Rules meant to protect investors have turned out to be no match for bankers pitching today’s businesses to the public markets.
In theory, disclosures required of would-be public companies should provide investors with the critical information needed to determine whether they want to buy in, and at what price. Less obviously but equally important, disclosures should bolster good management practices by establishing sound performance metrics. However, existing disclosure regulations fail on both counts. They are outdated, and it is time for them to change.
Current rules were designed for a different era, when the companies going public were more established and had proven business models. Today’s companies, in contrast, often have untested business models. What companies disclose about their customers is completely voluntary, so executives can — and do — select data that paints their companies in the best possible light. Their disclosures are bloated, uninformative, and often misleading, and investors lack the data they need to make informed decisions or to hold managers and board members accountable.
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As an alternative to one-size-fits-all disclosure rules, we propose triggered disclosures tailored to the value drivers of the company going public. Under these disclosures, claims about customer value and potential market size must be supported by consistent, objective collection of baseline data related to those claims. These slimmer, more focused disclosures would provide investors with a better basis for valuing and pricing today’s companies. They also could force founders and managers to tell more realistic stories about their businesses, not fairy tales, while holding them accountable for delivering on their promises.
Disruptions in the IPO Game
As the number of initial public offerings has surged over the last few years, we’ve seen significant changes in both the types of companies seeking to go public and the investor base. Many companies enter the market with large losses and no tangible pathway to profitability. While 80% of the companies that went public between 1980 and 1990 were profitable, only 20% of those going public between 2016 and 2020 were. Companies are also waiting longer to go public — the age of the median company was 12 years in 2020, compared with six years in the 1980s — and spending more time scaling up revenues instead of building profitable business models.
1. For more information on exactly how these disclosures can come together to inform an assessment of overall valuation, see D.M. McCarthy, P.S. Fader, and B.G.S. Hardie, “Valuing Subscription-Based Businesses Using Publicly Disclosed Customer Data,” Journal of Marketing 81, no. 1 (January 2017): 17-35.