Under New JOBS Act, More IPO Prospects Consider Filing Confidentially
SolarCity, the cleantech company backed by Tesla and SpaceX CEO Elon Musk, filed for an IPO this past week. But there’s hardly been a peep about it compared to most offerings.
That’s because under the recently passed JOBS Act, SolarCity didn’t have to publicly share anything about its financial performance when it filed. This is unlike LinkedIn and Pandora, which had to publicly release three years of data in filings that were more than 150 pages long. In SolarCity’s case, the company merely put out a two-paragraph statement saying that it had confidentially filed with the SEC and planned to have an IPO.
This is the new world under the JOBS Act, which was hastily passed last month. SolarCity qualifies as an “emerging growth” company, or one that’s had less than $1 billion in total revenues in the most recent year. If SolarCity does move forward with an IPO, it won’t have to release data to the public until 21 days before the investor roadshow. On top of that, those documents won’t have to meet the same auditing requirements that more mature publicly-held companies have to address. It will also only have to show two years of data, instead of three.
At least two other CEOs I’ve talked to who run later-stage companies and are planning to file in the next three to 12 months say they would consider it. But they’re leaning toward the old route because they’re concerned about how investors will perceive confidential filings. (The SEC FAQ on confidential filings is here.)
Are the changes good? Are they bad? Honestly, it’s hard to say because regulation usually has long-term ripple effects that are hard to see without hindsight.
So let’s consider. The JOBS Act was really a mix of several ideas: crowdfunding, loosening the 500-shareholder rule and the relaxing some of the post-Enron, Sarbanes-Oxley rules that made it expensive for smaller companies to go public.
It gives companies more flexibility in staying private or going public. On the one hand, it’s less difficult to become publicly-traded. But it’s also easier to stay private too since a company doesn’t have to release financials until it has more than 2,000 shareholders excluding employees, up from the previous 500-shareholder limit.
Net-net, it’s hard to say how this will affect the average time-to-IPO. While private secondary markets have become more important over the last five years, they are simply not large or liquid enough to give venture firms the exits they need right now. So companies still need to tap public markets. This could change over the next 10 years though. Who thought founder liquidity would have become as widespread as it is a decade ago?
The downsides to confidential filings are obvious: The public gets left in the dark for a little bit longer (though not forever). The two years of financials, instead of three, means less data to show the kind of hockey-stick growth curve that investors usually like to see. Giving “emerging growth” companies a five-year grace period to adjust to new auditing requirements means fewer controls to prevent the kind of disastrous accounting restatement that Groupon had to make earlier this year. (No, the current rules did not prevent the Groupon snafu, but does that mean we should make them even weaker?)
Now let’s go onto the positives. So first, an IPO candidate can covertly test market appetite. If there isn’t as much demand as they thought, they can pull out without the negative publicity. Secondly, if the IPO window suddenly shuts down because of market volatility like last August, the company’s not left dangling out in the open for the better part of a year.
The world has also changed quite a bit since 80 years ago, when the original legislation establishing these rules was passed. Three weeks is eons in an interconnected world where bad news spreads faster than you can say “tweet.” There are also plenty of investors like Yuri Milner’s DST and other individual accredited investors who have stepped up in secondary markets on the belief that the modern online and social media provides more than enough information to make educated investment decisions. (But Milner gets special access given how much he invests and SecondMarket usually requires the company to make some disclosures, but the company gets to choose what and with whom they share their information.)
Overall, confidential filings don’t seem bad in and of themselves, so long as the public eventually gets the information before they can trade the stock.
But as we loosen regulations, we should always remember that the system only works if investors have trust in the companies and documentation they’re seeing. What people forget is that what we have now was born out of the Great Depression, when regular people lost or were swindled out of untold fortunes. When the original Securities Act was passed in 1933, president Franklin D. Roosevelt wrote a letter to Congress, saying that the “issue of new securities to be sold in interstate commerce shall be accompanied by full publicity and information.”
He went on to say that the old Latin saying, “Caveat Emptor,” or “Buyer Beware,” should be expanded to read “Let the seller also beware.” He said, “It puts the burden of telling the whole truth on the seller.”
That burden isn’t, well, so burdensome in private markets. For pre-IPO companies, the reality is that most of the sources that journalists and the public have access to are people who are highly incentivized to make the company seem better than it really is. It’s no coincidence that most of the media attention on Groupon before it revealed its financials was all rah-rah all the time. Most every source that journalists had access to were investors or employees. These were the people who plowed nearly $1 billion into the company thinking it would be a quick 2 or 3X return by the time the lock-up ended.
In fact, in several cases so far this year like Groupon and Zynga, private secondary markets — which have less information and are much less liquid — have been far more generous with the valuations they award.
Ironically, in this tech “blubble” or whatever you want to call it, it’s the public markets that have been more judicious.