Initial Public Offerings of Sponsor-Backed U.S. Corporations

Transcription

1 Initial Public Offerings of Sponsor-Backed U.S. Corporations July 1, 2014 through December 31, 2015

2 Table of Contents Background... 1 Key Trends... 1 Controlled Company Status... 2 Director Nomination Rights... 2 Veto Rights... 4 Defensive Measures... 4 Action by Written Consent... 4 Stockholder Right to Call Special Meetings... 5 Supermajority Vote to Amend Charter and Bylaws... 6 Delaware Section Board Independence... 7 Monitoring Agreements... 8 Dual Class Stock and Up-C Structure... 9 Emerging Growth Companies... 9 Appendix A...11

3 Initial Public Offerings of Sponsor-Backed U.S. Corporations July 1, 2014 through December 31, 2015 The IPO market provided liquidity for many private equity firms during the 18 months ended December 31, 2015, notwithstanding the year-over-year decrease in IPO activity in 2015 as compared to We reviewed the PE sponsor-backed IPOs during this period to identify trends in corporate governance and defensive measures adopted by these newly public companies. The corporate governance profile of sponsor-backed public companies differs in many respects from those of public companies generally and venture-backed companies. The PE sponsor s controlling interest, both before and after the IPO, allows the PE sponsor to adopt (1) board structures and nominating policies that ensure a large degree of control throughout the sponsor s investment and (2) charter and bylaw provisions tailored to a controlled company such as provisions permitting action by written consent and allowing stockholders to call special meetings. For purposes of our survey, we examined IPOs generating $100 million or more in gross proceeds and, for purposes of comparability, excluded limited partnerships, limited liability companies, blank check companies and foreign issuers. The classification of deals as PE sponsored involved some measure of subjectivity. Annex A contains a complete list of the IPOs reviewed in our survey. All data was obtained from the final prospectus and other filings made with the Securities and Exchange Commission. Key Trends A review of the PE-backed IPOs over this period revealed the following trends: Board Structure. In the IPOs reviewed, 94% of the companies adopted a staggered board and 97% of the companies provided for directors to be elected by plurality voting. Nomination Rights. Approximately 66% of PE firms retained the right to nominate directors following the IPO, with approximately 66% of the companies surveyed entering into contractual nomination agreements with the PE sponsor. Further, 57% of those nominating agreements did not require the PE sponsor s nominees to resign once the PE sponsor s ownership level in the company declined below specified thresholds. Monitoring Agreements. Of companies with monitoring agreements in place, 67% paid a fee to the PE sponsor in connection with termination of the agreement upon the IPO, with fees ranging from $1 million to $78 million. The average size of the termination fee was approximately $19.4 million and the median was approximately $12.9 million. Termination fees and accelerated payments under monitoring agreements with portfolio companies have recently come under increased scrutiny from the SEC and an October 2015 SEC enforcement case resulted in the PE sponsor disgorging accelerated monitoring fees to the funds and paying a significant fine. Many PE sponsors are reviewing their practices regarding termination fees and accelerated payments in light of this increased regulatory focus. Because there have been very few IPOs completed since the October 2015 SEC enforcement case, it is difficult to draw any conclusions on the impact of this case on market practice. Dual Class Stock and Up-C Structure. Approximately 19% of the IPOs reviewed utilized dual class stock to facilitate what is often referred to as an Up-C structure. With this structure, certain pre-ipo investors own their economic interests in a pass-through entity partially owned by the public corporation and partially by the pre-ipo investors, thereby retaining more favorable tax treatment for the pre-ipo investors. 1

4 EGC Financial Statement Presentation. Approximately 59% of the companies surveyed qualified as emerging growth companies. Over half of these companies elected to present only two years of audited financial statements and approximately 74% presented less than five years of selected financial data. Controlled Company Status PE firms generally continue to own a significant amount of stock post-ipo, often a controlling stake. Of the companies surveyed, 94% remained controlled companies under applicable New York Stock Exchange or Nasdaq Stock Market standards post-ipo, meaning that more than 50% of the voting interests of these companies continued to be held by the PE sponsor or a group of PE sponsors. Percentage of Companies Electing to be Treated as Controlled Companies Under Stock Exchange Guidelines 6% 94% Controlled Companies Not Controlled Companies the right to appoint directors to the board (which can generally only be accomplished by issuing the PE sponsor a different class of stock than that held by the public). Percentage of Companies with Nominating Agreements 34% 66% PE Sponsor Given Nomination Rights PE Sponsor Not Given Nomination Rights PE sponsors are often comfortable relying upon nomination rights (rather than the direct right to appoint directors) to ensure their continued representation on the board because plurality voting will ensure their nominees are elected. In cases where directors are elected by plurality vote rather than majority vote, the directors receiving the most votes are elected (even if less than a majority of shares are voted for election). With plurality voting, absent a proxy contest by a third party, the persons nominated by the company will be elected. In 97% of the companies surveyed, the company s charter or bylaw provisions provided for plurality voting. Voting Standard for Election of Directors 3% Director Nomination Rights PE sponsors generally seek to maintain representation on the board of directors following the IPO until they have sold down their stake in the company. Due to the significant economic stake maintained by these sponsors, it is not surprising that approximately 66% of the companies surveyed entered into nominating agreements with the PE sponsor in connection with the IPO, giving the PE sponsor the right to nominate a specified number or percentage of directors to stand for election. None of the IPOs we surveyed provided a PE sponsor with 97% Plurality Majority 2

5 Of the 21 companies surveyed with nominating agreements, nine of the nominating agreements gave the PE sponsor the right to nominate a number of directors that was generally proportional to the PE sponsor s percentage ownership. Seven of the nominating agreements provided for nomination rights based upon the PE sponsor maintaining a percentage of the PE sponsor's pre-ipo ownership (rather than percentage of outstanding stock) a sponsor-friendly term because nomination rights are not impacted by subsequent dilution of the sponsor s holdings due to stock issuances by the company. Use of Staggered Board 6% 94% Nominating Agreement Terms Use Staggered Board Do Not Use Staggered Board 24% 43% 33% Tied to Maintaining Ownership of Stock Held At or Immediately Following IPO Proportional Representation Other Formulations Nominating agreements often do not require that a PE sponsor s representatives resign in the event that the PE sponsor s ownership falls. As a result, a change in ownership only impacts the number of directors that the PE firm is entitled to nominate at the next annual meeting. If, for example, a PE sponsor s representative is placed in the class of directors that is not up for election until the third annual meeting post-ipo, the sponsor is ensured representation for three years regardless of whether its ownership level decreases. Nominating Agreements Requiring Directors to Resign The use of a staggered board can in some cases further protect a PE sponsor s right to continued board representation. With a staggered board, one-third of the directors stand for election each year and directors generally serve three-year terms. 94% of the companies surveyed utilized a staggered board. 57% 43% Require Director Resignation Do Not Require Director Resignation 3

6 Veto Rights In some cases, PE sponsors have sought to further control portfolio companies following an IPO by maintaining a contractual right to veto specified corporate transactions, such as changes in board size, changes in control and charter amendments. Unlike board representation, contractual veto rights allow a PE sponsor to exercise control in its capacity as a stockholder rather than as a director. In five of the IPOs surveyed, PE sponsors also received contractual veto rights. Contractual Veto Rights For example, sponsor-controlled companies often permit stockholders to call special meetings, permit stockholders to take action by written consent and permit the amendment of the charter or bylaws without super-majority stockholder approval. These provisions would be highly unusual in noncontrolled companies. As a result, the charter and bylaws often provide that these stockholder rights are eliminated once the PE sponsor (or a group of PE sponsors) ceases to own 50% or some lower percentage of the common stock. 84% 16% PE Sponsor Has Contractual Veto Rights PE Sponsor Does Not Have Contractual Veto Rights Action by Written Consent 94% of the companies surveyed permitted stockholders to take action by written consent. Percentage of Companies Permitting Stockholder(s) to Take Action by Written Consent 6% % Permit Stockholder(s) to Take Action by Written Consent Do Not Permit Stockholder(s) to Take Action by Written Consent Joint Ventures Amending Charter Equity Issuances Debt Incurrence Buy/Sell Assets CIC/Reorg/Sale of All Assets Voluntary Liquidation, Dissolution, Bankruptcy Changes in Board Size Of the 29 companies that permitted action to be taken by written consent: 22 provided that these rights would fall away once the sponsor ceased to own a specified percentage of the outstanding stock (referred to in the chart below as a fall away percentage ); Defensive Measures PE firms generally seek to take advantage of the convenience of being a controlling stockholder for as long as they own 50% by relaxing defensive measures, thereby making it easier for stockholders to take action. One provided that action could only be taken by unanimous consent; Four provided that both the action being taken and the taking of the action by written consent must be approved by the board of directors (referred to in the chart below as board approved ); and 4

7 Two provided for action by written consent subject to a fall away percentage and that action by written consent could alternatively be taken if board approved (referred to in the chart below as fall away percentage or board approved ). Percentage of Companies Permitting Stockholder(s) to Call Special Meetings Fall Away Percentage, Unanimous, Board Approved or Combination 3% 7% 14% Board Approved Fall Away Percentage or Board Approved 76% Fall Away Must Be Unanimous Of the 25 companies that permitted stockholders to call special meetings: The following chart indicates the sponsor ownership percentage below which the right to take action by written consent fell away, including with respect to those companies that provided that alternatively the action by written consent could be board approved. Action by Written Consent Percentage Ownership Below Which Right Falls Away 23 provided that this right would fall away once the sponsor ceased to own a specified percentage (in some cases with the right to call a special meeting limited to the sponsor specifically so long as the sponsor maintained the specified percentage); One provided that a special meeting could only be called by stockholders upon the request of holders of a majority of the votes to be cast at the meeting; and 12% 4% Fall Away Percentage One provided that the right terminated once no class B common stock remained outstanding. 30% 58% 27% 35% 40% 50% or majority Stockholder(s) Right to Call Special Meetings Percentage Ownership Below Which Right Falls Away Stockholder Right to Call Special Meetings 78% of the companies surveyed permitted stockholders to call special meetings of stockholders. 5

8 Supermajority Vote to Amend Charter and Bylaws Only 31% of the companies surveyed required a supermajority vote of stockholders to amend the charter and bylaws at the time of the IPO. Percentage of Companies Requiring a Supermajority Vote of Stockholders to Amend the Charter and Bylaws All but one of the companies that permitted an amendment of the charter or bylaws with a simple majority vote provided that these documents could only be amended with a supermajority vote once the sponsor ceased to own a specified percentage of the outstanding common stock. The chart below specifies the ownership threshold below which a supermajority vote was required to amend some or all of the provisions of the company s charter and bylaws. Threshold Ownership Below Which Supermajority Vote Required for Amendments 5% 5% 43% 69% 31% Requires Supermajority Vote Does Not Require Supermajority Vote 14% 28% 5% 30% 35% 40% 50% None No class B common stock outstanding Delaware Section 203 Public companies controlled by PE sponsors generally opt out of Section 203 of the Delaware General Corporation Law ( DGCL ), Delaware s anti-takeover statute. The statute generally provides that any person that acquires 15% or more of a public company s stock without board approval becomes an interested person and prohibits transactions between the company and any interested person for a period of three years, subject to limited exceptions. By opting out, the PE sponsor retains the ability to transfer 15% or more of the company s stock to a third party without the transferee becoming an interested person under Section 203. If a company has opted in to Section 203, the PE firm would need board approval in order to exempt the transaction from Section 203, which would implicate directors fiduciary duties to all stockholders. Because Section 203 does provide a strong defensive measure, it can be desirable for the company to be subject to Section 203 after such time as the PE sponsor ceases to control the company. This is generally accomplished in one of two ways. Some companies opt out of Section 203 but include in the charter a modified version of Section 203, which excludes from the definition of interested person the PE sponsor, its affiliates and any person or group that acquires 15% or more of the company s common stock as a result of a transfer from the PE sponsor. Alternatively, some companies include in the charter a provision that states that the company will opt in to Section 203 but not until a future date when certain conditions are met. Generally, these springing Section 203 provisions provide that the company will become subject to Section 203 when the PE sponsor owns less than a specified percentage of the company s common stock. This percentage varied from as high as 50% to as low as 5%. 6

9 Delaware Section 203* Companies with a Majority of Independent Directors at IPO 19% 16% 65% 20% 80% 66% 34% Opt-in (6 companies) Opt-out (21 companies) Springing (5 companies) In Charter Not in Charter *One company reviewed is a Maryland corporation. It opted out of Maryland s comparable anti-takeover statute and was counted as an opt out for purposes of this survey. Companies With a Majority Independent Board at IPO Companies Without a Majority Independent Board at IPO Of the companies surveyed: Board Independence Controlled companies are exempt from certain of the governance requirements imposed by the stock exchanges. Specifically, controlled companies are not required to have a majority of independent directors (as defined under stock exchange rules) and are not required to have compensation and nominating committees comprised of a majority of independent directors. In addition, all newly public companies are entitled in any event to utilize a phase in of the independence rules. For companies that do not qualify as controlled companies, the phase in rules require that they have at least one independent director at the time of the IPO, two independent directors within 90 days and fully independent committees within one year of the IPO. The PE-sponsored companies surveyed generally made use of the flexibility provided by the controlled company and/or phase in rules. In cases where the IPO prospectus did not contain disclosure of the board of directors determination as to which directors were independent, the data below is based upon our review of the relationships disclosed in the IPO prospectus. Only 32% had nominating committees and only 43% had compensation committees comprised of two or more independent directors; 44% had nominating committees with no independent directors or had no nominating committee; and 19% had compensation committees with no independent directors. In contrast, 75% of the companies surveyed had audit committees comprised of two or more independent directors at the time of the IPO. Number of Independent Directors on Nominating Committee at IPO 3% 13% 16% 13% 25% 31% 0 Directors 1 Director 2 Directors 3 Directors 4+ Directors No Committee 7

10 Number of Independent Directors on Compensation Committee at IPO Percentage of Companies that Paid a Fee in Connection with Termination of the Monitoring Agreement 34% 19% 0 Directors 1 Director 2 Directors 3 Directors 33% 67% 9% 38% Terminated Agreement With Payment of a Fee Number of Independent Directors on Audit Committee at IPO Terminated Agreement Without Payment of a Fee 22% 53% 25% 1 Director 2 Directors 3 Directors Although not all related agreements were filed (perhaps because they were terminated), in several cases the monitoring agreements specified a termination fee tied to the remaining term of the agreement or to a set number of years of additional payments (e.g., 10 years). In some cases, these payments were discounted to present value. In other cases, it appears that the amount of the payment was negotiated between the company and the PE sponsor. Monitoring Agreements Prior to an IPO, PE sponsors often enter into monitoring agreements with their portfolio companies. These agreements often provide for an annual fee to be paid by the portfolio company to the sponsor for services rendered to the portfolio company, as well as transaction-related fees for services rendered in connection with acquisitions and financings. Of the companies surveyed, 22 had monitoring agreements in place at the time of the IPO, all but one of which were terminated in connection with the IPO. In 67% of these IPOs, the PE sponsor received a termination fee. The one monitoring agreement that was not terminated was amended and restated in connection with the IPO and provided for termination no later than the second anniversary of the IPO. The termination fees paid in connection with the termination of monitoring agreements ranged from a low of $1 million to a high of $78 million. The average termination fee paid was approximately $19.4 million and the median fee was $12.9 million. Size of Termination Fees Millions of Dollars $80.0 $70.0 $60.0 $50.0 $40.0 $30.0 $20.0 $10.0 $0.0 Low High Average Median 8

11 Initial Public Offerings of Sponsor-Backed U.S. Corporations July 1, 2014 through September 30, 2015 Termination fees and accelerated payments under monitoring agreements with portfolio companies have recently come under increased scrutiny from the SEC and an October 2015 SEC enforcement case resulted in the PE sponsor disgorging accelerated monitoring fees to the funds and paying a significant fine. Many PE sponsors are reviewing their practices regarding termination fees and accelerated payments in light of this increased regulatory focus. Because there have been very few IPOs completed since the October 2015 SEC enforcement case, it is difficult to draw any conclusions on the impact of this case on market practice. 1 Dual Class Stock and Up-C Structure 25% of the companies surveyed had two classes of common stock at the time of the IPO. Of these companies, 67% utilized their dual class stock to facilitate what is often referred to as an Up-C structure. Percentage of IPOs with Dual Class Stock partnership interests in the existing partnership. The public purchases class A common stock in the IPO corporation and the pre-ipo investors receive class B common stock of the IPO corporation. The limited partnership interests, together with the related shares of class B common stock, can be exchanged for class A common stock on a one-for-one basis, which is generally only done when the pre-ipo investor wishes to sell its interest. The class B common stock has voting rights but no economic rights because the pre-ipo investors continue to directly own limited partnership interests in the partnership representing their economic interests. Emerging Growth Companies A newly public company with less than $1 billion in revenue is generally able to elect to be treated as an emerging growth company, or EGC. Nineteen of the 32 companies surveyed qualified as EGCs. Emerging Growth Companies 75% 25% 33% 67% 41% 59% Dual Class Stock (8 companies) Single Class of Stock (24 companies) Utilize Up-C Structure Do Not Utilize Up-C Structure Qualified as EGC An Up-C structure allows certain pre-ipo investors to continue to hold interests in a partnership rather than converting the partnership to a corporation at the time of the IPO. This structure is designed to preserve flow-through tax treatment for pre-ipo equity holders. With an Up-C structure, a new corporation is taken public by selling stock to the public. The newly public company uses the proceeds of the offering to purchase Did Not Qualify as EGC EGCs are permitted to include two rather than three years of audited financial statements in their IPO registration statements and may present as few as two years of Selected Financial Data (as compared to the five years required for non-egcs). 1 For more information regarding this SEC enforcement case, please see October 13, 2015 KirklandPEN, Private Fund Manager Settles SEC Enforcement Case for Accelerated Monitoring Fees and Service Provider Discounts. 9

12 Initial Public Offerings of Sponsor-Backed U.S. Corporations July 1, 2014 through September 30, 2015 Percentage of EGCs Presenting Two Years of Audited Financial Statements Number of Years of Selected Financial Data Presented by EGCs 26% 16% 47% 53% 16% 42% 2 Years 3 Years 2 Years 3 Years 4 Years 5 Years Acknowledgments Kirkland partners Carol Anne Huff and John Gunderson designed and oversaw this survey. Special thanks to associate Alex Schwartz and 2015 summer associates Mackenzie Jo Drutowski and Katherine Gause for their assistance on the survey. If you have any questions about the matters addressed in this publication, please contact the following Kirkland authors, your regular Kirkland & Ellis attorney or any member of our Capital Markets Practice Group. Carol Anne Huff Kirkland & Ellis LLP 300 North LaSalle Chicago, IL John O. Gunderson Kirkland & Ellis LLP 300 North LaSalle Chicago, IL This communication is distributed with the understanding that the author, publisher and distributor of this communication are not rendering legal, accounting, or other professional advice or opinions on specific facts or matters and, accordingly, assume no liability whatsoever in connection with its use. Pursuant to applicable rules of professional conduct, this communication may constitute Attorney Advertising LLP. All rights reserved. 10

13 Appendix A Below is a complete list of the IPOs reviewed as part of the survey. Amplify Snack Brands, Inc. Blue Buffalo Pet Products, Inc. Bojangles, Inc. Catalent, Inc. Civitas Solutions Inc. CPI Card Group Inc. El Pollo Loco Holdings, Inc. Evolent Health, Inc. First Data Corporation FMSA Holdings Inc. GoDaddy Inc. INC Research Holdings, Inc. Metaldyne Performance Group Inc. Milacron Holdings Corp. Neff Corp. Ollie s Bargain Outlet Holdings, Inc. Party City Holdco Inc. Performance Food Group Company Planet Fitness, Inc. PRA Health Sciences, Inc. Press Ganey Holdings, Inc. Ryerson Holding Corporation Shake Shack Inc. Smart & Final Stores, Inc. STORE Capital Corporation Summit Materials, Inc. Surgery Partners, Inc. TransUnion Univar Inc. Vivint Solar, Inc. VWR Corporation Wingstop Inc. 11

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