General counsel at emerging-growth companies where executives are considering an initial public offering need to be aware of five offering-related trends that have emerged in the last year.
Changes in the federal securities laws have created a number of new regulatory accommodations for such companies’ IPOs, but, in our experience, companies are not necessarily opting in. While certain trends have emerged, a general counsel’s decision on whether to take advantage of these new accommodations requires a highly deal-specific evaluation.
The Jumpstart Our Business Startups Act (JOBS Act) became law on April 5, 2012. This act significantly changed federal securities laws, by easing regulatory burdens for emerging-growth companies during the IPO process. The JOBS Act defines an emerging-growth company as a company with annual gross revenues of less than $1 billion during its most recently completed fiscal year and a first registered sale of common equity securities that occurred after Dec. 8, 2011.
The offering-related trends are developing in relation to each of the following five changes in federal securities laws under the JOBS act.
1. A confidential submission process: An emerging-growth company may submit its draft IPO registration statement and related amendments for confidential review by the Securities and Exchange Commission (SEC) if it publicly files all confidential submissions with the SEC at least 21 days prior to the roadshow, including when company executives make presentations to potential investors.
This confidential-filing option means SEC review can begin before the emerging-growth company has to disclose publicly its intent to conduct the IPO and sensitive company information. If the company doesn’t find adequate market interest in, or optimal market conditions for, its IPO, the confidential process lets the company withdraw the registration statement and avoid the market stigma associated with a failed offering.
According to SEC staff testimony to a U.S. House of Representatives subcommittee on April 11, approximately 175 companies have taken advantage of the confidential submission process.
An Ernst & Young study released in April, "The JOBS Act: One-Year Anniversary," found that approximately 63 percent of the emerging-growth companies that have filed IPO registration statements to be listed on one of the three major U.S. stock exchanges since enactment of the JOBS Act have taken advantage of the confidential submission process.
General counsel need to think strategically about this option, as competing interests may outweigh its benefits for some companies. For example, an emerging-growth company involved in a dual track IPO/merger-and-acquisition process may prefer instead to publicize its business and attract bidders. Similarly, publicly filing the IPO registration statement may permit a public company parent to discuss the filing publicly in communications with investors and analysts without worrying about fair disclosure issues stemming from Regulation FD.
2. Communications that test the waters: An emerging-growth company or any person authorized to act on its behalf, including an underwriter, may solicit interest in the IPO (orally or in writing) from certain institutional investors, either before or after filing a registration statement. This lets the emerging-growth company test the waters and determine whether there is sufficient institutional-investor interest before incurring the time and expense associated with preparing a registration statement and clearing SEC comments so the IPO roadshow can commence.
However, general counsel at emerging-growth companies should encourage executives to exercise caution with test-the-waters communications. Fraud liability still can attach, and underwriters will want indemnification for any liability associated with the communications.
Moreover, the SEC may issue comments requesting supplemental submission of written test-the-waters communications, in an effort to ensure there is not any uneven information between the communications and the registration statement.
As a result of these considerations, the advisability of test-the-waters communications under this JOBS Act option is deal-specific, based on the need to gauge market interest and investor receptiveness.
3. Scaled disclosures for financial statements: An additional benefit for general counsel to consider is a shorter period for disclosing financial information. An emerging-growth company issuing equity securities may present just two years of audited financial statements (rather than three years) in its IPO prospectus, and it is not required to provide selected financial data for any period before the earliest audited financial statements presented (rather than five years’ worth of such data). This scaled disclosure may save the time of completing an audit and associated costs.
However, in our experience, the substantial majority of emerging-growth companies are not taking advantage of these accommodations. That’s because there’s a benefit in greater disclosure: Presenting an emerging-growth company’s long-term financial and growth trends with three years of audited financials and five years of selected financial data can assist the underwriters in marketing the IPO and can ease liability concerns.
Accordingly, while emerging-growth companies may save time and money under the scaled financial statement accommodations, marketing and liability concerns generally have outweighed these benefits.
4. Scaled disclosures for executive compensation: An emerging-growth company may provide scaled executive compensation disclosures in accordance with SEC rules applicable to "smaller reporting companies."
This means an emerging-growth company may exclude the detailed compensation discussion and analysis and some compensation tables required of larger companies. The company also may provide compensation information for three (rather than five) executive officers for the past two (rather than three) years.
Unlike historical financial statements, marketing and liability concerns are not as prevalent for executive compensation information, which in our experience has led to a majority of emerging-growth companies taking advantage of these accommodations.
5. Transition period for new accounting standards: Emerging-growth companies are not required to comply with any new or revised financial accounting standard issued by the Financial Accounting Standards Board to its Accounting Standards Codification after April 5, 2012, until the standard applies to private companies.
This gives an emerging-growth company a longer transition period when there is a different effective date for an accounting standard specified for private companies.
Although the transition period may save an emerging-growth company time and money on compliance, a majority of such companies don’t rely on this accommodation. Concerns arise that their data may not be comparable to that of other public peer companies.
An emerging-growth company may take an à la carte approach and choose to take advantage of some, all or none of the JOBS Act’s IPO-related regulatory accommodations. However, market trends have emerged based on practical considerations, as emerging-growth companies and underwriters consider whether to take advantage of these accommodations.
General counsel need to consider the circumstances of each IPO when deciding whether the benefits associated with these accommodations trump deal-specific marketing, liability and other considerations.