take off. We would note, however, that the best protections are likely to come from the market and technology themselves, since platforms hosting issuers will want to preserve their reputations. Just as Ebay figured out a way to convince customers that they could trust the sellers on their site, we are confident that crowd-funding platforms, or those serving them, will find equally effective ways to validating the trustworthiness of issuers on their sites. These measures won’t prevent all fraud, just as eBay cannot, but they should keep it to an acceptable minimum so that investors generally can be confident that they are not dealing with crooks. It will be important for regulators to monitor the progress of crowd-funding platforms and step in with new rules if fraud becomes too big a problem.

Finally, despite its title, it’s essentially impossible to predict in advance how many jobs the JOBS Act actually will create. It may be a few, or it could be a lot. One of the surprising things learned from the Kauffman Firm Survey — the only longitudinal data base on US entrepreneurs — is that many growth companies got their start from humble beginnings, when the entrepreneur was just a sole proprietor. Making it easier, as the JOBS Act will do, for risk-takers like these individuals to launch and grow their companies is clearly in our national interest.