Monday, April 9, 2012

EdWeekly: "Potential Benefits for Education Startups Seen in U.S. Bill"

Congress last week passed a bill that makes it easier for startup companies to raise capital and go public, two oft-cited barriers for new ventures looking to enter the education market.
After passing in the Senate March 22, the Jump-Start Our Business Start-Ups, or JOBS ACT received final approval from the House of Representatives on March 28 and, as of press time, was expected to be signed into law by President Barack Obama.
The legislation, a rare example of conflict-free, bipartisan congressional support, is a composite of several smaller bills but puts forward two main initiatives aimed at helping startup companies grow faster:
• The measure would establish a new form of company financing called "crowd funding." Companies would be able to raise up to $1 million by selling small numbers of shares to a large number of buyers through several mediums, including the Internet. It's been compared with the social-financing website Kickstarter, where projects are introduced with development and financing goals and users can donate money to help the projects become realized. (Kickstarter, however, does not offer actual stake in the projects and companies being funded.)
Key Features of the Bill
• The bill establishes a new form of company financing called “crowd funding.” Companies could raise up to $1 million by selling small numbers of shares to a large number of buyers, through several mediums including the Internet.
• It allows companies that earn less than $1 billion in revenue to bypass certain financial reporting requirements in the five years after filing for an Initial Public Offering, or IPO. For instance, those companies won’t have to conduct an external audit of their internal controls and only have to disclose two years of previous financial information rather than three.
• The bill’s intent is to spur growth of younger companies, with the idea of creating more jobs. Companies with less investor-friendly ideas could raise money more easily through the crowd-funding route, as well.
• The JOBS Act also would allow companies that earn less than $1 billion in revenue to bypass certain financial-reporting requirements in the five years after filing for an initial public offering, or IPO. Those companies would not have to conduct an external audit of their internal controls and only would have to disclose two years of previous financial information rather than three.
One of the main reasons the education industry has been slow to embrace entrepreneurs as quickly as other sectors is the difficulty in raising capital in a highly regulated field skeptical of for-profit involvement. There are also few publicly traded companies in education, in part because of the difficulty of addressing both investors' and students' needs. The new legislation could put a dent in both of those barriers, though field experts expect the crowd-funding to have a larger impact.
"In K-12, it's a hard place to raise capital, and a lot of the entrepreneurs are raising less than $1 million anyways," said Adam J. Newman, a founding and managing partner of Education Growth Advisors, an education business advisory firm in Stamford, Conn. "It certainly creates a way for more dollars to come in."

A 'New Resource'

Formal and informal mechanisms are already in place for early-stage companies to raise money. In education, the NewSchools Venture Fund, based in San Francisco, for instance, invests in companies that may be too risky for venture capitalists. It is financed by a wide range of private donors. The organization recently announced the creation of an educational technology seed fund that aims to help ed-tech startups find early-stage funding.
For example, three years ago, NewSchools invested in BetterLesson, a Boston-based company that allows educators to use the Web to share and catalog lesson plans, after NewSchools recognized the need for such a tool in the education community. BetterLesson is quickly gaining traction among educators and, although NewSchools continues to contribute funding to the company, in its latest round of funding last August, most investments came from elsewhere, including traditional venture-capital firms.
The nebulous "friends and family" donation is another staple for early-stage startup companies. Those investments could be emboldened or even replaced by the crowd-funding initiative, said Steve Pines, the executive director of the Education Industry Association.
"It could represent an important new resource, particularly for the startups who don't have the rich uncle," said Mr. Pines, whose nonprofit organization is based in Vienna, Va., and helps education entrepreneurs connect with the K-12 market.
Though he doesn't think the JOBS Act would have a large effect on education startups, Tom Vander Ark, a managing partner of education venture firm Learn-Capital, in San Mateo, Calif., said the crowd-funding measure is conducive to companies "that advance social and return-seeking agendas," like those in education. People are more willing to invest small amounts in a company with less earning potential if it is helping education, he said.
Mr. Vander Ark said a more successful way to spur startup investments through federal legislation would be to open some of the U.S. Department of Education's innovation- and technology-related grants—such as the Investing in Innovation, or "i3" fund—to for-profit companies.

'Expensive and Onerous'

As for the IPO provisions in the bill, expert predictions fall short of a noticeable increase in such filings down the road. Mr. Pines said the bill could lead more companies owned by private-equity firms to go public, so private investors could see quicker returns on their investments, without as much hassle.
"[Current federal] requirements are expensive and onerous," Mr. Pines said. "So if those are suspended for five years, that's a big deal. Does it make the difference in going public? I don't know. But by suspending the requirements in the near term, it may give an early-stage company the kind of running space it needs."
Experts say the increasing flow of venture capital into K-12 and heightened interest in educational technology are generating opportunities for market newcomers, but the highly local nature of K-12 education makes it difficult for companies to grow quickly. After nine years of less than $100 million of venture-capital funds being invested in K-12 education, 2010 saw $131 million invested, followed by a major increase in 2011, to $334 million, according to statistics from the Chicago-based investment and consulting firm GSV Advisors. Those down years followed the dot-com bubble of the late 1990s when there was also a large flow of venture capital into K-12.
Proponents say the bill will allow companies to grow faster and, thus, hire more people.
Mr. Newman said some of the questions about investor protections and market saturation asked by opponents are legitimate ones. It's also worth questioning if the easier access to capital "disaggregates" the market, spreading thinner the money coming in, he said.But across all sectors, opponents to the legislation cautioned that loosening regulations on startup investments—many put in place following the burst of the dot-com bubble—could spur a repeat of that history. Despite its support in Congress, the bill was opposed by Securities and Exchange Commission Chairwoman Mary L. Schapiro, several major labor unions, and consumer-watchdog groups.
"Does it continue to enable businesses that shouldn't be funded to get dollars and crowd out more viable and credible businesses?" Mr. Newman asked. "I don't think the marketplace has a shortage of good ideas. It probably has too many."
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