LIFE WILL FIND A WAY
– John Hammond, Jurassic Park (1997)
It’s amazing how many important ideas can be gleaned from
a Hollywood blockbuster. “Life will find a way” — or stated
differently, you have to do what you have to do in order
to survive, grow, and prosper — is just one of them. For
technology and life sciences companies intent on finding the
most reliable source of attractively priced equity capital to
grow and prosper, an initial public offering is often the best
2014 and 2015 to date have been the most receptive years
for IPOs in more than ten years, particularly for tech and life
sciences IPOs, but that doesn’t mean that the capital markets
always have been — or always will be — receptive to IPOs. In
fact, market windows of opportunity tend to open and close
with little advance notice and with considerable frequency.
But the fact is that year in and year out, for several decades,
IPOs have been the financing gold standard for companies
that aspire to grow.
Over time, alternatives to IPOs have arisen and many
companies have elected to stay private longer, often with the
assistance of venture capital and private equity firms and the
growth of private secondary sale markets. M&A opportunities
also can look very attractive to companies that cannot go
public and either have outgrown — or worn out their welcome
with — their existing financing sources. Despite the existence
of alternatives, many companies will, when opportunity
knocks, elect to go public, an option made more attractive
by the 2012 Jumpstart Our Business Startups Act (JOBS
Act). So even if the knock is occasionally inaudible, it’s worth
thinking about how best to prepare for an IPO.
296 U.S. IPOs completed in 2014 accounting for $85.64 billion
in aggregate gross proceeds, and 110 U.S. IPOs completed in
2015 through June, accounting for $19.02 billion in aggregate
THE EMERGING GROWTH COMPANY
The JOBS Act created a new class of issuer: the emerging growth company
(EGC). An EGC is defined as an issuer with total annual gross revenue of
less than $1 billion during the most recent fiscal year. Most companies
considering or preparing for an IPO will qualify for EGC status, which
will allow them to take advantage of a number of benefits, both during the
offering period and once public. An EGC can have as long as five years to
take advantage of such status.
THE OFFERING PROCESS
The public offering process is divided into three periods. The pre-filing
period between determining to proceed with a public offering and the
actual SEC filing of the registration statement is the “quiet period” and
subject to potential limits on public disclosure relating to the offering.
The waiting or pre-effective period between the SEC filing date and
the effective date of the registration statement is when the company may
make oral offers, but may not enter into binding agreements to sell the
offered security. The final period is the post-effective period between
effectiveness and completion of the offering.
The Registration Statement
A registration statement contains the prospectus, which is the primary
selling document, as well as other required information, written
undertakings of the issuer, and the signatures of the issuer and the
majority of the issuer’s directors. It also contains exhibits, including basic
corporate documents and material contracts. U.S. companies generally file
a registration statement on Form S-1. Most non-Canadian foreign private
issuers use a registration statement on Form F-1, although other forms
may be available. There are special forms available to certain Canadian
The prospectus describes the offering terms, the anticipated use of
proceeds, the company, its industry, business, management, and
ownership, and its results of operations and financial condition. Although
it is principally a disclosure document, the prospectus also is crucial to the
selling process. A good prospectus sets forth the “investment proposition.”
As a disclosure document, the prospectus functions as an “insurance
policy” of sorts in that it is intended to limit the issuer’s and underwriters’
potential liability to IPO purchasers. If the prospectus contains all SECrequired
information, includes robust risk factors that explain the risks
that the company faces, and has no material misstatements or omissions,
investors will not be able to recover their losses in a lawsuit if the price
of the stock drops following the IPO. A prospectus should not include
“puffery” or overly optimistic or unsupported statements about the
company’s future performance. Rather, it should contain a balanced
discussion of the company’s business, along with a detailed discussion of
risks and operating and financial trends that may affect the company's
results of operations and prospects.
Companies organized as S
corporations, partnerships, or LLCs
taxed as partnerships, which do not
pay federal income tax at the entity
level, should consider the potential tax
implications of an IPO.
For S corporations, an IPO generally
terminates S status for federal
income tax purposes. The former S
corporation is generally taxed as a C
corporation and, as a result, will now
be subject to a corporate level tax.
Going public will also result in the
S corporation having two short tax
years—one, the S short year, which
ends the day before the IPO, and the
other, the C short year, which begins
on the IPO date. In general, income
and loss of the S corporation for the
entire year in which the IPO occurs
must be allocated between the S
and C short years on a daily pro-rata
basis. This could produce inequities.
If the S corporation is a cash method
taxpayer, conversion to a C corporation
generally requires it to use the accrual
method of accounting. This could
lead to adjustments under Section
481 of the Internal Revenue Code
to avoid duplication or omission of
income items or deductions. These
adjustments may be taxable income to
the former S corporation shareholders.
To avoid these potential problems, the
S shareholders may elect a “closing
of the books” allocation under certain
Shareholders of the former S
corporation may want to receive
distributions from the S corporation
to cover tax obligations attributable
to flow-through items for the S short
year. If such tax distributions are made
after the IPO, it may be taxable to the
former S corporation shareholders.
A partnership will generally lose its
pass-through tax status on conversion
to a C corporation in connection with
SEC rules set forth a substantial number of specific disclosures required
to be made in the prospectus. In addition, federal securities laws,
particularly Rule 10b-5 under the Securities Exchange Act of 1934,
require that documents used to sell a security contain all the information
material to an investment decision and do not omit any information
necessary to avoid misleading potential investors. Federal securities
laws do not define materiality; the basic standard for determining
whether information is material is whether a reasonable investor would
consider the particular information important in making an investment
decision. That simple statement is often difficult to apply in practice.
Although the JOBS Act provides for certain reduced disclosure
requirements for EGCs, an issuer should still be prepared for a timeconsuming
drafting process, during which the issuer, investment bankers,
and their respective counsel work together to craft the prospectus
The Pre-Filing Period
The pre-filing period begins when the company and the underwriters
agree to proceed with a public offering. During this period, key
management personnel will generally make a series of presentations
covering the company’s business and industry, market opportunities,
and financial matters. The underwriters will use these presentations
as an opportunity to ask questions and establish a basis for their “due
From the first all-hands meeting forward, all statements concerning
the company should be reviewed by the company’s counsel to ensure compliance with applicable rules.
Communications by an issuer more than 30 days prior to filing a registration statement are permitted as long as
they do not reference the securities offering. A statement made within 30 days of filing a registration statement
that could be considered an attempt to pre-sell the public offering may be considered an illegal prospectus,
creating a “gun-jumping” violation. This might result in the SEC’s delaying the public offering or requiring
prospectus disclosures of these potential securities law violations. Press interviews, participation in investment
banker-sponsored conferences, and new advertising campaigns are generally discouraged during this period.
Under the JOBS Act, however, an EGC (or its designated representatives) may engage in “test-the-waters”
communications with certain investors (known as Qualified Institutional Buyers, or QIBs, and Institutional
Accredited Investors) to gauge interest in the offering during both the pre-filing period and after filing. The
company should consult with its counsel and the underwriters before engaging in any “test-the-waters”
communications. The SEC will also ask to review copies of any written materials used for this purpose.
In general, at least four to six weeks will pass between the distribution of a first draft of the registration statement
and its filing with or confidential submission to the SEC. To a large extent, the length of the pre-filing period will
be determined by the amount of time necessary to obtain the required financial statements.
The JOBS Act allows an EGC to submit drafts of the registration statement to the SEC for its review on a confidential
basis. This allows the company to work through the SEC comment process (discussed below) without the glare of
publicity and without competitors becoming aware of the proposed offering. The confidentially submitted registration
statement should be a materially complete submission, as the SEC might decide not to review an incomplete registration
statement, slowing down the offering process. Furthermore, the company must publicly file the confidentially submitted
registration statement, along with all amendments, at least 21 days before the start of any “road show.”
Tech and Healthcare companies represent the
largest segments of IPOs.
an IPO. Revenue Ruling 2004-59,
2004-24 IRB 1050, sets forth the
tax consequences of a partnership
converting to a C corporation under
a state law formless conversion act.
Such a conversion will be deemed
a tax-free transaction in which
the partnership first contributes
its assets and liabilities to a C
corporation in exchange for stock of
the C corporation, and immediately
after, the partnership liquidates
and distributes the stock of the C
corporation to its partners. Although
this deemed transaction is generally
tax free, gain may be recognized if, at
the time of the formless conversion,
the partnership’s liabilities exceed
the tax basis.
Careful tax planning is recommended
to address these concerns.
NYSE NASDAQ GLOBAL MARKET1
Minimum Number of
400 round lot holders Same
Minimum Number of
Publicly Held Shares
* Shares held by directors, officers, or immediate families and
other concentrated holdings of 10% or more are excluded.
Same, with similar exclusions.
Market Value of
Publicly Held Shares
Generally $40M* Any of :
• Income Standard: $8M;
• Equity Standard: $18M;
• Market Value Standard: $20M;
• Total Assets/Total Revenue
Minimum per Price
At least $4.00 at initial listing Same
Minimum Number of
N/A Four; unless company qualifies
for listing under the Income or
Equity Standards, which each
For U.S. companies, one of the following:
• Earnings Test: Pre-tax earnings from continuing operations,
subject to adjustments, must total $100M for the last three fiscal
years (two years if company is an EGC), including a minimum of
$25M in each of the two most recent fiscal years; or
• Valuation/Revenue with Cash Flow Test: (1) $500M in global
market cap, (2) $100M in revenues during the most recent
12-month period, and (3) $100M aggregate adjusted cash flows
for the last three fiscal years with at least $25M in each of the two
most recent fiscal years; or
• Pure Valuation/Revenue Test: (1) $750M in global market cap and
(2) $75M in revenues during most recent fiscal year; or
• Affiliated Company Test: (1) $500M in global market
capitalization, (2) parent or affiliated company is a listed company
in good standing, (3) parent or affiliated company retains control
of, or is under common control with, the entity; and (4) operating
history of 12 months.
For non-U.S. companies, one of the following:
• Earnings Test: Pre-tax earnings from continuing operations,
subject to adjustments, must total (1) $10M for the last three
fiscal years, including a minimum of $2M in each of the two most
recent fiscal years and positive amounts in all three years, or
(2) if there is a loss in the third fiscal year, $12M for the last three
fiscal years, including a minimum of $5M in the most recent
fiscal year and $2M in the next most recent fiscal year; or
• Global Market Capitalization Test: $200M in global market
capitalization (existing public companies must meet the minimum
global market capitalization for a minimum of 90 consecutive
trading days prior to listing on the NYSE).
One of the following:
• Income Standard: (A) $1M in
annual pre-tax income from
continuing operations in most
recently completed fiscal year
or in two of the three most
recently completed fiscal
and (B) stockholders’ equity
of $15M; or
• Equity Standard:
Stockholders’ equity of $30M;
• Market Value Standard: N/A
for IPO; or
• Total Assets/Total Revenue
Total assets + total revenue
of $75M each for the most
recently completed fiscal
year or two of the three most
recently completed fiscal
NYSE VS. NASDAQ GLOBAL MARKET PRINCIPAL QUANTITATIVE LISTING REQUIREMENTS
The following table summarizes the principal quantitative listing requirements; there are also qualitative requirements.
1 The other tiers (Nasdaq Global Select Market and Nasdaq Capital Market) have similar requirements.
Foreign private issuers benefit
from less onerous securities law
requirements. A “foreign private
issuer” (FPI) is a foreign issuer, other
than a foreign government, that meets
• No more than 50% of its outstanding
voting securities are directly/indirectly
owned of record by U.S. residents.
• Less than a majority of its executive
officers or directors are U.S. citizens
• No more than 50% of its assets are
located in the United States.
• Its business is administered principally
outside the United States.
FPIs receive certain accommodations,
• Interim (rather than quarterly) reporting
based on home country and stock
• Exemption from proxy rules and from
Section 16 insider reporting and short
swing profit recovery provisions.
• Aggregate (rather than individual)
executive compensation disclosure, if
permitted by home country.
• Offering document financial
statements updated semi-annually
• No obligation to apply U.S. GAAP,
although reconciliation of significant
variations may be required.
• Form 6-K filings furnished not filed; no
• No CEO/CFO certifications of interim
• Certain corporate governance
requirements are satisfied by home
• Pre-marketing IPO SEC filings may be
An FPI can also be an EGC. In 2014,
FPIs represented 19% of all EGC IPO
registration statements filed, and in the
first half of 2015, FPIs represented 16% of
all EGC IPO registration statements filed.
Like U.S. companies, FPIs are
subject to the Sarbanes-Oxley Act
requirements governing internal
control over financial reporting.
The Waiting Period
Responding to SEC Comments on the Registration Statement
The SEC targets 30 calendar days from the registration statement filing or confidential submission date to
respond with comments. It is not unusual for the first SEC comment letter to contain a significant number of
comments that the issuer must respond to both in a letter and by amending the registration statement. After
the SEC has provided its initial set of comments, it is much easier to determine when the registration process is
likely to be completed and when the offering can be made. In most cases, the underwriters prefer to delay the
offering process and to avoid distributing a preliminary prospectus until the SEC has reviewed at least the first
filing and all material changes suggested by the SEC staff have been addressed.
Preparing the Underwriting Agreement, the Comfort Letter, and Other Documents
During the waiting period, the company, the underwriters and their counsel, and the company’s independent
auditor will negotiate a number of agreements and other documents, particularly the underwriting agreement
and the auditor’s “comfort letter.”
Pursuant to the underwriting agreement the company agrees to sell, and the underwriters agree to buy,
the shares and then sell them to the public; until this agreement is signed, the underwriters do not have an
enforceable obligation to acquire the offered shares. The underwriting agreement is not signed until the offering
is priced. In the typical IPO, the underwriters will have a “firm commitment” to buy the shares once they sign
the underwriting agreement.
Underwriters’ counsel will submit the underwriting agreement, the registration statement, and other offering
documents for review to the Financial Industry Regulatory Authority (FINRA), which is responsible for
reviewing the terms of the offering to ensure that they comply with FINRA requirements. An IPO cannot proceed
until the underwriting arrangement terms have been approved by FINRA.
In the “comfort letter,” the auditor affirms (1) its independence from the issuer and (2) the compliance of
the financial statements with applicable accounting requirements and SEC regulations. The auditor also will
note period-to-period changes in certain financial items. These statements follow prescribed forms and are
usually not the subject of significant negotiation. The underwriters will also usually require that the auditor
79% of EGC IPOs have made confidential submissions since
enactment of the JOBS Act, through the first half of 2015.
undertake certain “agreed-upon” procedures, which can be subject
to significant negotiation, in which it compares financial information
in the prospectus (outside of the financial statements) to the issuer’s
accounting records to confirm its accuracy.
Marketing the Offering
During the waiting period, marketing begins. The only written
sales materials that may be distributed during this period are the
preliminary prospectus, additional materials known as “free writing
prospectuses,” which must satisfy specific SEC requirements, and any
“test-the-waters” communications described above. While binding
commitments cannot be made during this period, the underwriters
will receive indications of interest from potential investors, indicating
the price they would be willing to pay and the number of shares they
would purchase. Once SEC comments are resolved, or it is clear that
there are no material open issues, the issuer and underwriters will
undertake a two- to three-week “road show,” during which company
management will meet with prospective investors. As noted above, the
company must publicly file the confidentially submitted registration
statement, along with any amendments, at least 21 days before the
beginning of the road show.
Once SEC comments are cleared and the underwriters have assembled
indications of interest for the offered securities, the company and its
counsel will request that the SEC declare the registration statement
“effective” at a certain date and time, usually after the close of business
of the U.S. securities markets on the date scheduled for pricing the
The Post-Effective Period
Once the registration statement has been declared effective and the
offering has been priced, the issuer and the managing underwriters
execute the underwriting agreement and the auditor delivers the final
comfort letter. This occurs after pricing and before the opening of
trading on the following day. The company then files a final prospectus
with the SEC that contains the final offering information.
On the third or fourth business day following pricing, the closing
occurs, the shares are issued, and the issuer receives the proceeds.
The closing completes the offering process. Then, for the following 25
days, aftermarket sales of shares by dealers must be accompanied by
the final prospectus or a notice with respect to its availability. If during
this period there is a material change that would make the prospectus
misleading, the company must file an amended prospectus.
Most companies must make legal and operational changes before
proceeding with an IPO. A company cannot wait to see if its IPO is
likely to be successful prior to implementing most of these changes.
Many corporate governance matters and federal securities law
requirements (including Sarbanes-Oxley), as well as applicable
AN OUNCE OF
Underwriters and their counsel
will focus on your company’s
intellectual property portfolio.
Prepare in advance for the IPO
IP diligence process. Speak with
your IP counsel. Underwriters
generally have a few areas of
Strength of Patent Position
Do your patents cover your
commercial products? Are your
patent claims easy to design
around? Are your patents invalid
or otherwise defective? And do
you have a sufficient period of
Are there any third-party
patents or other IP that pose
potential infringement risks, and
if so, what is your strategy for
mitigating those risks?
Does your company own or have
all rights to license and use its
patents, software, and other
IP? Do any inventors have an
obligation to assign to another
entity or company? And is IP
ownership generally clean?
Advance preparation will not
only demonstrate a level of
sophistication and commitment
to the IPO process, but will also
help you avoid potential pitfalls
along the way. Ask at the outset
about the type of IP opinion that
will be requested at closing.
securities exchange requirements, must be met when the IPO
registration statement is filed, or the issuer must commit to satisfy
them within a set time period.
A company proposing to list securities on an exchange should review
the governance requirements of each exchange, as well as their
respective financial listing requirements, before determining which
exchange to choose. An issuer must also address other corporate
governance matters, including board structure, committees and
member criteria, related party transactions, and director and officer
liability insurance. The company should undertake a thorough review
of its compensation scheme for its directors and officers as well,
particularly its use of equity compensation.
Primary and Secondary Offerings
An IPO may consist of the sale of newly issued shares by the company
(a “primary” offering), or a sale of already issued shares owned by
shareholders (a “secondary” offering), or a combination of these.
Underwriters may prefer a primary offering because the company
will retain all of the proceeds to advance its business. However, many
IPOs include secondary shares, either in the initial part of the offering
or as part of the 15% over-allotment option granted to underwriters.
Venture capital and private equity shareholders view a secondary
offering as their principal realization event. A company must also
consider whether any of its shareholders have registration rights that
could require it to register shareholder shares for sale in the IPO.
“Cheap stock” describes options granted to employees of a pre-IPO
company during the 18-24 months prior to the IPO where the exercise
price is deemed (in hindsight) to be considerably lower than the fair
market value of the shares at grant date. If the SEC determines (during
the comment process) that the company has issued cheap stock, the
company must incur a compensation expense that will have a negative
impact on earnings. The earnings impact may result in a significant onetime
charge at the time of the IPO as well as going-forward expenses
incurred over the option vesting period. In addition, absent certain
limitations on exercisability, an option granted with an exercise price
that is less than 100% of the fair market value of the underlying stock
on the grant date will subject the option holder to an additional 20% tax
pursuant to Section 409A of the Internal Revenue Code.
The dilemma that a private company faces is that it is unable to
predict with certainty the eventual IPO price. A good-faith pre-IPO fair
market value analysis can yield different conclusions when compared
to a fair market value analysis conducted by the SEC in hindsight
based on a known IPO price. There is some industry confusion as to
the acceptable method for calculating the fair market value of nonpublicly
traded shares and how much deviation from this value is
permitted by the SEC. Companies often address this “cheap stock”
concern by retaining an independent appraiser to value their stock
Directors’ and officers’ (D&O) insurance
protects directors and officers from
losses resulting from their service to a
company. Typically, a D&O insurance
policy maintained by a private company
will not provide coverage for securities
offerings, such as an IPO, and will not
contain the coverage or provisions
applicable to public companies.
A company that is going public should
review its existing D&O coverage and
seek additional coverage. A public
company’s D&O insurance program
generally contains three types of
coverage in one policy:
covers D&Os’ costs and expenses for
defense and payouts under settlements
and judgments where indemnification
may not otherwise be available, for
example, due to state law limitations.
provides reimbursement to the
company if it has indemnified D&Os
in connection with a claim. Side B
coverage is the most commonly
invoked portion of a D&O policy.
known as “entity coverage,” covers
the company itself. For public
companies, coverage usually includes
only claims resulting from alleged
securities law violations.
Most D&O insurance policies have
complicated applications and impose
compliance obligations upon the
company. False statements in the
application or failure to comply with
these obligations can result in the
loss of coverage if any substantial
liabilities arise. As a result, a company
will want to be certain that it has
one or more employees who have
appropriate experience preparing
the application and who will assume
compliance responsibilities once the
policy is effective.
The Big Four accounting firms continue to be the most active
accounting firms involved in IPOs.
In 2014, 91.0% of IPOs had a 180-day lock-up period, and in the
first half of 2015, 84.5% of IPOs had a 180-day lock-up period.
options. However, it now appears that most companies are using one
of the safe-harbor methods for valuing shares prescribed in the Section
Governance and Board Members
A company must comply with significant corporate governance
requirements imposed by the federal securities laws and regulations
and the regulations of the applicable exchanges, including with regard
to the oversight responsibilities of the board of directors and its
committees. A critical matter is the composition of the board itself.
All exchanges require that, except under limited circumstances, a
majority of the directors be “independent” as defined by both the
federal securities laws and regulations and exchange regulations. In
addition, boards should include individuals with appropriate financial
expertise and industry experience, as well as an understanding of
risk management issues and public company experience. A company
should begin its search for suitable directors early in the IPO process
even if it will not appoint the directors until after the IPO is completed.
The company can turn to its large investors as well as its counsel and
underwriters for references regarding potential directors.
THE UNDERWRITER’S ROLE
A company will identify one or more lead underwriters that will be
responsible for the IPO. A company chooses an underwriter based
on its industry expertise, including the knowledge and following of
its research analysts, the breadth of its distribution capacity, and its
overall reputation. A company should consider the underwriter’s
commitment to the sector and its distribution strengths. For example,
does the investment bank have a particularly strong research
distribution network, or is it focused on institutional distribution? Is
its strength domestic, or does it have foreign distribution capacity? The
company may want to include a number of co-managers in order to
balance the underwriters’ respective strengths and weaknesses.
A company should keep in mind that underwriters have at least two
conflicting responsibilities: to sell the IPO shares on behalf of the
company and to recommend to potential investors that the purchase
of the IPO shares is a suitable and a worthy investment. In order to
better understand the company — and to provide a defense in case the
underwriters are sued in connection with the IPO — the underwriters
and their counsel are likely to spend a substantial amount of time
performing business, financial, and legal due diligence in connection
with the IPO, and making sure the prospectus and any other
offering materials are consistent with the information provided. The
underwriters will market the IPO shares, set the price (in consultation
with the company) at which the shares will be offered to the public,
and, in a “firm commitment” underwriting, purchase the shares from
the company and then re-sell them to investors. In order to ensure an
orderly market for the IPO shares, after the shares are priced and sold,
the underwriters are permitted in many circumstances to engage in
certain stabilizing transactions to support the stock.
The Sarbanes-Oxley Act of 2002
requires publicly traded companies
to implement corporate governance
policies and procedures that are
intended to provide minimum
structural safeguards to investors.
Certain of these requirements are
phased in after the IPO, and some
requirements have been made less
burdensome for EGCs under the
Key provisions include:
• Requirements related to the
company’s internal control over
financial reporting, including
(1) management’s assessment
and report on the effectiveness
of the company’s internal
controls on an annual basis,
with additional quarterly review
obligations, and (2) audit of the
company’s internal controls
by its independent registered
public accounting firm. However,
a company will not need
to comply with the auditor
attestation requirement as long
as it qualifies as an EGC.
• Prohibition of most loans to
directors and executive officers
(and equivalents thereof).
• Certification by the CEO and CFO
of a public company of each
SEC periodic report containing
• Adoption of a code of business
conduct and ethics for directors
and senior executive officers.
• Required “real time” reporting of
certain material events relating
to the company’s financial
condition or operations.
• Disclosure of whether the
company has an “audit
committee financial expert”
serving on its audit committee.
FINANCIAL REPORTING AND ACCOUNTING
The JOBS Act significantly reduced the extent of financial reporting required in an IPO registration statement.
An EGC must include audited financial statements for the last two fiscal years (three years for a non-EGC);
financial statements for the most recent fiscal interim period, comparative with interim financial information for
the corresponding prior fiscal period (which may or may not be audited depending on the circumstances); and
income statement and condensed balance sheet information for the last two years (five years for a non-EGC) and
interim periods presented.
Early on, the company should identify any problems associated with providing the required financial statements
in order to seek necessary accommodation from the SEC. For a domestic company, these statements must be
prepared in accordance with U.S. GAAP, as they will be the source of information for “Management’s Discussion
and Analysis of Financial Condition and Results of Operations” (MD&A). The SEC will review and comment on
the financial statements and the MD&A. The SEC’s areas of particular concern are:
To provide for an orderly market and to prevent existing shareholders
from dumping their shares into the market immediately after the IPO,
underwriters will require the issuer as well as directors, executive officers,
and large shareholders (and sometimes all pre-IPO shareholders) to
agree not to sell their shares of common stock, except under limited
circumstances, for a period of up to 180 days following the IPO, effectively
“locking up” such shares. Exceptions to the lock-up include issuances of
shares in acquisitions and in compensation-based grants. Shareholders
may be permitted to exercise existing options (but not sell the underlying
shares), transfer shares to family trusts, and sometimes to make specified
private sales, provided that the acquiror also agrees to be bound by the
lock-up restrictions. These lock-up exceptions will be highly negotiated.
In connection with an IPO, the issuer may want the option to “direct”
shares to directors, officers, employees and their relatives, or specific
other designated people, such as vendors or strategic partners. Directed
share (or “family and friends”) programs, or DSPs, set aside stock
for this purpose, usually 5-10% of the total shares offered in the IPO.
Participants pay the initial public offering price and generally receive freely
tradable securities although they may be subject to the underwriter’s lockup.
The DSP is not a separate offering by the company but is part of the
plan of distribution of the IPO shares and must be sold pursuant to the IPO
• Disclosure of material off- Controlling Your Shares
balance sheet arrangements
and contractual obligations.
• Approval by audit committee
of any services provided to
the company by its audit firm,
with certain exceptions for
de minimis services.
• Whistleblower protections for
employees who come forward
with information relating to
federal securities law violations.
• Compensation disgorgement
provisions applicable to the CEO
and CFO upon a restatement of
financial results attributable to
The exchanges’ listing
requirements contain related
substantive corporate governance
independent directors; audit,
nomination, and compensation
committees; and other matters.
• revenue recognition
• business combinations
• segment reporting
• financial instruments
• impairments of all kinds
• deferred tax valuation allowances
• compliance with debt covenants
• fair value
• loan losses
In September 2014, Alibaba, a China-based, online and mobile
marketplace, raised $21.8 billion, the largest IPO ever.
An issuer will not be required to include either a management’s report
on its internal control over financial reporting or an auditor’s report on
such internal control until the second annual report following its IPO.
An integral part of the IPO process is the SEC’s review of the
registration statement. Once the registration statement is filed or
confidentially submitted, a team of SEC staff members is assigned
to review the filing. The team consists of accountants and lawyers,
including examiners and supervisors. The SEC’s objective is to assess
the company’s compliance with its registration and disclosure rules.
The SEC review process should not be viewed as a “black box” where
filings go in and comments come out; rather, as with much of the IPO
process, the relationship with the SEC is a collaborative process.
The SEC’s principal focus during the review process is on disclosure.
In addition to assessing compliance with applicable requirements,
the SEC considers the disclosures through the eyes of an investor in
order to determine the type of information that would be considered
material. The SEC’s review is not limited to just the registration
statement. The staff will closely review websites, databases, and
magazine and newspaper articles, looking in particular for information
that the staff thinks should be in the prospectus or that contradicts
information included in the prospectus.
The review process is time-consuming. While there was a time when
the review process could be completed in roughly two months,
now, given the length of the prospectus and the complexity of the
disclosure, it can take three to five months. This depends on the
complexity of the company’s business and the nature of the issues
raised in the review process.
Initial comments on a registration statement are provided in about 30
days; depending on the SEC’s workload and the complexity of the filing,
the receipt of first-round comments may be sooner or later. The initial
letter typically contains about 20 to 30 comments, with a majority of
the comments addressing accounting issues. The company and counsel
will prepare a complete and thorough response. In some instances, the
company may not agree with the SEC staff’s comment, and may choose
to schedule calls to discuss the matter with the staff. The company will
file or confidentially submit an amendment revising the prospectus and
provide the response letter along with any additional information. The
SEC staff generally tries to address response letters and amendments
within 10 days, but timing varies considerably.
Frequent Areas of Comment
It is easy to anticipate many of the matters that the SEC will raise in the
comment process. The SEC makes the comment letters and responses
from prior reviews available on the SEC's website, so it is possible to
determine the most typical comments raised during the IPO process.
The Dodd-Frank Wall Street
Reform and Consumer Protection
Act, enacted in 2010, created
sweeping changes to financial
regulation. Also included were
new corporate governance
and executive compensation
requirements, including the socalled
“Say on Pay,” applicable to
public companies. Many of these
requirements do not apply to a
company that qualifies as an EGC.
The JOBS Act provided important
accommodations for EGCs, which
make completing an IPO easier.
Among the most important are:
• Only two years of audited
financial statements and
selected financial data are
required in the registration
• No compensation discussion
and analysis is required in
• Availability of confidential
review of draft registration
statement and amendments;
• Ability to test-the-waters
before and after filing a
registration statement by
engaging in oral and written
qualified institutional buyers
and institutional accredited
• Ability to opt out of compliance
with new or amended financial
• Transition period of up to five
years for compliance with
auditor attestation on internal
controls requirement; and
• A broker-dealer may
publish research reports
about a company currently
in registration even if it is
participating in the offering.
Overall, the SEC staff looks for a balanced, clear presentation of the
information required in the registration statement. Some of the most
frequent comments raised by the SEC staff on disclosure, other than
the financial statements, include:
• Front cover and gatefold: On the theory that “a picture is
worth a thousand words,” does the artwork present a balanced
presentation of the company’s business, products, or customers?
• Prospectus summary: Is the presentation balanced?
• Risk factors: Are the risks specific to the company and devoid of
• Use of proceeds: Is there a specific allocation of the proceeds
among identified uses, and if funding acquisitions is a designated
use, are acquisition plans identified?
• Selected financial data: Does the presentation of non-GAAP
financial measures comply with SEC rules?
• MD&A: Does the discussion address known trends, events,
commitments, demands, or uncertainties, including the impact
of the economy, trends with respect to liquidity, and critical
accounting estimates and policies?
• Business: Does the company provide support for statements
about market position and other industry or comparative data?
Is the disclosure free of, or does it explain, business jargon?
Are the relationships with customers and suppliers, including
concentration risk, clearly described?
• Management: Is the executive compensation disclosure,
particularly the compensation discussion and analysis, clear?
Does it include discussion of performance targets, benchmarking,
and individual performance?
• Underwriting: Is there sufficient disclosure about stabilization
activities (including naked short selling), as well as factors
considered in early termination of lock-ups and any material
relationships with the underwriters?
• Exhibits: Do any other contracts need to be filed based on
disclosure in the prospectus?
A FINAL THOUGHT
While windows open and close, and emerging growth companies may
have different views concerning the right moment to commence active
and intense preparation for an IPO, it is rarely too early to undertake
the advance planning described above. Much of this preparatory work
is neither time-consuming nor expensive. Yet it will enhance greatly the
opportunity to get into the market quickly, when the market is there.
And even if an IPO does not turn out to be the option of choice, this
preparatory work should prove valuable in facilitating other funding
opportunities or even acquisition by an existing public company.
The EGC provisions of the JOBS Act have
now been available for more than two
years. Each EGC will decide which of the
scaled disclosure and other benefits to
accept, and there has been significant
variation in acceptance levels. From April
2012 through June 2015:
• 79% of EGC IPOs have taken advantage of
the confidential review process. However,
an EGC should consider that in 2014
the average number of days from initial
confidential submission to IPO date was
127 days versus 145 days for non-EGCs,
and 177 days for EGCs who do not submit
• 57% of EGC registration statements
included only two years of audited financial
statements, MD&A, and selected financial
data (not including EGCs that are also
smaller reporting companies or that do not
have two years of reporting history)
• 70% of EGC registration statements
excluded a compensation discussion and
analysis (not including EGCs that are also
smaller reporting companies or foreign
Few EGCs appear to be taking advantage
of the ability to use test-the-waters
communications and broker-dealers are still
generally not publishing research reports
during the registration process or during the
customary 25-day post-closing “quiet period.”
In addition, 77% of EGCs are opting to comply
with new or amended financial accounting
standards. Investment bankers and counsel
to EGCs may be advising them to consider
whether the benefit of reduced compliance
obligations may adversely affect market
perception and industry comparability.
From April 2012 through June 2015, EGCs
conducting an initial public offering have
come from many industry sectors:
• Healthcare – 35%
• Technology – 20%
• Financial Services – 14%
• Oil & Gas – 10%
Transportation – 7%
• Real Estate – 5%
• Other – 21%
Source: PWC, 2014 US Capital Markets Watch; IPO Vital Signs.
Smallest U.S. IPO – an EGC provider of financial
technology services raised $7.2 million.
PRIVATE SALE DUAL-TRACK
APPROACHES (IPO/PRIVATE SALE)
• Less or no dilution
• Less expensive and
• No public obligations
• No acquisition “currency”
• Limits equity compensation
• Investor pressure for
• No “public” profile
or market following
• Can be complete
• Avoids market instability
• No public obligations
• Typically, no continuing
involvement by management
• May be time-consuming
• Potential to maximize
• More responsive to
• Unsuccessful sale
could affect IPO valuation
• More time-consuming
WAY TO GO?
A growing company has a number of financing alternatives in addition to a traditional firm commitment, underwritten IPO.
Reverse Merger IPO
(merger into a public shell)
Rule 144A IPO/“PIPO”
• Combination IPO and sale
• Potentially faster
than traditional IPO
• Can be combined with
raising private capital
• Attractive to smaller
• Has a bad reputation
• Need to find “clean”
• Potential for
• SEC-style disclosure;
no SEC review and delay
• Access to capital
• Limited to institutional
• Available only to certain
• Delays but may not avoid
public disclosure and
Regulation A+ Offering
(with exchange listing)
• Unlocks perceived value of a
business unit or subsidiary
• All benefits of being public
• Compliance with complex
• SEC process is substantially
similar to IPO
• All considerations of
• Provides IPO on-ramp
• Scaled SEC disclosure
• Attractive to smaller
• Blue Sky exemption
only for Tier 2 offerings
(up to $50 million)
• Not available for certain
ABOUT MORRISON & FOERSTER
We are Morrison & Foerster — a global firm of exceptional credentials in many areas. Our clients include some of the largest
financial institutions, investment banks, Fortune 100, technology, and life sciences companies. We’ve been included on The
American Lawyer’s A-List for 12 straight years, and Fortune named us one of the “100 Best Companies to Work For.” Our lawyers
are committed to achieving innovative and business-minded results for our clients, while preserving the differences that make us
stronger. Visit us at www.mofo.com.
You will find our capital markets and finance related twitterings on @Thinkingcapmkts.
Imagine that, the latest developments from securities lawyers in 140 characters or less.
The Jumpstart Our Business Startups (JOBS) Act is sure to jumpstart capital-raising for emerging companies,
as well as facilitate capital formation for existing public companies of all sizes. Given our longstanding
commitment to serve emerging companies and the breadth of our capital markets and corporate practices,
we supplemented our JOBS Act page (www.mofo.com/jumpstart) with the Jumpstarter blog. Visit our blog
(www.mofojumpstarter.com) for up-to-the-minute news and commentary.
David M. Lynn
Ze’-ev D. Eiger
Anna T. Pinedo
Remmelt A. Reigersman
For jumpstarts, upstarts and start-ups