Lyft, Uber, and the Changing Disclosure Rules For Unicorn IPOs

Xconomy San Francisco — 

When a much-watched tech company such as Lyft, Uber, or Pinterest files for an initial public stock offering, people eagerly scour the sudden trove of information that such a private business must finally disclose when it begins to offer shares to the general public, rather than only to sophisticated inside investors such as venture capital firms.

For newly public company Lyft, (NASDAQ: LYFT) though, the IPO disclosure requirements were significantly lower than they would usually be for businesses with multiple billions of dollars in annual revenue—and lower than they are for Lyft’s big rival Uber, which is now gearing up for its own initial public offering.

Although Lyft was a “unicorn” reportedly valued at $15.1 billion by its VC backers last summer, the company was able to qualify for a series of exemptions to the US Securities and Exchange Commission’s financial reporting rules—breaks originally advocated in Congress as a way to make it easier for smaller, “emerging” companies to access the public markets for capital.

The San Francisco-based ride-hailing app company, second only to Uber in the US market, slipped in under the wire when it claimed standing as an “emerging growth company,” or EGC, as it filed with the SEC in early December in preparation for the IPO it completed late last month. Because of that EGC status, Lyft wasn’t required to disclose as much about its financial results, for example, or about the pay packages for some of its top executives. (More details soon on how Lyft qualified as an EGC.)

The EGC status stems from Title I of the Jumpstart Our Business Startups Act, or JOBS Act, enacted in 2012 with a number of provisions to support the growth of young companies whose easier access to capital would, it was hoped, allow them to hire more workers. The bill’s intent was to lower the cost burden for many IPO hopefuls by granting them temporary exemptions to certain accounting standards and other rules.

Some finance experts question whether the bill is achieving its intended effect, and whether its expected benefits outweigh potentially negative consequences for Main Street investors and even the IPO hopefuls themselves. While that debate continues, the SEC is moving to further loosen financial disclosure requirements for IPO candidates. That includes tech companies valued at over $1 billion, which have raised billions of dollars from venture capital firms before going public, and may be better able than other startup companies to afford the extra expense of paying auditors and accountants to prepare more detailed reports to inform investors.

Disclosure exemptions—the pros and cons

Although the JOBS Act passed with bipartisan support in Congress, it wasn’t without critics, who worried that important safeguards for investors would be eroded as companies offered their shares on public exchanges after providing thinner-than-usual details on their finances and operations. Some wags dubbed the law the “Jumpstart Our Bilking of Suckers Act,” commentator Floyd Norris noted in the New York Times in 2012.

Opponents of the JOBS Act include the Consumer Federation of America, an umbrella organization of nonprofit groups, which advocates for the interests of ordinary investors such as mutual fund shareholders.

Among the other skeptics is Daniel Taylor, an associate professor of accounting at the University of Pennsylvania’s Wharton School. Taylor says allowing IPO candidates to withhold information from the investor community could foster a public market for weaker companies, just as used car dealers who hide mechanical flaws can continue to move “lemons” off their lots. Taylor says he’s drawing on the insights of Nobel Prize-winning economist George Akerlof, who argued in a seminal 1970 paper, “The Market for Lemons,” that measures to remove the information gap between sellers and buyers could collapse the market for dud cars and many other low-value products.

Unsophisticated Main Street investors might lose money even if they don’t buy shares in individual EGCs, Taylor says, because newly public companies can be folded into indexes and may become part of their mutual fund portfolios or individual retirement accounts (IRAs). Their investment gains could be affected if the overall quality of public companies declines, he says. And there is research suggesting that looser financial reporting requirements don’t actually save companies money, and can end up dinging their stock market performance, he adds.

The SEC, however, has committed to extending disclosure exemptions and other benefits of the JOBS Act to firms much larger than the typical emerging growth company. In fact, these breaks have already spread well into unicorn territory. Uber, which may reach a market capitalization of as much as $100 billion through its IPO, has made use of one of those newer breaks—though it still enjoys significantly fewer advantages than Lyft. This new break is the reason why we haven’t been able to see Uber’s disclosures to the SEC until this week, even though it filed for an IPO in December.

More exemptions are proposed. In a series of speeches and interviews in August, SEC Chair Jay Clayton said the agency’s regulations could be modernized and streamlined without putting investors’ interests at risk. In fact, Clayton said, the rule changes would also open up opportunities for Main Street investors to secure stakes in emerging companies that have increasingly delayed going public and relied on private fundraising instead. The SEC is updating or eliminating “requirements that are outdated, overlapping, or duplicative of other Commission rules” or generally accepted accounting principles, he said during a speech in Nashville.

The circumstances under which Lyft qualified as an EGC may rarely be repeated. But that element of its IPO story makes it part of a wider pattern. Other unicorns such as Pinterest and Zoom Video Communications—whose pending IPOs may make them each worth multiple billions of dollars—qualified easily for emerging growth company standing because their annual revenues for the past full year each fell below a JOBS Act cap. Like Lyft, many tech unicorns have already raised billions of dollars from venture capital firms, which peg their private valuations in the billions because of their growth potential. For many, though, their revenue isn’t large enough yet to deliver a profit.

How Lyft qualified as an emerging growth company

Under the JOBS Act when it was passed, a private company wishing to qualify as an EGC could have no more than $1 billion in revenue for its most recent full financial year. Lyft, which priced its IPO on March 28, reported revenue more than double that for its full prior year of 2018—over $2.1 billion.

But because Lyft first filed for its IPO in December, before 2018 came to an end, it could apparently rely instead on the revenue for its most recent full year— 2017—when it gained EGC standing. (Lyft, which is in a post-IPO quiet period, declined to comment on the filing.) The company’s revenue for 2017 was $1.059 billion—still more than the original $1 billion limit. However, the JOBS Act had also called for that cap to be adjusted every five years for inflation, and in 2017 the ceiling was raised to $1.07 billion. Lyft could squeak in by a margin of about $10.1 million.

However, people might wonder, wouldn’t Lyft’s standing as an EGC expire at the close of 2018, because its revenue of more than $2.1 billion for that year blew past the JOBS Act cap? The answer is no, because of … Next Page »

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