Markets In Action

Emerging Growth Companies… and why we need more of them

We write frequently on Project Invested about the importance of companies going public through the initial public offering (IPO) process . That’s because having a large number of firms making the leap from private ownership to the public capital markets is one of the vital signs of a healthy economy. But the number of public companies has been on the decline for the last couple of decades—today the total number has fallen to roughly half what it was twenty years ago.

To better understand why this trend matters, it’s worth delving a little more deeply into some of the key terminology that surrounds the IPO process. Here’s a term you may have come across that represents a key concept in thinking about these issues: emerging growth company (EGC).

The Securities and Exchange Commission defines an EGC as a company that has total annual gross revenues of no more than $1.07 billion per year (indexed for inflation, so that number increases periodically), and “as of December 8, 2011, had not sold common equity securities under a registration statement.”

These relatively smaller and but growing companies got a boost in 2012 with the passage of the Jump Start Our Business Start-ups (JOBS) Act. This bipartisan legislation, signed by President Obama, encouraged more companies to take the steps to go public through an IPO.

The thinking behind the JOBS Act was to streamline the IPO process, by reducing filing burdens and easing the regulatory pathway, and opening up avenues for creative and innovative sources of business financing (like equity crowdfunding, which Project Invested has explored in previous articles). Such steps would make it easier for smaller and medium-sized companies to take advantage of the larger pools of capital funding available in the public markets, and create more opportunities for investors, while continuing to provide high levels of investor protection.

The EGC designation is seen as a transitional phase, and the relaxed disclosure requirements are temporary measures that are intended to provide an “on-ramp” for smaller and medium-sized companies to enter the public markets. Over time, and as the company grows in its post-IPO phase, it will take on full compliance and reporting requirements just as any other public company would.

“America’s high-growth entrepreneurs and small businesses play a vital role in creating jobs and growing the economy,” Obama remarked during the signing ceremony for the JOBS Act. “I’m pleased Congress took bipartisan action to pass this bill. These proposals will help entrepreneurs raise the capital they need to put Americans back to work and create an economy that’s built to last.”

There are a number of reasons behind the decline in the number of public companies, including an increased supply of private funding, and the rise in mergers and acquisitions. But another critical factor, as many experts note, are the excessive regulatory and administrative burdens that serve as a disincentive for companies that might otherwise go public.

Initial indications are that the JOBS Act played an important role in promoting more IPO activity among EGCs. According to an April 2018 study by PwC, the number of IPOs grew nearly 25% in the six years since the JOBS Act took effect (compared to the six years prior to the law’s enactment) with more than 80% of those IPOs by companies that qualified as EGCs.

The PwC report notes that while many companies may at first have been apprehensive about JOBS Act provisions, that apprehension is fading as more companies take advantage of the law’s simplified disclosure and registration requirements. Among the most active sectors for IPO activity are growth industries like health care and technology, according to a separate study by EY.

That’s a great start. But while those numbers show improvement, we still have a long way to go to get to the level of IPO activity needed to generate real returns in the form of more innovation and greater economic growth.

However, there are steps that could be taken to get us there. Earlier this year, SIFMA and several other organizations published a report titled “Expanding the On-Ramp: Recommendations to Help More Companies Go and Stay Public,” with the goal of promoting policy changes that will lead to increased IPO activity. The “Expanding the On-ramp” report recommends several policy changes to enhance the JOBS Act and to further streamline the process of helping companies secure capital investment.

EGCs are a vital component of a vibrant economy, since a steady pipeline of growing companies helps to drive innovation and increase competition. That type of dynamism is an important ingredient in any strong and growing economy, the “Expanding the On-Ramp” report notes.

“Only about 12% of Fortune 500 companies in 1955 were still on the list in 2014, while the other 88% either have gone out of existence, merged with another company, or fallen out of the Fortune 500,” the report explains. “This dynamism has forced businesses to change with the times or be replaced by new entrants with innovative ideas and products that meet the needs of an ever-changing marketplace.”

Emerging growth companies tend to be the key drivers of that form of dynamism, since they are more likely to challenge incumbents for market position by providing new goods and services, charting the course toward future innovation, and creating productivity gains and growth. That’s why paying close attention to the EGC sector—and creating conditions that help this sector to thrive on a fair playing field—is so important for the future of the U.S. economy.