The Wrong Tool for the JOBS: Why the JOBS Act Will Fail

by Charles Krakoff on April 4, 2012

in Competitiveness, Democracy and Governance, Economics, Investment, Politics, The Markets

If you think that the main problem small businesses face is raising capital you probably aren’t a small business owner. If you think that the reason businesses don’t hire more people is that they don’t have enough money, you almost certainly aren’t a small business owner. That’s probably why the JOBS Act passed with overwhelming majorities in both the House and Senate: there aren’t too many small business owners in either chamber. The Republicans like the bill because it supposedly helps small businesses, the Democrats because it promises to create more jobs.

Most of the criticisms of the JOBS Act, including Andrew Ross Sorkin’s attack in yesterday’s New York Times, focus on the increased risk to investors. The JOBS Act loosens disclosure requirements for small businesses (defined as those with less than $1 billion in sales) seeking to raise capital from individual investors or initial public offerings. By doing so, it all but guarantees that some investors will lose money when dicey accounting or other undisclosed practices come to light, as recently happened with Groupon, which was forced by the SEC forced to write down its earnings by $14.3 million when certain accounting irregularities came to light.

Such risks are real, though Sarbanes-Oxley reporting requirements, instituted in the aftermath of the Enron meltdown, do impose a proportionally heavier burden of compliance on small businesses than on large ones and there is some argument for lightening that burden. The real fault, though, is that the JOBS Act, for all that its ridiculous acronym proclaims otherwise, will not create any new jobs.

It’s a common fault of many start-up ventures that they pay more attention to raising capital than to building a viable business. I speak from firsthand experience. A dozen or so years ago I worked in a couple of internet start-ups that had big plans and tried to raise big money. In one of them we burned through around $10 million of other people’s money without a single dollar in revenue before the investors finally pulled the plug. True, that venture did create quite a few well-paid jobs and paid for some nice perks, but they were all gone in less than 18 months. I can identify a whole slew of reasons why we failed, but lack of money was certainly not one of them. If anything, we had too much of it. If we’d had less, the discipline of scarcity might have spurred us to get a product to market sooner.

In one sense, of course, businesses fail because they run out of money, just as people die because their hearts stop beating.  But lack of funding is rarely the primary cause of business failure. Any venture capitalist could tell you that; according to many estimates, as many as 90% of venture capital investments fail outright or underperform. Solyndra, the solar power firm that went bankrupt after receiving over $500 million in U.S. government loans, is a case in point. Solyndra failed because its management failed to anticipate huge Chinese government investment in solar panel production, which caused a worldwide glut and collapse of prices.  That’s the kind of error that has sunk many companies.

According to the U.S. Small Business Administration, there are at least 10 reasons for small business failure. Lack of funds is one, but the other nine are lack of experience, poor location, poor inventory management, over-investment in fixed assets, poor credit management, personal use of business funds, unexpected growth, competition, and low sales. The JOBS Act won’t do much about these. In fact, according to a recent Harvard Business School article,  one effect of additional funding could be “the potential to turn a little failure into an enormous one.”

The JOBS Act will also probably result in minimal new job creation. Most business owners and managers do everything they can to avoid adding staff until the cost of hiring becomes less than the cost of not hiring. They hire people when they can’t afford not to.

It is sad that the only time, apparently, that Democrats and Republicans can come together in a spirit of bipartisan cooperation is when they are both completely wrong about everything.

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{ 1 comment… read it below or add one }

Venugopal Chepur April 8, 2012 at 9:30 am

Hi Charles,

Thanks for the nice post. You are right about many things that you have enlisted as reasons why the Jobs Act will fail. Yes. It may probably fail, perhaps a great deal as well. But politicians will succeed, because they want the initial spurt, that euphoria and the climate that seemingly appear so appeasing that politicians are actually doing their job! Isn’t that’s good enough for them to get votes?

Regards, Venu

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