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How to Make a Sponsored IPO Sail Through the Process

Merrill Disclosure Solutions | September 02, 2014


Abstracted from: Advance Planning For Sponsor-Backed IPOs
By: Matthew Kaplan and Steven Slutzky
Debevoise & Plimpton, New York NY
Review of Securities & Commodities Regulation, Vol. 47, No. 10, Pgs. 123-128

Less labor for IPOs under the JOBS Act. Careful preparation for linked legal and business obstacles should precede the IPO for a private equity firm's portfolio company, advise attorneys Matthew Kaplan and Steven Slutzky. Measured by gross proceeds, almost 50% of the more than 200 IPOs finished in 2013 had private equity sponsors. The federal JOBS Act of 2012, available if the new issuer qualifies as an emerging growth company, can speed up the IPO. Under the JOBS Act, an emerging growth company is essentially an issuer with gross revenues under $1 billion in the most recently ended fiscal year; the status ends on the earliest of four specified dates. The emerging growth company may submit an S-1 registration statement to the SEC confidentially but has to file publicly all its submissions and the SEC's responses 21 days or more prior to the road show. It may also sound out institutional accredited investors on pricing before the IPO; put two (rather than three) years' audited financial statements and as few as two (not five) years' selected financial information in the S-1; avoid the audit of internal controls over financial reporting that Section 404(b) of the Sarbanes-Oxley Act mandates; and simplify disclosure of executive compensation in the S-1 and in post-IPO reporting.

SEC rules that make work for issuers. The SEC rules requiring auditors to be independent are intricate for any issuer, the authors warn, but more so for a sponsored IPO, whose auditor could violate the rules by performing non-audit services for the issuer's affiliate - i.e., the sponsor. As a result, share buyers might gain rescission rights. The securities laws generally require offers of IPO shares to be made through a compliant prospectus, and the SEC's view of offers is expansive enough to encompass numerous innocent written or spoken statements. Noncompliant offers could result in suspension of the IPO, rescission rights for share purchasers, or civil and criminal penalties. SEC rules promulgated under Sarbanes-Oxley Section 404 require an issuer to assess its internal controls over financial reporting every year.

Employment of disclosure controls and other tasks. Under Sarbanes-Oxley and SEC rules, issuers must set up and assess the efficacy of their “disclosure controls and procedures,” which greatly overlap internal controls and which should guarantee that issuers timely provide the information needed in SEC reports. In many sponsored IPOs, issuers have previously entered into agreements on voting rights, minority shareholders' tag-along rights and drag-along duties, and registration rights. Advance scrutiny of these agreements can avoid delays, the authors suggest. Moreover, restructuring rights can prevent parties to a shareholder agreement from having unwelcome reporting duties as a group under 1934 Act Section 13(d). In the SEC's view, however, each member of a group jointly holding more than 10% of an issuer's equity securities must still comply with the reporting and short-swing-trading provisions of 1934 Act Section 16. Stock-exchange rules require setting up several board committees and making each plus a full-board majority independent, but an exception favors sponsored IPOs: only the audit committee of a controlled company (as defined) must be independent.

Accounting chores; preoccupation with sponsor's fees. Four accounting problems might arise for a sponsored IPO, note the authors. Meticulous independent valuation, disclosure, and recordkeeping can avert the “cheap stock” problem, which occurs in many sponsored IPOs when the offering price far exceeds (and the stock's fair value on the option-grant date also exceeds) the option exercise price. A past or IPO-related deal or occurrence could make pro forma financial statements in the S-1 essential or desirable. A substantial past or IPO-related acquisition could necessitate discrete financial statements in the S-1 and an auditor's comfort letter. Finally, the SEC targets non-GAAP financial measures in IPO prospectuses, so issuers should sufficiently define the measures they use, with clarification that foresees SEC comments. Private equity firms and newly acquired portfolio companies usually enter into management or consulting agreements, which an IPO generally terminates, thereby generating a fee. Its size and conditions could compromise the independence of the sponsor's board nominees under stock-exchange rules and create other regulatory problems for the sponsor.

Abstracted from Review of Securities & Commodities Regulation, published by RSCR Publications, 2628 Broadway, Ste. 29A, New York NY 10025-5055. To subscribe, call (866) 425-1171; or visit

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