October 30, 2002

In a recent discussion on when small businesses should go public, the new legislation to prevent investor fraud, the Sarbanes-Oaxley legislation, came up. 

As you know, that bill was instigated by the problems at Enron, Worldcom, and Tyco, among others.  The idea was to change the system of auditing and reporting that helped to foster alleged fraud against shareholders. 

Most corporate boards are being inundated with reports from their lawyers and their accountants explaining what this legislation means to them.  Although the signing of reports by CEOs and CFOs received the most press attention, requirements about independence of accountants from corporate management, independence of board members from management, and much more stringent reporting requirements were addressed. 

Perhaps, this legislation will lower corporate fraud.  But that was not what was discussed about public small businesses. 

Unfortunately, legislators tend to think of business as large corporations.  Yet 85% of all new hires are selected by companies with less than 500 employees.  When legislation requires new reports, large businesses get their programming department to handle the problem.  Small businesses invariably must outsource these needs. 

Furthermore, funds are in short supply for most small businesses.  Any additional costs can mean the difference between success and failure for small public enterprises. 

When we added estimates of additional accounting fees, legal fees, board fees (to find the independent members that still can add to corporate guidance), and exchange compliance costs, we assumed that Sarbanes-Oaxley probably added about $250,000 per year to the cost of operating a small public enterprise. 

The average profit margin for corporate America is about 5 percent.  Using that estimate to determine the size of sales needed to shoulder the additional compliance costs, the average public small business must be well over $5 million in size to meet these costs. 

Five million in sales is not very much for those corporate transgressors that Sarbanes-Oaxley was trying to prevent.  The average manager's house in those companies is worth more than that. 

However, most small retailers, virtually all small farms, and a host of emerging enterprises could not cross that hurdle.  As a result, the legislation will prevent many businesses from going public until they are substantially larger than in the past. 

Those advantages of liquidity, compensation transparency for those paid in stock as well as money, access to capital, and visibility that public companies receive will be lost to the emerging company.  Indeed, some of those companies might be thwarted from ever emerging at all. 

Once again, legislation designed for the large corporation will have its greatest impact on the small business. 

Because of the damage to new business development that this legislation creates, I would recommend that the small business loan pool be widened and the terms eased for operating performance.  I certainly would agree that the loss write-offs against ordinary income be increased from $3000 to at least the $8250 and then adjusted for inflation that is contained in some Congressional bills.  This unilateral increase in costs without any benefits for small business certainly will generate losses for some investors. 

I also hope that the accounting and legal professions will design compliance tools that reduce the costs that small business will experience to meet the legislation. 

In the future, I believe all corporate regulation legislation should contain a cost evaluation for small business development.  If we understood how much additional cost burden was being pushed onto small business, perhaps the legislation could have exempted public companies below certain sizes. 

The mere fact that the small business impact of this legislation was not raised indicates the degree to which small business is ignored by Washington. 

What irony would it be if small business development is seriously hampered because of legislation that was stimulated by the abuses of big business.  



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