Twitter Inc., Gilt Groupe Inc. and other Internet startups urged Congress to pass legislation easing financial-reporting rules for closely held companies.
Twitter Chief Executive Officer Dick Costolo and Gilt CEO Kevin Ryan, along with 36 other executives and investors, oppose a restriction that requires closely held companies to disclose financial data when they have 500 or more shareholders.
“The 500 shareholder rule is outdated, overly restrictive, and limits U.S. job creation and American global competitiveness,” the group wrote in a letter this week to members of Congress.
The startups are angling to generate support for legislation proposed earlier this year that would increase the limit to at least 1,000 shareholders. Because young companies hire rapidly and try to lure new employees with stock options, the current rules can force startups to go public too soon, said Gilt Groupe’s Ryan. Businesses in that situation may not be ready for public scrutiny, he said.
“The current legislation doesn’t reflect what is going in today’s economy and has unintended consequences,” Ryan, whose e-commerce company is based in New York, said in an interview. “Because companies don’t want to trigger the 500-shareholder rule, the solution they take right now is they stop giving out options.”
While companies with 500 or more shareholders aren’t required to file for an initial public offering, they have less incentive to stay private at that point, because they would have to disclose financial information to the U.S. Securities and Exchange Commission either way. The new 1,000-shareholder legislation, introduced in June by Representative David Schweikert of Arizona, would exclude employees and accredited investors from the rules, giving startups even more flexibility.
Gilt, with almost 900 employees, expects to approach the 500-shareholder limit within two years, Ryan said. Matt Graves, a spokesman for San Francisco-based Twitter, declined to elaborate on the letter.
By preventing companies from doling out shares to enough parties, the current restrictions constrain the ability of startups to seek funding or make acquisitions, said Jeff Clavier, an investor in Palo Alto, California, who signed the letter to Congress.
“They are having to work around the 500-shareholder rule just to do their business,” Clavier said.
The SEC is studying whether the growth of closely held companies is being hindered by shareholder limits, Mary Schapiro, the agency’s chairman, said in testimony in May. The restrictions have governed closely held companies since 1964.
Facebook has said it plans to disclose financial results by April 30, 2012, to adhere to SEC rules. That may lead it to file for an IPO. Facebook is considering raising about $10 billion in an offering that would value the company at $100 billion, a person with knowledge of the matter said last month.
Twitter, Facebook, Zynga and other startups have already been given more leeway in certain situations. The companies won approval from U.S. regulators to issue restricted stock units without running afoul of the shareholder limit. Restricted stock units represent the right to a specified number of shares of common stock in the future if certain conditions are met.
Lawmakers also are trying to give more flexibility to private financial institutions. In November, House lawmakers passed a proposal that would increase the shareholder threshold for closely held banks to 2,000 from 500.
Secondary exchanges, such as one run by SecondMarket Inc., have allowed early investors and employees to sell their shares without companies having to pursue an IPO.
The exchanges offer an alternative for companies that want to put off the costs and difficulties of going public, according to SecondMarket CEO Barry Silbert. Selling shares in an IPO puts companies at the mercy of short-term investors and opens them up to more lawsuits, Silbert said in written testimony that he plans to deliver to a Senate subcommittee today.
“Companies will continue to remain private,” he said.