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Well we didn't quite expect that.
The response to yesterday's announcement that The Motley Fool would be going public was overwhelming. More than 18,400 emails poured in, most "Fooled" by the prank. The Major Announcement From David and Tom Gardner has more than 1,200 recommendations. Our Creative Accountant job posting drew four (!) earnest applicants.
Thanks to Fools everywhere for your overwhelming response! We hope you enjoyed the joke as much as we did devising our short-lived IPO.
We are not, in fact, going public. There is nothing inherently wrong with going public, but we wanted to shine a light on two worrisome trends among new IPOs -- trends that the new JOBS Act could likely exacerbate.
1. Poor stewardship
With any IPO, investors should ask: Who is running the company? Will going public change the way the business is run?
When Amazon.com (Nasdaq: AMZN ) went public in 1997, founder/CEO Jeff Bezos issued a "manifesto" to prospective shareholders in which he made clear that for him, "it's all about the long term." He warned shareholders that Amazon may "make decisions and weigh tradeoffs differently than some companies" and urged them to make sure that a long-term approach "is consistent with your investment policy."
It's true that many companies -- including Amazon and, very soon, Facebook -- go public as a way of providing liquidity to their investors. There's nothing wrong with that, per se; what's troubling is when a presumed "liquidity event" fundamentally changes the way a business is run.
Bezos said Amazon would be "working to build something important, something that matters to our customers, something that we can tell our grandchildren about."
Contrast that stewardship with what was buried in our (fake) Form S-1:
- Our Gordian-knot corporate structure: "As a shareholder of The Motley Fool, you will not be buying shares in the actual company. You will be buying shares of a bank holding company that is the 87% owner of a structured investment vehicle organized in Suzhou. The remaining 13% is owned by Motley Fool employees who will be paid out special preferred dividends in lieu of actual economic interest in operations."
- Nepotism: Our CFO, "Billy" Gardner (who is not a real person, to be clear) is qualified for his position because "as an 8th grader at the prestigious Meadow All Day and Night School, he placed third in the basic arithmetic bee, and just recently passed an online class in Excel."
- Among our listed Risks was a potential inability to "fend off falcon attacks."
- Our core values included "Apathetic," "Deceitful," and "Dreary."
- Our filing held unrealistically optimistic assessments of our strengths, a list of poorly thought-out future business models including a stock-based hourly deal (buy "a $600 share of Apple for just $300"), and projected a ridiculous $15 trillion cash balance in 2025 that would exceed the nation's current GDP.
- We released a hilariously opaque video hyping the IPO loaded with highfalutin business jargon that revealed nothing about our purpose as a business.
- Fairy tales: In addition to normal (so-called GAAP) net income, our prospectus contained an unjustified, make-believe metric called "Foolish net income" that was more than double our real net income.
Lest you think this last joke was pulled from thin air, consider that absurd, highly optimistic metrics were all the rage during the 1990s Internet hype, when companies loudly trumpeted growth in "non-GAAP earnings" and "eyeball" counts.
More recently, critics of the initial Groupon (Nasdaq: GRPN ) IPO led the daily-deal provider to dump its adjusted consolidated segment operating income metric from its amended S-1. That metric stripped out critical costs like marketing expenditures, resulting in basically "profits when subtracting all expenses."
This accounting stuff flies under the radar for many of us, but it can be incredibly important when judging IPOs. (Warren Buffett once quipped that he reads S-1s like some guys read Playboy.)
Another warning sign for Groupon investors came when the company had to restate its fourth-quarter losses because of a "material weakness in its internal controls." That's accounting-speak for "there are major problems with how the company produces its financial information and protects against potential fraud."
Of course, accounting problems aren't unique to fresh IPOs. But newly public companies can put you at greater risk. Insiders, early investors, and investment bankers may be so eager to get the company into public hands that numbers get fudged. And because private companies face much less scrutiny, years of mistakes -- whether honest or not -- can come out of the woodwork after an IPO.
And these dangers are only likely to increase, thanks to the JOBS Act that just passed Congress. The bill weakens investor protections across the board for IPOs. Among other things, it lets most IPOs skip their internal-controls test, allows them to only show two years of audited financial statements, and helps them to clear up accounting issues secretly with the SEC without revealing their existence to investors.
The bottom line is, you want to be sure that a company is ready to be public. Not every company that wants to go public should go public.
Which brings us to issue No. 2 with our April Fool's Day IPO:
2. The wrong motives
Any time you invest in a company, it's critical that management's interests are aligned with yours. That's why it's so imperative for us to understand the real reason a company is going public.
Sometimes companies go public for a perfectly good reason -- say, the need to raise extra capital to grow the business. Other times, insiders and venture-capital or private-equity firms just want to cash out their stakes by dumping companies on the public. That's when you have to be careful you're not getting duped.
From our announcement letter: "In order to guarantee that every Motley Fool member has access to an abundance of shares at that $4.01 price, we two founders will be selling virtually our entire stake in the pre-after-hours market today."
Tom Gardner has repeatedly stated that a core metric he looks at is the amount of insider ownership. It's normal for insiders to sell some stock after a company goes public; they may need to diversify their finances a little. But any time insiders sell off a massive stake, your ears should perk up.
It was recently reported that Zynga's (Nasdaq: ZNGA ) CEO and other insiders are planning to sell 43 million shares (nearly $600 million). Now the man at the top, Mark Pincus, will hold a 35% stake in the company he founded, down slightly from 36.5%. More concerning was Groupon's already-rich founders' decision to sell $870 million (about a fifth) of their own shares to the public at a time when the loss-making deal site could have really used the money.
Keep in mind that when you're buying an IPO, venture-capital or private-equity investors -- and usually insiders -- are selling. And they probably know the company better than we do.
Other warning signs from our S-1:
- Unhinged executive compensation: After selling off his stake, Tom Gardner would receive a ridiculous package that included $2.5 million per year for security, 4 million shares of stock, and 1 million shares per year for life!
- Our board of celebrities, potentially dodgy characters, and "yes-men": The people allegedly evaluating our management team to ensure they're doing right by shareholders included an unknown investment banker, a former member of Motley Crue, and a supposed billionaire friend of David Gardner named Donald Dump. The board should have integrity, independence, and knowledge about our industry.
- Bizarro auditor: Instead of a reputable firm, we went with the no-name, conflicted Coopers & Andersen, whose qualifications included playing high school football alongside Tom Gardner. In an alarming conflict of interest, we also used them as our investment banker, so they actually would stand to gain from fake financials.
- Our weird corporate structure left shareholders holding strange toxic assets but no ownership stake in The Motley Fool. The gimmick of selling a shell company that has a service contract with a real company is real. It's been popular with lots of publicly listed Chinese firms that need to skirt Chinese foreign ownership laws, and it's important to be aware of. It also has no legitimate use for companies with mostly American operations (like our IPO).
Though we exaggerated many of the red flags above for Foolishness, all of them are problems we've seen in actual public companies.
IPOs are usually structured to disproportionately benefit insiders, investment banks, and their favored clients. Some companies -- Google (Nasdaq: GOOG ) and Sam Adams-maker Boston Beer (NYSE: SAM ) come to mind -- managed to buck the trend when they went public, but they're the exception.
The bottom line is that we need to learn about a company that is going public. Why is it selling shares? Are the interests of the people running the company aligned with yours? Does the company have long-term competitive strengths? These are all good questions to ask.
Take your time -- there's no need to rush out and buy a hyped-up IPO on the first day. It's wiser to wait a while until you really understand the business and feel comfortable owning it for the long term.
From all of us at Fool Global Headquarters in Alexandria, Va., we hope you enjoyed the joke -- happy April Fool's!