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A Guide to Tech IPO B.S.

How to see through the hype of Snapchat’s public offering

(Ringer illustration)
(Ringer illustration)

It’s finally time for the Next Great Tech IPO. Snap Inc. (née Snapchat) has nearly completed the tried-and-true startup hustle of turning an egocentric platform for young people into a billion-dollar public company. The startup is expected to file for its public offering with the Securities and Exchange Commission (SEC) sometime this week, with stock up for sale as soon as March. If you believe Snapchat will not only vanquish Facebook but displace television as the go-to mode of media consumption for young people, buy the stock. If you think the app’s growth is going to stall out thanks to increased competition from Instagram, don’t buy it. If you would like to see a modest return on your investment that yields substantial growth in the long term due to the power of compound interest, invest in index funds.

For those considering buying into Snapchat, or any high-flying tech stock, a word of warning: The deck is stacked against you. The IPO process has been engineered by Wall Street to benefit investment banks and the deep-pocketed investors who keep them in business, often at the expense of less-savvy shareholders who just want to make a financial bet on the popular app of the moment. The Facebook IPO is the most egregious example of this practice in recent times. But understanding a few key finance terms can at least give you a fighting chance to recognize if you’re about to get hosed by the richest people in New York and Silicon Valley simultaneously (again … please invest in index funds). Learn these terms and turn on your bullshit detector when you see them pop up in coverage of Snapchat’s impending IPO.

Institutional Investor

Definition: “A nonbank person or organization that trades securities in large-enough share quantities or dollar amounts that it qualifies for preferential treatment and lower commissions.” (All definitions via Investopedia.)

These are the entities playing pro ball on Wall Street: hedge funds, pensions, mutual funds, insurance companies, and other organizations with lots and lots of money. As of 2010, they own about two-thirds of all public equities. And during an IPO, they often know things that regular folks (known as “retail investors”) don’t. When Facebook went public in 2012, the company revised its revenue projections downward just days before its IPO. According to multiple lawsuits, research analysts at major banks were given a heads-up, and they were able to alert their clients — big institutional investors. Retail investors were never informed, and thus were blindsided when Facebook’s stock tumbled shortly after its IPO due to weak earnings. The suits against Facebook were dismissed, but the fact remains that the most powerful investors can have access to privileged information that doesn’t show up in a company’s corporate filings.

Generally Accepted Accounting Principles (GAAP)

Definition: “A common set of accounting principles, standards, and procedures that companies must follow when they compile their financial statements.”

The SEC requires that public companies disclose their revenues and expenses in a specific way so that investors can accurately compare the performance of different firms. But many companies — especially tech companies — believe this accounting methodology is old hat. While they’re required to disclose profits and losses according to generally accepted accounting principles, they often ask investors to evaluate them using different measures, known as non-GAAP metrics. This allows companies to pretend that certain expenses, such as stock-based compensation for employees, don’t actually affect their bottom line. Twitter has caught flak for this practice, and Tesla was called out by the SEC for focusing too much on the finance-world version of “alternative facts.” Snapchat has always been quiet about its finances, but as a poster child of the unicorn era, it’s probably wildly unprofitable and has likely issued many, many stock options to employees. Expect some smoke and mirrors in its earnings reports — though thanks to increased SEC scrutiny, those attempts may not be as blatant as what older tech companies have attempted.

Risk Factors

Definition: “Something that increases risk or susceptibility.”

Companies can — and do — lie to the press, but lying to the SEC can be a criminal offense. That’s why it’s always good to pore over SEC filings, where companies must be more candid than they are in their marketing. In particular, the “Risk Factors” section of the IPO filing (which must be updated with each annual earnings report) is a treasure trove of real talk from our most powerful corporate institutions. Facebook first acknowledged it could lose teenage users to more youthful platforms like Instagram via a risk factors listing. Twitter admitted 5 percent of its monthly users were fake in the same way. If Snapchat has any deep, dark secrets, they’ll be exposed in this section of the filing.

Nonvoting Shares

Definition: “Shares that do not give the holder voting rights at shareholder meetings.”

Tech IPOs are often about marketing the genius of a company’s founder as well as the viability of its business model. To most effectively leverage that genius, many companies now argue, a founder should be able to retain control over his company even as financial ownership is distributed among shareholders. Hence, we’ve seen the rise of the nonvoting share. Google restructured in 2012 to begin issuing nonvoting shares, and Facebook did the same last year. Snap is reportedly going a step further by selling nonvoting shares the day it goes public. If the structure is indeed put in place, cofounders Evan Spiegel and Bobby Murphy will be able to direct the company as they please without listening to stock owners.

Offering Price

Definition: “The price at which publicly issued securities are made available for purchase by the investment bank underwriting the issue.”

The offering price (or IPO price) is decided the night before a company’s shares hit the market, based on the appetite for the stock by those institutional investors I discussed earlier. Typically, high-volume traders who are clients of the banks organizing the public offering are able to get in at the IPO price. Everyone else has to wait until the stock officially opens for trading. If the bankers have done their jobs properly, the opening price will be higher than the IPO price, ensuring that early shareholders have already made a quick buck.

Lock-up Period

Definition: “A legally binding contract between the underwriters and insiders of a company prohibiting these individuals from selling any shares of stock for a specified period of time.”

Remember that time 50 Cent tried to pump and dump his own penny stock? That’s why company insiders aren’t allowed to do whatever they want to influence a stock’s price. One important stipulation of many IPOs is the lock-up period, which prevents insiders at a newly public firm from selling off their stock for typically about six months. That allows time for outside investors to better understand a business’s finances before its CEO can decide to cut and run. A company’s stock price the day its lock-up period expires is a gut check of employees’ confidence in the firm’s future. When Twitter employees got the chance to sell their shares in 2014, the social network’s stock crashed to an all-time low.

An earlier version of this piece incorrectly stated that lock-up periods were mandated by the SEC; instead, they are voluntary measures that are often written into an IPO.