Start-Ups Slam Into Sarbanes

It's not surprising that the first fixes to the law would be for small companies. Of all the complaints about Sarbanes-Oxley, the loudest and most frequent are coming from small companies and their backers. Venture capitalists in particular are concerned that the cost and complexity of Sarbanes-Oxley compliance are preventing many emerging companies from listing on U.S. exchanges.

Corporate griping about the new law is being kept to the boardroom, however. "It's very difficult for an executive, say a CEO or a CFO, to publicly bemoan Sarbanes-Oxley," says Alex Slusky, a managing partner of Vector Capital. "They're afraid it would sound like they're not honest about rules meant to protect investors."

There are parts of Sarbanes-Oxley that few object to, such as requiring CEOs and CFOs certify financial reports or auditor independence. But others are causing problems, VCs say, including the demand that only independent directors be placed on a company's audit committee. Often, that means recruiting a director to the board who has little or no knowledge of the company and its industry.

By far, the biggest sticking point for small companies and their investors is Section 404, which requires companies to produce an annual control report including an assessment of how well those controls are working. That entailed introducing IT systems to manage financial data and countless hours spent with auditors. All of this not only forced start-ups to pay new fees, it often also sucked up a good deal of management time.

Initially, the SEC estimated that Sarbanes-Oxley compliance would cost companies around $91,000 over the first three years. But some say small companies are seeing their costs as high as $4 million.

A study last December from CRA International found that companies with market caps between $75 million and $700 million paid an average of $2.4 million in compliance costs in the first two years. (The silver lining: Costs dropped 39% in the second year to $900,000 from $1.5 million.)