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

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a 2015 amendment to the JOBS Act that was tucked into a federal transportation bill.

Companies like Lyft that had already filed for an IPO as qualified EGCs could maintain that status until they completed their public offerings, even if changes in their financial conditions in the meantime would otherwise have stripped them of the EGC designation. That grace period was created under the FAST Act (or Fixing America’s Surface Transportation Act), as explained in this article by David Westenberg, an IPO expert at the law firm WilmerHale.

If not for the FAST Act, Lyft would have had to revise its prospectus—a description of its share offering and the company’s condition—to comply with more stringent financial reporting requirements during the few months of this year when its IPO was still pending.

Lyft’s status as an emerging growth company expired as soon as its IPO took place, as the company’s prospectus confirms—a very unusual chain of events. Most other EGCs can keep that standing well after they go public, and can continue to take advantage of reduced financial reporting requirements for as long as five years, provided that their revenue doesn’t exceed the JOBS Act cap, and they don’t pass certain other milestones. For Lyft, however, being an EGC for a bit less than three months still delivered some important benefits (more details to come).

Vast majority of IPO candidates qualify as emerging growth companies

Most companies that claim standing as EGCs aren’t close to being in Lyft’s league—even the ones that manage to carry off an IPO. By late 2016, of the 664 EGCs whose shares were already listed on an exchange, 594 reported annual revenue between zero and $199 million, according to a study by the staff of the Public Company Accounting Oversight Board (PCAOB). Only 70 EGCs had attained annual revenue of $200 million or more, and of those, only 10 posted yearly revenue above $800 million.

But the impact of the JOBS Act breaks on public financial disclosures is pervasive, because the revenue cap to qualify as an EGC was set so high from the beginning, at $1 billion. Since the JOBS Act was passed in 2012, 85 percent of IPO candidates have qualified as emerging growth companies, according to the law firm WilmerHale’s “2018 IPO Report” issued in June last year.

As noted above, other tech unicorns now on the IPO runway have easily qualified as EGCs, based on their IPO filings that have been made public: Pinterest, the design-based social media network, had 2018 revenue of $755.9 million; and video conferencing company Zoom’s annual revenue for the year ended Jan 19, 2019 was $330.5 million.

Both these companies plan to pull off IPOs that result in market capitalizations in the multiple billions. If they do, this could start a clock for the expiration of their EGC status in less than five years—even if their revenue doesn’t breach the JOBS Act cap—because an EGC’s public equity float can’t exceed $700 million. The public float is the dollar value of company shares trading on public exchanges,  excluding shares owned by company officers, directors, and shareholders with controlling interests.

Barbara Roper, director of investor protection at the Consumer Federation of America, says she was “appalled’’ when the JOBS Act passed with a $1 billion annual revenue cap for EGCs. She says the further expansion of the JOBS Act exemptions is eroding the stronger investor safeguards that followed the bankruptcies of scandal-plagued Enron and WorldCom in 2001 and 2002, and the worldwide financial crisis triggered in 2008 with the collapse of over-leveraged US financial institutions.

In the case of fast-growing Lyft, whose IPO raised more than $2 billion, and whose market capitalization reached more than $20 billion on the day the offering closed, such worries on behalf of investors might seem unduly heightened—that is, if its share price had continued to surge upwards from its IPO price of $72, as it did on the first day of trading, March 29.

But on the second day, the stock dropped by 12 percent as analysts who were beginning their coverage of Lyft voiced doubts about the company’s ability to achieve profitability, as Investor’s Business Daily reported. Lyft’s net loss had amounted to a formidable $911.3 million in 2018.

One analyst put a “sell” rating on Lyft, and a target share price of $42, CNBC reported. By Wednesday, April 3, more than 38 percent of the 32.5 million shares Lyft sold in the IPO had been borrowed by short sellers, who are betting that Lyft’s share price will sink by a margin that nets them a handy profit, according to MarketWatch. As of the close of trading on Thursday, Lyft shares had slipped further underwater to close at $61.01 apiece. That’s more than 15 percent below the $72 IPO share price.

The aftermath of Lyft’s IPO, which led the pack in the current IPO season, may have dimmed the optimism of another unicorn IPO hopeful: Pinterest scaled back its fundraising targets in Lyft’s wake, as TechCrunch reported.

The track record of emerging growth companies

Among all companies that went public in 2017, 30 percent had shares trading below their offering price by the end of the year, according to WilmerHale. On the other hand, 44 percent of those IPO companies saw a share price bump of at least 25 percent. Investors, using the information they can get, try to predict which companies will fall into which buckets.

As of late 2016, emerging growth companies as a group were starting to show some frailties compared to other public companies, according to the PCAOB. EGCs were more likely to report material weaknesses in the effectiveness of their internal controls over financial reporting, and their auditors were more likely to report substantial doubt about a company’s ability to continue as a going concern.

While investors in emerging growth companies might be exposed to more risk, there may also be downsides for EGCs themselves when they take advantage of JOBS Act exemptions from traditional financial reporting rules, Wharton professor Taylor says. Among these are the underpricing of their shares in an IPO, and later market volatility, Taylor and his colleagues concluded in a 2017 research paper.

Due to “information uncertainty,” uneasy investors in IPO shares often want to pay less and increase the chance that they’ll benefit from a share price bump as trading begins, the research team found. After that, the stock price of an EGC that has opted to reduce its disclosures can be more volatile than for newly public firms that complied with traditional reporting standards, Taylor says.

But some companies still opt to make use of the JOBS Act exemptions, even if they only qualify for a brief period.

Among the benefits: They can submit financial statements—which include revenue and profit or loss—for only two years rather than three. Lyft waived this exemption and reported three years. EGCs can also opt to reveal the compensation packages for only three top executives, rather than five. Lyft disclosed those details for its CEO and co-founder, Logan Green; and two others it says are its next most highly compensated officers: chief product officer Ran Makavy, and chief operating officer Jon McNeill. Lyft didn’t include the pay packages for John Zimmer, its co-founder and president, or its chief financial officer, Brian Roberts.

Other significant breaks have already been extended to non-EGCs, or plans are in the works to do so:

—Draft registration statements out of the public eye

Emerging growth companies can submit an initial registration filing for an IPO to the SEC confidentially. That means that potential investors, analysts, and news organizations can no longer follow the real-time back and forth exchanges in public documents between the company and the SEC staff, as the prospectus is filled out and possibly amended according to the SEC’s suggestions, Taylor says.

Due to SEC rule changes, however, Uber had advantages similar to Lyft’s ability to file for an IPO confidentially. In December, Uber also filed its draft registration statement under wraps, even though it had disclosed revenue of $2.95 billion in the third quarter of 2018 alone. According to WilmerHale, the SEC staff in mid-2017 created a new procedure for “non-public review” of these filings, making it open to most IPO candidates. The change didn’t result from an amendment to the JOBS Act, according to the law firm.

When Uber publicly filed its prospectus Thursday, its confidential December 6 draft registration statement was also made public, along with … Next Page »

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