Uber and Lyft Show What’s Wrong With the IPO Market

(Bloomberg Opinion) -- The impending initial public offering of Uber Technologies Inc. promises to be a monumental event in more ways than one. If all goes as planned, investors — including Uber drivers and fund managers acting on behalf of pensioners and other regular folk — will give the ride-hailing company as much as $9 billion with astonishingly little clue about what they’re getting in return.

This isn’t how the stock market was supposed to work. To restore some discipline, regulators must redefine the rules of the road.

Like many of the “unicorns” that have come to market in recent years — including Lyft, Snap and Pinterest — Uber is asking investors for an act of faith. Its traditionally required disclosures, such as three years of audited financial statements, mostly confirm billions of dollars in annual losses. Beyond that lies the great unknown. Uber’s prospectus offers only the vaguest picture of how it intends to achieve earnings that could justify a valuation of $90 billion or more. It says little about nascent businesses such as scooters and driverless cars that are supposed to drive its growth.

Lack of information will encourage investors to be cautious, you might think. Indeed it should. But a troubling dynamic seems to emerge: the fear of missing out. Big institutional investors buy in to ensure that they won’t fall behind their peers. This gives their customers a bad deal. What’s worse, along the way, the IPO buyers may agree to terms that subvert the whole idea of public ownership of companies.

Consider the resurgence in offerings that give one class of shareholders more voting rights than others. Uber, to its credit, decided against this. But insiders at Facebook, Snap, Lyft and many more have used dual-class structures to retain control while raising money from the public. From 2015 through 2018, 20 percent of all IPOs, and 35 percent of tech IPOs, were designed this way. Initially, the dual-class offering might help founders fulfill their visions, and in that way serve the interests of the second-class owners. But over time this structure is apt to create an entrenched elite that can outvote ordinary investors on just about anything. The evidence shows that this lack of accountability eventually destroys value.

Disclosure and structure of ownership both need some regulatory attention. Specifically, companies going public should be expected to share the metrics they actually use to manage their businesses — including projected targets and strategies for mitigating risks. This needn’t be burdensome, because the companies typically provide such information to their private investors anyway. With the expectation of this disclosure in place, if companies have no such information to offer, outside investors should find it easier to pause before piling in.

There should be limits, too, on the rights investors can sign away. In recent years, some companies — such as Smartsheet and Twilio — have done dual-class issues in which the extra voting rights expire after a certain number of years. These sunset provisions preserve the potential benefits of leaving initial control in the hands of founders, while avoiding the risk of creating a dynastic birthright. That’s a sensible compromise. The Securities and Exchange Commission, or the exchanges it oversees, should make such provisions mandatory.

As home to the world’s largest and deepest capital markets, the U.S. sets standards for the world. SEC Chairman Jay Clayton has said those standards should evolve along with the markets. He’s right, and here’s a chance to follow through.

Editorials are written by the Bloomberg Opinion editorial board.

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