3 Reasons Twitter's IPO Shouldn't Thrill Average Investors

Thanks to the JOBS Act, you may want to tag this initial public offering #riskybusiness. Here's why:

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Twitter Seeks to Avoid Facebook's IPO Stumble With Its Own Debut
Bloomberg via Getty Images
Ever since Facebook (FB) went public last year, investors have expected Twitter to follow suit. Last week, would-be Twitter buyers got their wish, as the company announced it was going public.

The company's method of making the announcement wasn't all that surprising -- Twitter tweeted it. Yet one key fact marked a big change to the IPO process: Investors didn't get access to the IPO filing that companies have to submit to the SEC to get approval to go public. Instead, Twitter took advantage of new legal provisions allowing it to keep its IPO filing on Form S-1 confidential.

This less-public method for launching a public offering came from the Jumpstart Our Business Startups Act. Many of the provisions of the JOBS Act allow would-be public companies to prepare for their IPOs differently from how they have in the past -- differences that have major implications for IPO investors seeking to make informed decisions about whether to buy shares of companies that are coming public.

1. Institutional Investors Will Get a New Edge

Ordinary investors already suffer from substantial disadvantages in the IPO process. Many underwriting brokers reserve shares of the most-popular IPOs for their select customers, locking out many small investors entirely. As a result, ordinary investors often have to resort to buying shares on the open market after the initial offering, which can involve paying a big premium to the IPO price.

Under the JOBS Act, institutional and other preferred customers will get another advantage. Companies considering an IPO will be able to meet with what the law calls qualified institutional buyers to get a sense of their interest in buying shares. That will give those accredited investors and institutions more potential advance notice of a coming IPO, giving them more time to research and investigate the company before the general public even knows an IPO is coming.

2. Expect More Speculation Based on Fewer Facts

High-profile IPOs create a lot of hype, especially when the companies involved are in hot sectors of the market. Now that Facebook has finally recovered from its post-IPO collapse and climbed comfortably above its offering price, social-media stocks are hot again. Twitter couldn't have timed its IPO better to get maximum attention from investors.

But, without access to Twitter's SEC filing, the professional analysts, journalists, and other commentators whose job it is to help educate investors about the coming initial public offering will have far fewer hard facts at their disposal. Instead, they'll have to turn to less reliable information about the company and its business prospects, potentially creating misleading impressions about the company that will only be rebutted once the SEC filing is made public. Moreover, they'll have less time to critique and challenge Twitter's filing after the confidentiality period ends.

In addition, the quality of information won't be as good even once it becomes public. For instance, the JOBS Act allows companies to go public with just two years of financial data, rather than the three to five years of information previously required. In addition, companies are allowed to offer streamlined disclosures about executive compensation and can use an extended phase-in period to start following guidelines on internal controls.

All told, the changes will leave you needing to be even more careful to avoid letting hype affect your judgment.

3. Many Companies Will Use IPO Alternatives to Raise Capital

One revolutionary move the JOBS Act made was to remove a ban on advertising offerings of private securities. As long as a company can demonstrate that all of its purchasers qualify as accredited investors -- people with high incomes or net worth, as well as certain institutions -- it can solicit and advertise to such purchasers.

Moreover, under what's known as the crowdfunding exemption, companies can solicit investment from non-accredited investors. Companies can raise up to $1 million annually, with limits on the amount that any one person can invest based on income and net worth figures. Although companies using the crowdfunding exemption have to file information with the SEC, it's much less extensive than what a full IPO filing would require.

Be Careful Out There

The JOBS Act made it a lot easier for companies from Twitter to tiny local businesses to raise capital. But the new rules also come with traps for unwary investors. Only by exercising caution can you avoid investing in problematic businesses and make smart moves with your money.

You can follow Motley Fool contributor Dan Caplinger on Twitter @DanCaplinger or on Google+. He has no position in any stocks mentioned. The Motley Fool recommends Facebook. The Motley Fool owns shares of Facebook.

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