Minority and Small Business IPOs

A fundamental challenge confronting growth-oriented minority- and women-owned businesses, and indeed, small business in general, is building greater scale and capacity.

Changes in supply-chain management practices, intense global competition and government fiscal austerity measures have affected minority firms more severely. This is because these new measures tend to reward small businesses that are larger and more dynamic.

Gaining access to capital is fundamental to businesses that seek to grow beyond the startup and early growth phase to becoming professionally managed enterprises.

However, access to capital is particularly problematic for minority firms. Small-business loans are one means of capital access, but a more compatible form of capital is equity financing raised through public offerings.

In the past, many small businesses that sought to raise capital did so through Penny Stock IPO. While there is no precise definition of a penny stock IPO, the benchmark is stock offerings whose initial asking price ranges between three and five dollars.

Recently, President Obama proposed, and Congress approved, an updated approach by which small companies can raise capital through public offerings, the JOBS Act (i.e. Jumpstart Our Business Startup).

JOBS and penny stock IPOs are not identical; however, there are many lessons to be learned from penny stock IPOs that may be valuable to small businesses wishing to take advantage of the new JOBS Act.

This is part one of a two-part article on small business IPOs. In this first part, we summarize the JOBS Act and look at the advantages and disadvantages of penny stock IPO. Part two will examine factors that contribute to successful penny stock IPOs and identify warning signs that indicate potential pitfalls.

The JOBS Act

In April, the Obama Administration signed into law the Jumpstart Our Business Startups (JOBS) Act. It is designed to make capital more  accessible to small business startups and facilitate small business initial public offerings. The key provisions of the Act are “crowdfunding”, “mini public offerings,” and “IPO on-ramp.”

Crowdfunding allows small businesses to raise up to $1 million annually from a variety of small-dollar accredited investors by using the web. Accredited investors are individuals with high net worth.

The mini public offering provision increased the threshold below which firms are exempt from certain SEC requirements. Specifically, the threshold was increased from $5 million-$50 million. The provision also reduced the bureaucracy involved in raising investor capital.

The IPO on-ramp provision provides high-growth companies an extended period of time, after going public, to comply with Sarbanes-Oxley auditing requirements. Companies have up to two years to comply, with some exceptions.

Advantages and Disadvantages of Penny Stock IPOs

While the JOBS Act is not designed to foster Penny stock offerings, companies utilizing the Act and those issuing stocks are most likely to be small. Therefore, we list below the advantages and disadvantages of penny stocks.

The advantages:

  • more cash available for R&D, operating expenses and long-term growth
  • higher market value because the company’s prestige and reputation are enhanced
  • greater ability to attract and retain talented employees
  • increased ability to make merger and acquisition deals
  • an easier exit strategy available to investors and shareholders

The Disadvantages

  • greater cost associated with under writing fees, legal and accounting advisers, printing costs, filing fees, exchange listing fees
  • more expenses associated with reporting and certifying financial information
  • loss of singular control by the original owners
  • less privacy and more transparency of operations
  • disclosure requirements
  • more pressure to perform

Surprisingly, there is very little scholarly research on penny stock IPOs. One excellent paper by Bradley, Cooney and others, found that companies issuing penny stocks were generally small, and the issue was more likely to be underwritten by banks with lower prestige in contrast to venture capital funds. The study also documented that penny stock IPOs experienced significantly higher initial returns than did ordinary IPOs. However, over the long run they under performed. The higher short-run returns were attributed to price manipulations, wherein the stocks were under price at the initial offering. This allowed greater room for appreciation.