According to a post this week on SFGate, several companies, including LinkedIn, Demand Media, and Groupon, made pre-IPO profitability claims that turned out to be not quite as bright as the companies reported before they went public -- and hence became subject to financial reporting regulations.
This illustrates a clear problem with the current pre-IPO rules -- one which the SFGate post points out is even more troubling in light of proposed legislation to actually loosen restrictions on companies seeking pre-IPO dollars. The proposed measures include raising the maximum number of non-employee investors from 500 to 2,000 before going public and allowing more crowd-sourced funding.
It's widely known that there is a grey market for pre-IPO stock. In fact, I wrote about this issue back in January, when Facebook was reportedly being valued at $50 billion by Goldman Sachs.
I complained in that post about the danger of this approach, mostly because you have a grey stock market complete with investment bankers, yet no government oversight. What’s more, these companies and the investment banks selling this stock are free to make all kinds of claims without anyone checking the books to see if they're true, and unfortunately, the veil doesn't come off until the company is public.
And honestly, what's the incentive for them to be completely truthful? The more they embellish the financial picture, the higher the price goes.
The trouble with the grey market and the proposals before Congress to reduce restrictions further is that they make the stock-buying process more of a hit-or-miss proposition than it needs to be, and when the books open, it's, “Mea culpa; turns out we weren't quite as profitable as we thought.” But this isn't an intelligent way to set market value.
Of course, nobody is forcing anybody to buy anything. But who doesn't want to be in on the ground floor of the next big thing before it takes off? Still, if you're making that bet on bad information, it's putting lots of money into these companies' pockets -- and providing little recourse when the truth finally comes out.
I understand that the government is trying to loosen restrictions that hold back small companies from growing more quickly and adding more jobs to an economy desperately in need of them, but I think the powers that be need to be careful how they tread here.
Letting companies buy and sell stock before they are public to raise funds for their employees is risky enough in my view, but reducing restrictions on investments in pre-IPO companies only puts a bigger burden of risk on investors -- all outside the view of government watchdogs.
It seems to me that, in this instance, we need more oversight, not less. We've seen that, when left to their own devices, these companies are going to exaggerate to increase the value of their organizations.
If we truly want truth in investing, and we absolutely should, we don't want to make it easier for companies to continue to do that.
— Ron Miller is a freelance technology journalist, blogger, FierceContentManagement editor, and contributing editor at EContent magazine.