Confidential IPOs are a relatively new addition to the public markets, one that most investors don’t know a lot about.
Despite the general confusion around their use and what exactly a confidential initial public offering is, there have been several high-profile confidential IPOs in the past few years.
Just a few weeks ago we learned that mobile payment processing company Square Inc., founded by Twitter (NYSE: TWTR) co-founder and interim CEO Jack Dorsey, is planning to go public and has filed paperwork for a confidential IPO.
Of course, we only know this because “a source familiar with the matter” leaked the information to The Wall Street Journal and other financial media outlets. It’s entirely possible that the information was leaked to drum up interest from potential investors and even to stir up an acquisition offer – but that’s a separate story entirely.
But the use of confidential IPO treatment by such a high-profile company raises bigger questions. What exactly is a confidential IPO, and what is the story behind this relatively new stock market development?
Inside Confidential IPOs
Signed into law by President Barack Obama in April 2012, the Jumpstart Our Business Startups Act – aka the JOBS Act – created the confidential IPO and also made it significantly easier for startups to raise money privately and stay private for longer.
What exactly does “confidential IPO” mean?
The JOBS Act allows for certain “emerging growth companies” – startups with less than $1 billion in annual revenue – to file their S-1 IPO paperwork confidentially, enabling the fine tuning and back-and-forth between the company and the Securities and Exchange Commission to take place outside of the public eye. The confidential IPO rules also allow the filing company some additional leeway when it comes to financial reporting and disclosures.
The original purpose of the legislation was to make it easier for startups to access capital – either through public markets or private funding – and, therefore, boost the economy and create jobs.
It’s hard to put an exact figure on how many confidential IPOs have been filed. Frankly, many of the companies using confidential IPO treatment are relatively unheard of. Each company’s S-1 filing and other IPO paperwork is eventually made public no less than 21 days from the beginning of the management team’s IPO road show.
In fact, the only time you are likely to hear about a confidential IPO is when it involves a high-profile company and some kind of leak to financial journalists.
But surely you’ve heard of grocery chain Natural Grocers (NYSE: NGVC), professional soccer team Manchester United (NYSE: MANU) or Twitter, all of which started their IPO process under confidential IPO treatment.
Since all drafts of a company’s S-1 filing are eventually made public as part of the IPO disclosure process, all that the confidential IPO really does for a company is buy it additional time before disclosing its IPO paperwork and correspondence with the SEC.
The Confidential IPO Rationale
Why would a company pursue a confidential IPO?
Confidential IPO treatment means that the investing public won’t know about a company’s back-and-forth between the company and the SEC in real time. It also greatly loosens the financial disclosure rules the company is subject to.
Under traditional IPO rules, a company must report two years of audited financial statements and an additional three years of unaudited financial statements. But under the confidential IPO rules, companies only need to report two years of audited financial statements and unaudited financial statements going back two years.
The confidential IPO rules also stipulate that the company can opt out of certain Sarbanes-Oxley rules for up to five years, as long as they don’t grow beyond a certain market capitalization. You may recall that Sarbanes-Oxley Act of 2002 was enacted to enhance financial controls to protect investors, and was put in place in the wake of the Enron collapse.
At best, the confidential IPO doesn’t do much for a company besides let it negotiate the details of an IPO with the SEC in private. But the confidential IPO also loosens the disclosure requirements for companies at the time of their IPO, as well as certain reporting and financial control requirements following their IPO.
I struggle to see how the confidential IPO benefits investors – buyer beware.
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