How 'Confidential' IPOs Are Changing the Market
After Facebook's underwhelming IPO ushered in a five-week summer drought of public filings, many are hoping the sky opens up this fall.
The JOBS Act was supposed to help seed those clouds.
Through some of its provisions, companies with less than $1 billion in annual revenue, dubbed emerging-growth companies, have looser rules for how they file with the U.S. Securities and Exchange Commission to take a company public--including the ability to keep that very fact private.
Investors have taken to calling these confidential IPOs, or sometimes, secret IPOs. Designed to help smaller companies assess interest before putting their books in front of the world's investors, the optional process went into effect April 5. Filing as an emerging-growth company requires less paperwork, including submitting just two years (rather than the usual three) of financial statements to the SEC. What's more: Every bit of the filing, including correspondence about it, is kept out of the eyes of the media, competitors, and the investment community until the company decides to make it public (no later than 21 days before the IPO presentation series, known as a roadshow).
This allows companies with less than $1 billion in revenue to test the waters for an IPO by getting feedback from the SEC and certain investors; it also makes it easier for a company to quietly back away from an IPO if the response isn't sunny.
To date, more companies have filed secretly since the JOBS Act was signed than have used the traditional filing method, according to SEC data and an Inc. analysis.
In the first two months of the confidential filings, they outpaced regular filings three to two, SEC deputy director Paula Dubberly noted at a conference. According to an Inc. review of data from PrivCo, Hoover's, and Renaissance Capital on companies that have filed S-1 documents since April 5, fewer than 40 appear to have done so publicly. The SEC says, meanwhile, roughly 60 companies have filed confidentially.
Still, it's too soon to know, and--even if more time had passed--ultimately it would be difficult to prove whether the legislation is actually encouraging more companies to go public.
"I would be shocked if there's a detectable effect from the JOBS Act in the number of publicly traded companies and employment," says Jay Ritter, a finance professor at the University of Florida and expert on IPOs.
Yet keeping a filing confidential does have its benefits, especially for a generation of fast-growth tech start-ups, says Jacqueline Kelley, a partner at Ernst & Young.
"There are back-and-forths with the SEC that they want to be able to work on before it becomes publicly available," she says. "Also, not being in the spotlight during this time is desirable, and being able to focus on the filing, rather than the media and investor relations."
Just imagine how welcome that would have been for Google, whose S-1 gave Silicon Valley a trove of competitive information, or Groupon, which faced a deluge of media attention when the SEC questioned its accounting practices, causing the company to adjust its revenue and income figures before its roadshow.
Even though these confidential filing options have been on the table for only five months, they're already producing public companies. Of the 17 that went public in August, more than half were initially confidential, according to Renaissance Capital.
A look at the seven IPOs slated for mid- to late September on the Nasdaq shows at least three were initially filed confidentially. These are: Trulia, a real estate listing start-up based in San Francisco, which filed plans to raise as much as $90 million; Smith Electric Vehicles, a maker of electric trucks in Kansas City, Missouri, that wants to raise $76 million; and GlobeImmune, a biopharmaceutical company based in Louisville, Colorado, that hopes to raise $60 million. Each is scheduled to begin trading the third week in September.
Because of the "quiet period" between filing an S-1 with the SEC and getting SEC approval to go public, these companies are prevented from answering questions to elaborate about why they filed confidentially before making their IPO intentions public.
Still, Plenty of Scrutiny Around Secrecy
Given all the potential benefits of filing confidentially, it's unclear whether the companies doing so are the ones the legislation sought to help.
Though confidential filings were designed to be ideal for fast-growing technology companies, the definition of emerging-growth company can easily be stretched. Among the companies known to have filed confidentially with the SEC (and that continued on the path to IPO) are established companies looking for cash infusions. Those include Hollywood's MGM Studios, the company behind grocery store Fairway Market, and the 134-year-old U.K. soccer team Manchester United.
"With Manchester United, I don't think there are a lot of trade secrets exposed in the prospectus," Ritter points out.
The new confidential filing process is also drawing scrutiny for limiting information available to investors and the public--until just three weeks before a full-fledged IPO roadshow begins.
"Investors need time to start to kick the tires," says Sam Hamadeh, CEO of PrivCo, a private research firm based in New York City. "If people don't know the financials, it won't draw investors to the honey. It's no longer the three to four months of getting people really excited about it."
Another side effect: Market analysis becomes less accurate because a full view of the IPO backlog is now obscured.
Kathleen Shelton Smith, a principal at Renaissance Capital, points out that companies filing with the SEC aren't required to be completely silent. They can share data with some investors before their IPO roadshow, under the new "test-the-waters communications" permitted under Securities Act Section 5(d).
"The market works because a whole lot of investors can look at everything," she says. "So our view of a lot of the JOBS Act takes us backward to, 'Here's a special class of people getting special information.' We don't think that helps matters whatsoever."
Although the average investor remains in the dark with a confidential filing, that method can be appealing to well-connected venture-backed firms with strong ties to a community of top investors.
"In this day and age, companies are really taking advantage of going to investors early, sometimes two years before their IPOs," Kelley says, noting that investor-relations conferences increasingly are hosting special events for private companies. "So by the time they get into that process, there's already a relationship with those investors."
Others are skeptical of emerging-growth companies relying too much on their existing investment community when going public.
"Private companies have to realize, when the dust settles after their IPO, you want it to be owned by a bunch of people who really want to own part of the company, and not someone who wanted to do a fast trade," Smith says.
Additional reporting by Nicole Carter and Jillian D'Onfro.
CHRISTINE LAGORIO-CHAFKIN | Staff Writer | Senior Writer
Christine Lagorio-Chafkin is a writer, editor, and reporter whose work has appeared in The New York Times, The Washington Post, The San Francisco Chronicle, The Village Voice, and The Believer, among other publications. She is a senior writer at Inc.