Brookings Institution Event on Promoting Economic Growth
AT TODAY’S Brookings Institute event entitled “Promoting Innovative Growth,” the topics of venture capital, growth equity, and initial public offerings (IPOs) were discussed.
In his opening remarks, Martin Baily of the Brookings Institution stated that there is currently a lack of funding available for small businesses due to depressed access to venture capital (VC) and more cautious behavior on the part of banks.
First Presentation
David Robinson of Duke’s Fuqua School of Business gave a presentation on the financing choices of young firms. He stressed the need to differentiate between “young business” and “small business.” He claimed that young start-ups, not small businesses, are the companies that create jobs and experience higher rates of growth.
He debunked a common misconception that because start-ups are opaque, they are screened out of the debt process. Citing a Kauffman Firm survey on start-ups in their first year, he said that about 40% of startup capital comes from outside debt. Robinson noted the importance of housing as a form of collateral for start-ups when they take on debt, and thus the housing crisis has had a significant impact on the ability for start-ups to take on debt. He added that in areas where home prices grew, there was a rise in employment of small firms.
To address these issues through policy, Robinson recommended initiatives that increase smaller firms’ access to debt financing.
Robinson was asked how to incentivize “main street banks” to lend more to smaller high tech firms. He replied that rather than structure the debt as a loan, they could design a contract that would enable the bank to reap more of the upside on a successful venture.
Panel I
The first panel discussed how middle market size firms, those between $10 million – $1 billion of annual revenue, use growth capital to expand their businesses and create jobs. Braun Jones of Outcome capital explained that private equity (PE) firms generally provide financing in amounts greater than $10 million, the rate at which venture capital firms no longer provide financing. Jones said, middle market firms are the “lifeblood of the U.S. economy” and have created higher rates of economic and employment growth that any other business size segment.
Walter Florence of Frontenac Capital stated that his firm takes a CEO first approach to building a relationship with the businesses they are funding and provide them with “patient capital,” which allows the company to grow over a period of about five to ten years.
Chuck Morton of Venable stated that private equity plays a key role in providing returns for limited partners including university endowments and public pensions. He also noted that the Jumpstart Our Business Start-ups Act (JOBS) has made it easier for firms to gain access to capital, conduct general solicitation, and protect investors while lessening the regulatory burden of a start-up.
Second Presentation
Jay Ritter of the University of Florida discussed ways to re-energize the IPO market. Ritter explained that over the past decade, the number of IPOs has greatly decreased and small firm IPOs have been “basically non-existent.” He added that firms are opting to merge or be acquired rather than take their companies public, a trend that began in the 90’s.
He said that while regulators and the public are concerned with this trend, he feels that the JOBS Act will “have no effect on IPO activity.” He stated that government regulation has only “minor effects” on IPO trends and that an increase in economies of scope, rate of growth, and speed to market have pushed companies towards “selling out.”
Ritter also noted that being acquired by a larger company allows a firm to get a higher return than trying to grow their business organically. He explained that the policy focus should be directed at large versus small companies rather than public versus private firms and concluded that no one factor can explain the prolonged drought in IPO activity because it is due to structural changes taking place in the market.
Ritter was asked if current regulations make it harder to be a small firm than a large one. He replied that the some regulations are “heavy handed,” with fixed costs of compliance favoring large over small, but it is not a first order problem. He also noted that these IPO patterns are not unique to the U.S., as similar downward trends are seen in Europe.
In conclusion, he proposed that the decrease in IPOs might be viewed as a private market success rather than a public market failure.
Panel II
In the second panel discussion, Eric Doppstadt of the Ford Foundation noted that the IPO market has not been favorable to tech companies and that stocks are trading at 30 year lows, creating low incentives for firms to go public. He also said that there has been a reduction in the supply of VC.
Joncarlo Mark of Upwelling Capital Group mentioned that university endowments have been consolidating their number of relationships with PE firms. Mark explained that this reduction makes each relationship more important and requires PE firms to bring more to the table than just capital. He also noted that PE has replaced part of the public market and has become very global.
Scott Kalb of KLTI Advisors said regulators focused on PE even though it was a not a cause of the financial crisis. He stated that regulation could restrict access to capital and may decrease revenue. Kalb also noted that asset managers have been getting more sophisticated and have been able to conduct more asset allocation on their own.
Pierre Lavallee of the Canadian Pension Plan commented on compensation of PE managers, noting that it has been decreasing over recent years.
The panel was asked whether new regulations and bank’s behavior have affected their firms. In response, there was consensus that some regulations have pushed certain activity to other areas where there is less regulation, such as the junk bond market. Kalb also noted a rise in the use of mezzanine financing.
Third Presentation
Ajay Agrawal of the University of Toronto gave a presentation on crowdfunding, calling it a “controversial frontier.” He stated that the JOBS Act assumes that crowdfunding will increase the flow of capital to entrepreneurs but pointed out several differences between crowdfunding and traditional means of raising capital, including: 1) different levels of information provided to the investor; 2) different preferences and expectations of the investor; and 3) different rule sets governing the funding process.
Agrawal explained that companies that benefit the most from crowdfunding are those who sell directly to consumers, and those least harmed by the high level of disclosure required in the process. He also mentioned that the majority of investors in a business tend to live an average of 3,000 miles from the start-up.
Keynote
In his keynote address, Rep. Jim Himes (D-Conn) offered his views on the JOBS Act. He stated that he could not predict how the Act will affect capital markets, and while he supports the intent of the legislation, he is “ambivalent about what it did in statute.” Himes specifically criticized the emerging growth company (EGC) definition and the IPO on-ramp elements, adding that there will be an “absolute catastrophe of fraud as a result of the JOBS Act.”
Himes mentioned that not all companies want to take advantage of the new provisions and thinks that the Act is “not likely to have a tremendous impact in the public markets.” He also stated that he is not sure that the Act will solve the issue of low numbers of IPOs.
Himes said it was widely “accepted as dogma” that the Sarbanes-Oxley Act was responsible for a reduction in IPOs, and that it would help if the regulation was lifted, but he said the JOBS Act may not be better for job growth and questioned whether IPOs create sustainable jobs.
Himes also suggested that a holistic approach be taken to looking at the financial system, which may currently be “picking winners and losers.” He offered five recommendations for looking at these issues moving forward:
- Provide more education to the members of Congress that is academic, non-partisan, and understandable;
- Take a “disciplined approached” in exploring the “array of financing tools” available;
- Determine if the playing field is being tilted by the “powerful current” between anti-regulatory associations and certain members of Congress;
- Tread carefully when “turning the knob of regulation” as changes may have a dramatic effect on the market, potentially affecting the balance between the buy and sell side; and
- Create regulations that provide for a vibrant, yet safe financial system that allows job-creating innovation and investment.
Keynote Q&A
Himes was asked how the Congress could be educated more effectively on these matters. He replied that getting staffer up to speed was important, as well as, building relationships between institutions such as the Brookings Institute and Congressional committee leaders.
In response to another question, Himes noted that a focus on EGC and VC is “remarkably absent” from Washington.
Regarding crowdfunding security, he stated that the House bill was dangerous, but the Senate bill “tightened it up,” and he expects the Securities and Exchange Commission to “tighten it even further,” which will result in “a good balance in the end.”
For a webcast of the event, please click here.
AT TODAY’S Brookings Institute event entitled “Promoting Innovative Growth,” the topics of venture capital, growth equity, and initial public offerings (IPOs) were discussed.
In his opening remarks, Martin Baily of the Brookings Institution stated that there is currently a lack of funding available for small businesses due to depressed access to venture capital (VC) and more cautious behavior on the part of banks.
First Presentation
David Robinson of Duke’s Fuqua School of Business gave a presentation on the financing choices of young firms. He stressed the need to differentiate between “young business” and “small business.” He claimed that young start-ups, not small businesses, are the companies that create jobs and experience higher rates of growth.
He debunked a common misconception that because start-ups are opaque, they are screened out of the debt process. Citing a Kauffman Firm survey on start-ups in their first year, he said that about 40% of startup capital comes from outside debt. Robinson noted the importance of housing as a form of collateral for start-ups when they take on debt, and thus the housing crisis has had a significant impact on the ability for start-ups to take on debt. He added that in areas where home prices grew, there was a rise in employment of small firms.
To address these issues through policy, Robinson recommended initiatives that increase smaller firms’ access to debt financing.
Robinson was asked how to incentivize “main street banks” to lend more to smaller high tech firms. He replied that rather than structure the debt as a loan, they could design a contract that would enable the bank to reap more of the upside on a successful venture.
Panel I
The first panel discussed how middle market size firms, those between $10 million – $1 billion of annual revenue, use growth capital to expand their businesses and create jobs. Braun Jones of Outcome capital explained that private equity (PE) firms generally provide financing in amounts greater than $10 million, the rate at which venture capital firms no longer provide financing. Jones said, middle market firms are the “lifeblood of the U.S. economy” and have created higher rates of economic and employment growth that any other business size segment.
Walter Florence of Frontenac Capital stated that his firm takes a CEO first approach to building a relationship with the businesses they are funding and provide them with “patient capital,” which allows the company to grow over a period of about five to ten years.
Chuck Morton of Venable stated that private equity plays a key role in providing returns for limited partners including university endowments and public pensions. He also noted that the Jumpstart Our Business Start-ups Act (JOBS) has made it easier for firms to gain access to capital, conduct general solicitation, and protect investors while lessening the regulatory burden of a start-up.
Second Presentation
Jay Ritter of the University of Florida discussed ways to re-energize the IPO market. Ritter explained that over the past decade, the number of IPOs has greatly decreased and small firm IPOs have been “basically non-existent.” He added that firms are opting to merge or be acquired rather than take their companies public, a trend that began in the 90’s.
He said that while regulators and the public are concerned with this trend, he feels that the JOBS Act will “have no effect on IPO activity.” He stated that government regulation has only “minor effects” on IPO trends and that an increase in economies of scope, rate of growth, and speed to market have pushed companies towards “selling out.”
Ritter also noted that being acquired by a larger company allows a firm to get a higher return than trying to grow their business organically. He explained that the policy focus should be directed at large versus small companies rather than public versus private firms and concluded that no one factor can explain the prolonged drought in IPO activity because it is due to structural changes taking place in the market.
Ritter was asked if current regulations make it harder to be a small firm than a large one. He replied that the some regulations are “heavy handed,” with fixed costs of compliance favoring large over small, but it is not a first order problem. He also noted that these IPO patterns are not unique to the U.S., as similar downward trends are seen in Europe.
In conclusion, he proposed that the decrease in IPOs might be viewed as a private market success rather than a public market failure.
Panel II
In the second panel discussion, Eric Doppstadt of the Ford Foundation noted that the IPO market has not been favorable to tech companies and that stocks are trading at 30 year lows, creating low incentives for firms to go public. He also said that there has been a reduction in the supply of VC.
Joncarlo Mark of Upwelling Capital Group mentioned that university endowments have been consolidating their number of relationships with PE firms. Mark explained that this reduction makes each relationship more important and requires PE firms to bring more to the table than just capital. He also noted that PE has replaced part of the public market and has become very global.
Scott Kalb of KLTI Advisors said regulators focused on PE even though it was a not a cause of the financial crisis. He stated that regulation could restrict access to capital and may decrease revenue. Kalb also noted that asset managers have been getting more sophisticated and have been able to conduct more asset allocation on their own.
Pierre Lavallee of the Canadian Pension Plan commented on compensation of PE managers, noting that it has been decreasing over recent years.
The panel was asked whether new regulations and bank’s behavior have affected their firms. In response, there was consensus that some regulations have pushed certain activity to other areas where there is less regulation, such as the junk bond market. Kalb also noted a rise in the use of mezzanine financing.
Third Presentation
Ajay Agrawal of the University of Toronto gave a presentation on crowdfunding, calling it a “controversial frontier.” He stated that the JOBS Act assumes that crowdfunding will increase the flow of capital to entrepreneurs but pointed out several differences between crowdfunding and traditional means of raising capital, including: 1) different levels of information provided to the investor; 2) different preferences and expectations of the investor; and 3) different rule sets governing the funding process.
Agrawal explained that companies that benefit the most from crowdfunding are those who sell directly to consumers, and those least harmed by the high level of disclosure required in the process. He also mentioned that the majority of investors in a business tend to live an average of 3,000 miles from the start-up.
Keynote
In his keynote address, Rep. Jim Himes (D-Conn) offered his views on the JOBS Act. He stated that he could not predict how the Act will affect capital markets, and while he supports the intent of the legislation, he is “ambivalent about what it did in statute.” Himes specifically criticized the emerging growth company (EGC) definition and the IPO on-ramp elements, adding that there will be an “absolute catastrophe of fraud as a result of the JOBS Act.”
Himes mentioned that not all companies want to take advantage of the new provisions and thinks that the Act is “not likely to have a tremendous impact in the public markets.” He also stated that he is not sure that the Act will solve the issue of low numbers of IPOs.
Himes said it was widely “accepted as dogma” that the Sarbanes-Oxley Act was responsible for a reduction in IPOs, and that it would help if the regulation was lifted, but he said the JOBS Act may not be better for job growth and questioned whether IPOs create sustainable jobs.
Himes also suggested that a holistic approach be taken to looking at the financial system, which may currently be “picking winners and losers.” He offered five recommendations for looking at these issues moving forward:
- Provide more education to the members of Congress that is academic, non-partisan, and understandable;
- Take a “disciplined approached” in exploring the “array of financing tools” available;
- Determine if the playing field is being tilted by the “powerful current” between anti-regulatory associations and certain members of Congress;
- Tread carefully when “turning the knob of regulation” as changes may have a dramatic effect on the market, potentially affecting the balance between the buy and sell side; and
- Create regulations that provide for a vibrant, yet safe financial system that allows job-creating innovation and investment.
Keynote Q&A
Himes was asked how the Congress could be educated more effectively on these matters. He replied that getting staffer up to speed was important, as well as, building relationships between institutions such as the Brookings Institute and Congressional committee leaders.
In response to another question, Himes noted that a focus on EGC and VC is “remarkably absent” from Washington.
Regarding crowdfunding security, he stated that the House bill was dangerous, but the Senate bill “tightened it up,” and he expects the Securities and Exchange Commission to “tighten it even further,” which will result in “a good balance in the end.”
For a webcast of the event, please click here.