Disrupting the Disruptors? The “Going Public Process” in Transition

For decades, the process that private companies in the United States have used to get listed on public markets has followed a familiar script, using bankers as intermediaries to price and sell their offerings, primarily to preferred clients. As the number of public offerings has surged in the last few years, there have also been disruptions at three levels.

• The first is in the types of companies going public, with many firms entering the public markets with large losses and unformed business models. For much of the twentieth century, the prototype for a private company that was going public was that of a small, growing company, with a working business model, making or on the verge of making profits, and a need for capital that exceeded what venture capitalists could offer. The median going-public company has become larger (in terms of revenues, in constant dollar terms) and less profitable; only 20% of firms that went public between 2016 and 2020 were making money, in contrast to the 80% of firms that went public between 1980 and 1990.
• The second is in process that a private company follows to go public, for the last few decades, has been built around bankers as intermediaries. The traditional IPO process takes too long, costs too much, and leaves both issuing companies and investors dissatisfied, the former because the process takes too long and is too inefficient, and the latter because they feel that only a select few can partake at the offer price. One alternative is direct listings, where the company dispenses with the banking services (setting an offering price and roadshows) and lets the market set the price on the offering date. This process, by reducing the need for banking intermediaries, is less costly but it still takes time and comes with constraints, especially in the context of raising capital from the offering to cover future business needs. A special purpose acquisition company (SPAC) offers a different approach to going public, with an initial listing of an entity that raises public, with the intent of merging with a private business that wants to be in the public markets. The sponsors of the SPAC are the key players in this game, since investors in the entity are dependent upon the sponsors finding a target and negotiating a good deal. While SPACS may be more time efficient, and SPAC sponsors get a little more leeway than conventional IPOs in disclosure and marketing, the sponsor’s substantial slice of capital (20% or higher) is large enough to wipe out any potential timing and pricing benefits in the deal, making them often the only winners in this process.

• In the banker-led model for IPOs, the investors at the offering price tended to be institutional, receiving a windfall profit, when the shares started trading on the offering date. In the last few years, there has been a move towards opening up the process to individual and retail investors, and trading platforms like Robinhood have helped.

As larger and more money-losing companies go public, sometimes using processes which bypass bankers and other intermediaries, and retail investors, many young and inexperienced, are drawn into investing in IPOs, it is worth asking the question of whether the disclosure and market regulatory rules that were written to protect investors need revisiting, in the context of these changes.

The SEC’s rules for disclosure for private companies going public were written decades ago, and while the core requirements of the prospectus have not changed much over time, the filings themselves have become more detailed and longer over time. Apple’s prospectus from 1980 was considered long, running 73 pages, and Microsoft’s prospectus in 1986 was 69 pages long, with the appendices containing the financials. In contrast, Uber’s prospectus in 2019 was 285 pages long, with a separate section of 94 pages for the financial statements and other disclosures, itself an increase on the Facebook prospectus from 2012, which was 150 pages, with 36 pages added on for financial statements and other add-ons. While disclosures have become longer and more detailed, they have become less informative, with obfuscations about share count and withholding of key information about future plans. It is ironic that the SEC’s rules that restrict companies from making detailed and specific projections for the future are allowing many issuing companies to get the best of both worlds, using large total addressable markets and diffuse user statistics to make their valuation/pricing stories bigger, without having to provide the details that can be used by investors to evaluate them and hold them accountable.

Rather than tinker with existing disclosure rules, it is time for a rethink on disclosures by initial public offerings, built around the following principles:

1. Less is more: This notion that more disclosure is better than less is dangerous, and it has made prospectuses into data dumps. We would recommend cutting back on disclosure, starting with the risk section.
2. More Pricing information: All private companies should be required to disclose VC capital raised over their history and the company pricing in each round, both to make clear how much cash the company has burned through over its lifetime, and also to provide transparency on VC behavior.
3. Rather than restrict storytelling, require fuller stories, with more connection to numbers: Markets abhor vacuums, and preventing companies from forecasting the future only allows others, less scrupulous and informed, to fill in the empty spaces with their own details. The disclosure status quo is letting young companies off the hook, since they can provide the outlines of a story, without filling in the details that matter.
4. User/Subscriber/Customer details (conditional disclosure): With users, subscriber or customer data, it strikes us as counterproductive, especially given the misgivings we have about disclosures becoming denser and longer, to require all companies to disclose information on unit economics. Instead, we would argue for triggered disclosure, where any company that wants to build its story around its user or subscriber numbers (Uber, Netflix and Airbnb) will have to then provide full information about these users and subscribers.

Put simply, better disclosure rules for initial public offerings have to be tailored to the types of companies going public as well as the types of investors/traders who are drawn to buying shares in these companies.

The complete paper is available for download here.