NASDAQ Private Market Breakfast October 6, 2015
Agenda Overview Facilitating liquidity for existing security holders Tender offers Material nonpublic information Valuation issues Pre-IPO private placements 2
Overview 3
The JOBS Act and private offerings Although the aspect of the JOBS Act that has received the most attention relates to changes to the IPO process, in large measure, the JOBS Act related changes affecting the private market may be more significant. Title V and Title VI changes to the Exchange Act Section 12(g) threshold Changes to Rule 506 Legal certainty for matchmaking platforms Taken together, these measures have the effect of permitting companies to stay private longer and to rely on exempt offerings (while enabling companies to contact a broader range of potential investors) for their capital-raising. 4
Reliance on private or exempt offerings Even pre-jobs Act, based on various studies, it was already the case that more capital was being raised in reliance on Regulation D and Rule 144A (in aggregate) than in SEC-registered offerings according to the SEC s Division of Economic Research and Analysis (DERA), in 2012, for example, the total raised in registered offerings was $1.2 trillion whereas the total raised through all private offerings was $1.7 trillion Amounts for private offerings is likely to be understated given that many issuers fail to file Form Ds and amounts raised in 4(a)(2) offerings are not reported The amount raised in registered offerings includes debt offerings, whereas the majority of Reg D offerings involve equity or new capital These trends are likely to have become more pronounced since 2012 5
Reliance on private or exempt offerings Many companies that were able to deregister following the JOBS Act have done so Since the JOBS Act, approximately 90 banks have deregistered These banks will now have to rely on private or exempt offerings in order to raise capital going forward Companies are choosing to defer their IPOs and rely on private financing for much longer than in the past This is evident from various IPO reports For example, based on statistics for the period from 1/1/12 through 9/30/15, the median market cap for IPO issuers was approximately $386 million, and the average was $1.4 billion Fewer than 2.5% of IPO issuers has a market cap of $50 million or less 6
Larger privately held companies According to various reports, including the Wall Street Journal, there are now at least 117 private companies valued by venture capital firms at $1 billion or more Uber has been able to raise significant amounts (reportedly $5 billion) in private financings, giving it a value of close to $51 billion Many privately held companies have been able to raise capital from cross over investors (as we will discuss later) that traditionally invested only in IPOs and in publicly held companies These companies, often referred to as unicorns, have a median valuation after their most recent investment in 2015 of $1.1 billion (NYT, 9/23/15) 7
Privates have become more public Over the years, and not spurred by the JOBS Act, private placements and exempt offerings have become more public The shortened Rule 144 holding period has helped increase liquidity for restricted securities The prevalence of hybrid offering techniques has changed capital-raising Relaxation of the prohibition on general solicitation New financial intermediaries that rely principally on the internet A broader universe of investors interested in investing in the securities of private companies 8
Changing dynamics All of this suggests that: Private companies and their advisers need to consider how they address providing liquidity opportunities for long-term holders as well as employees, consultants, strategic partners, and others, given that a traditional liquidity opportunity (such as an IPO or an M&A exit) may not be available for many years Private companies are now more broadly held Private companies must give thought to the type of information that they share with third parties as we will discuss Private companies must consider their valuation and the market that may develop in their securities 9
Liquidity 10
Impediments to liquidity Although there are many more private financing approaches now available, and companies are likelier to complete many more (or at least larger) rounds of financing while remaining private, significant impediments to liquidity remain: Section 12(g) threshold Specific state law concerns regarding record holders Lack of a uniform state law exemption for resales of securities Ownership or transfer restrictions that are contractual Practical considerations regarding capitalization, information rights, inefficiencies associated with dispersed ownership 11
Liquidity alternatives 4(a)(1-½) sales Will the SEC Staff s guidance on general solicitation and what constitutes a pre-existing substantive relationship help? Rule 144 Sales pursuant to rights of first refusal/co-sale rights Repurchases by the issuer 12
Tenders 13
Tender offer rules Are tender offer rules applicable to privately held companies? The filing provisions of sections 13 and 14 of the Exchange Act and the rules thereunder would not apply because the issuer is not registered under the Exchange Act Anti-fraud and anti-manipulation provisions of section 13(e) (for issuer tender offers) and section 14(e) (for all tender offers) would apply if the offering is, in fact, a tender offer The determination of whether a transaction is a tender offer is based on facts and circumstances 14
Structuring alternatives Company buys back outstanding capital stock using cash on hand There may be impediments to doing so which may arise from venture capital or private equity financing Third-party (approved by the company) tenders for the company s shares Cleans up capital structure prior to an IPO Standalone offers or recurring tender offers (a liquidity program ) Eligible holders Percentage of holding eligible for sale Pro-ration or all-or-nothing offers 15
Material Non-Public Information and Valuation Issues 16
Insider trading Generally, most market participants associate concepts of insider trading with publicly traded securities However, the prohibition on insider trading stems from Rule 10b-5, which, by its terms, is not limited to public companies How should private companies think about insider trading and the information that they make public or that they are required (contractually) to share with certain parties? Information requirements? Regulation FD parallels? What constitutes current information? What can we learn from information requirements applicable to other exempt offerings? Should private companies implement trading windows? 17
Valuation Issues How are the shares of privately held companies valued and who is responsible for valuations? The IPO prices for many companies that have gone public have been lower than the prices at which these companies had last raised capital privately and lower than the prices at which secondary private transactions were completed Private companies also have been able to raise money at higher premiums than their direct competitors who are public What does this suggest, if anything? Are investors no longer applying a liquidity discount? Is the premium associated with the liquidation preference that typically accompanies preferred stock rounds sufficient to justify pricing of pre-ipo rounds? In IPOs, investment banks in pricing the IPOs and IPO investors demand an IPO discount ( IPO underpricing ) When VCs or cross over investors participate in successive private financing rounds, often they can negotiate for themselves downside protection, including protection should the company go public at a lower valuation but what about participants in secondary private markets? 18
Pre-IPO Private 19
The Pre-IPO private In recent years, the pre-ipo private placement has become ubiquitous From the issuer s perspective: Allows the issuer to remain private longer Allows the issuer to address its existing securityholders The issuer may have friends and family or longtime VC or PE holders that are seeking liquidity The issuer may not have among its holders any sector investors Size: the median size of IPOs in the tech and biotech sector continues to increase From the investment banker s perspective: The pre-ipo investors likely will be the anchor orders in the IPO Reduces IPO deal uncertainty Validates the company s technology Provides insights on valuation 20
The Pre-IPO private (cont d) From the investors perspective A broader array of funds that can invest in pre-ipo companies ( cross-over funds) Allows an investor to capture growth and establish a position before the IPO Considerations Deal structure and terms can be highly variable Common stock, preferred stock, convertible preferred Weighted average anti-dilution adjustments IPO protection terms such as minimum IPO price or minimum IPO valuation Acquisition protection Board representation Affirmative and negative covenants Information rights Financial statement requirements 21
The Pre-IPO private (cont d) Considerations (cont d) Time horizon Pre-IPO investors may have a specific timeline in mind for the IPO and a target valuation Milestones from the pre-ipo private to the IPO What does the company expect? Are expectations clearly understood by pre-ipo investors? How will the company explain valuation bump from pre-ipo private to IPO? 22