The WSJ's front page observes that Tech Firms Are Notably Scarce in IPO Parade. Unlike last week's news, this one didn't surprise me one whit. Here's why: the JOBS Act of 2012 was ballyhooed as a much-needed way to make it easier for companies to go public, rather than having to look to foreign markets or staying private to avoid the burdensome regulation epitomized by those dreaded words "Sarbanes-Oxley."
But the thing is, the JOBS Act didn't just make it easier for firms to go public. Instead, it was more like enabling legislation in the securities field. Here's what Congress says to private companies in the JOBS Act.
Congress: "Hey, do you want to go public? We'll make it easier! You don't have to report as much and you can do a test run with the SEC and once you're public you don't have to report as much stuff as you used to" (Title I).
Company: "Actually, we'd prefer to stay private."
Congress: "Oh, we can help you with that, too! We used to force companies like Facebook to go public if they had too many shareholders, but we'll change that (Title V). And now you can advertise to the general public (Title II) and raise more money (Title IV)! Oh, and your brother-in-law that has the crazy idea of making tea out of lawn-clippings? We'll let the general public invest in that, as long as they don't risk too much money and he wants $1 million or less...well, we'll let the SEC sort out the details on that one. (Title III, crowdfunding, final rules expected sometime this fall. Maybe)"
Company: "Cool, thanks. So I think we're going to stay private because even with the JOBS Act the public market is kind of harsh."
Harsh is right. Per the WSJ: Shares of Chinese e-commerce giant Alibaba Group Holding Ltd. dropped below their IPO price in August and are down nearly 39% this year. Shares of Twitter Inc. are down 23% this year and, at $27.71, aren’t much above their $26 IPO. Productivity-software company Box Inc.’s shares closed Thursday at $13.86, below their $14 IPO price... Zulily Inc., an online retailer that went public in 2013, agreed to be acquired by Liberty Interactive Corp. in August for $18.75 a share, after going public at $22."
Meanwhile, we have a multiplicity of "unicorns," privates companies worth over $1 billion. Paul Bard, director of research at Renaissance, is quoted in the article as saying “Private valuations…are supposed to factor in a discount for the added risk an investor is taking...Many of these private valuations are ignoring the fundamental risks involved in achieving their projections."
The understatement of the year, Mr. Bard. Sounds like a bubble to me. I'm not surprised that there aren't more tech IPOs. Given how easy the JOBS Act made it to stay private, I'm surprised that there are any.
I'm also a week late on the Etsy IPO, and I trolled around the likely law prof blogs to see if anyone else had beat me to the punch (if I missed someone, please let me know and I'll update accordingly).
Etsy IPO'd last Thursday, pricing at $16 and opening at $30, raising $267 million. According the WSJ Blog, that's the most ever for a NY-based VC-backed firm.
But for my money the more interesting take came from the NYT, since it concerned organizational form. Etsy is a B-Corp-- but not a benefit corp. Here's Haskell Murray on the difference. Bottom line, a B-Corp is a certification thing, and you can be a for-profit B-Corp. A benefit corporation is a whole separate kind of entity, one organized not just for profit.
Here's the NYT on the importance of the B-Corp designation to Etsy:
Etsy declares in its public offering prospectus that it wants to change the decades-old conventional retail model of valuing profits over community. It states that its reputation depends on maintaining its B Corp status by continuing to offer employees stock options and paid time for volunteering, paying all part-time and temporary workers 40 percent above local living wages, teaching local women and minorities programming skills, and composting its food waste.
But wait, there's more. To maintain its B-Corp status, Etsy must reincorporate as a benefit corporation in a few years. B Lab's website says "companies must elect benefit corporation status within four years of the first effective date of the legislation or two years of initial certification, whichever is later." The NYT suggests a slightly longer glide-path: "B Lab is giving companies four years from the date any relevant state legislation is passed to comply with the state law or risk losing B Corp certification. Since Delaware passed that law in August 2013, Etsy has until 2017 to become a benefit corporation." Yet Etsy CEO Chad Dickerson is quoted as saying Etsy had no plans to reincorporate as a benefit corporation: “Regardless of certification, we plan to focus on delivering a strong business that also generates social good,” he said."
It will interesting to see how a publicly traded corporation like Etsy weighs the benefits of B-Corp certification against the risks and costs of moving to benefit corporation status. Risks like opening yourself up to 10b-5 and derivative shareholder suits if you fail to fulfill whatever social purpose you articulate in your articles of incorporation. Not to mention the securities law issues around stressing the importance of B-Corp status while seeming to suggest that it will lose that status in a few years.
Update 2: I knew Haskell Murray must have been on this, but I didn't look back far enough to see this post.
The WSJ has launched the Billion Dollar Startup Club, which tracks venture-backed private firms valued at over $1 billion. I am getting crotchety in my old age, and view the fact that 73 companies fall into this category as a sign of extreme and unsustainable froth. After all, only 35 firms topped $1 billion in the dot-com bubble (adjusted for inflation).
For me these billion-dollar startups are a product of the JOBS Act's schizophrenia. On the on hand, Title I created the emerging growth companies that made it easier to go public. Because that's what we want, right? More public companies? But simultaneously Titles II, IV, and V made it easier for companies to stay private. Because that's what we want, right? For private firms to be able to raise money more easily and stay private longer? Hence the schizophrenia: the JOBS Act isn't sure what it wants, but it wants companies to be able to do it easier, whatever it is.
Now I sound like a hater, and I'm not. I just find it interesting that, for all of the talk of the need to make U.S. capital markets more amenable to new public companies, more and more VC-backed firms are staying private even with sky-high valuations.
Also, get off my lawn.
Kevin LaCroix has all the information on the first securities fraud lawsuit to be filed against Alibaba regarding its sale of ADS on the NYSE in September. For securities regulation professors, there are a few nice issues here.
Materiality. The complaint cites two separate "revelations" that appeared in the U.S. in the WSJ on the same day (January 29). One article reports that the company announced that it had come to an agreement with China's State Administration for Industry and Commerce to strengthen its websites ability to monitor unlawful activity. In addition, the article noted that the SAIC had met with Alibaba for the first time in July, two months prior to the IPO. This meeting was not mentioned in the registration materials. The other article reported disappointing revenue numbers and a decline in profits. That day, the share price drops about 7%. Which revelation caused the drop if we believe that a "market test" determines materiality? What about the "total mix" test? Would investors have wanted to know about the sit-down meeting? Aren't the disappointing numbers most likely non-actionable under a forward-looking safe harbor for any contrary statements in the registration materials?
The Difference Between Section 11 and 12 of the Securities Act and Section 10 of the Securities Exchange Act. The plaintiffs have only brought suit under Section 10, even though the false statements would be in the registration statement. Kevin hypothesizes that the plaintiffs can't meet the tracing requirements of the Securities Act, but a commenter also points out that those who purchased at the IPO or shortly thereafter bought at a purchase price lower than the market price now, even with the January 29 price drop, so no damages.
Fee-Shifting Provision. Alibaba has a fee-shifting provision in its (Grand Caymans) charter. Will the fee-shifting provision hold up in federal court under the Securities Exchange Act? Does federal securities law (specifically the PSLRA) pre-empt this provision? We shall see.
I've never been to a Shake Shack. I believe this fast casual restaurant operates in other parts of the U.S. and abroad, but its website has been down all morning. Why? Because Shake Shack is having a whiz bang IPO. After just a few hours on the board (it debuted last night), SHAK is up 132%.
Readers familiar with my scholarship and rants know that, unlike the rest of the world, I don't see that as a successful IPO. Instead of selling its shares at $21, Shake Shack (the entity) could have issued shares for almost $50. The difference there was left on the table, just as if you sold your house for $200,000 yesterday and the buyer sold it with no modifications today for $500,000. I wouldn't think of that house sale as successful, even if it was quick and I thought it was worth only $200,000. I would be steaming mad.
But the founder of Shake Shack isn't steaming mad because he still owns 21% of the company, and his shares are worth over $50 now. As he sells into the market (presuming he does it before the price drops), he will get more cash. But Shake Shack (the entity) doesn't. It now must grow, expand, wrestle with the challenges of being a public company -- all with the capital it raised at $21/share.
Not to beat a dead horse, but even the author of the Forbes article linked above seems to be unclear about what a successful IPO is. The author recognizes that Potbelly's share price is now just 2% higher than its IPO price, but "IPO buyers had their chance to exit with profits after the stock popped 120% on its first day of trading." That is not really a ringing endorsement for the efficiency and substance of capital markets.
Despite a delayed start, Alibaba's IPO seems to have gone off without the technical glitches that have marred some recent public offerings. Priced at the very top of its range at $68, it opened at $92.70. That's some kind of pop!
Investors apparently aren't listening to Harvard Law's Lucian Bebchuk, who earlier this week expressed governance worries about the firm, particularly its control by insiders.
In Alibaba, control is going to be locked forever in the hands of a group of insiders known as the Alibaba Partnership. These are all managers in the Alibaba Group or related companies. The Partnership will have the exclusive right to nominate candidates for a majority of the board seats. Furthermore, if the Partnership fails to obtain shareholder approval for its candidates, it will be entitled “in its sole discretion and without the need for any additional shareholder approval” to appoint directors unilaterally, thus ensuring that its chosen directors always have a majority of board seats.
For my money (or lack thereof--not a penny of mine is going to Alibaba), the bigger concern is the VIE structure whereby Americans can invest. As Dealbook explains, "the company that is going public is technically an entity based in the Cayman Islands that has contractual rights to the profits of Alibaba China, but no economic interest."
The concern is that Chinese courts will fail to honor these contractual rights. Dealbook quotes a U.S. lawyer who has worked in China as saying "“It’s prohibited for foreigners to own an Internet company of any kind in China — not discouraged, but prohibited” ... “Every lawyer agrees that if this goes to court in China, those contracts are void; they’re illegal.”
In a letter to the SEC, Senator Bob Casey tried to link VIEs to fraud-plagued Chinese reverse mergers of the past. This comparison misses the mark. In a reverse mergers a shell corporations that is publicly traded acquires a pre-existing Chinese corporation. The Chinese firm avoids the IPO process entirely, hence the colloquial "back-door IPO" moniker. It turns out that many of these firms had shoddy accounting practices, and some U.S. investors got burned.
The risk of accounting fraud appears to me to be a risk that you run when investing in any publicly traded comany where you know that the firm's main asset never got that initial SEC scrutiny and, while subject to the '34 Ac'ts periodic disclosure requirements, operates overseas in a country where corruption and fraud are widespread. That seems...risky. Whereas with Alibaba you're buying into a structure knowing that the Chinese government could declare it illegal and worthless at any time. That seems...like an act of faith.
Mark Mobius of Franklin Templeton and the WSJ editorial page share my skepticism about the VIE structure. Let's see how it goes.
Back in October I posted about a fantastic conference at the University of Kentucky on the Securities Act at 80. I've just posted my article on SSRN, abstract below. Any guesses on which JOBS Act change had an effect on underwriting spreads? You'll have to download to find out!*
*OK, that was kind of obnoxious, I'll just tell you. I find a statistically significant correlation between emerging growth companies that file a confidential draft registration statement and a lower gross spread. But go read the whole thing and tell me what you think.
U.S. underwriting fees, or spreads, have somewhat inexplicably clustered around 7% for years, a phenomenon that some have suggested evidences implicit collusion. The goal of Title I the JOBS Act of 2012 was to make going public easier for smaller firms; certain provisions specifically should make the underwriters’ task less risky, and thus less expensive. Presuming these provisions are effective, then one would predict that underwriting spreads would decrease as the costs to the underwriter for a public offering declined. Admittedly the prior presumption is a big one: it may be that the JOBS Act reforms were largely ineffective, and thus could be expected to have little effect on underwriter cost. This article is the first to examine post-JOBS Act underwriting spreads to determine whether spreads have in fact declined. A finding that underwriting costs stayed constant might be evidence of either collusion or that the JOBS Act was ineffective at reducing the cost of going public. I find that one provision has lowering the spread, thus suggesting elasticity in the spread and offering at least some evidence of the Act’s effectiveness.
Good morning! Were you looking for some beach reading material as Spring Break draws nearer? I just posted my latest paper, Pricing Disintermediation: Crowdfunding and Online Auction IPOs. Were you wondering what the future holds for raising equity online after Proposed Regulation Crowdfunding? Have you ever thought that maybe the quick birth and death of the online auction IPO could inform that question? Moreover, have you ever thought that maybe the social entrepreneurship crowdfunding space might fare differently? That corporate finance might solve the mission drift problem, not corporate governance? Have I got a page-turner for you!
It's unlikely, but not impossible. Twitter was a big lobbying force for the JOBS Act provision that changed the Section 12(g) of the Exchange Act's threshold from 500 to 2000 investors. And we know from this prospectus that it went public with 755 shareholders (p. 155) of record. But 12(g) has a second threshold: you have to register under the Exchange Act if you have 500 or more unaccredited shareholders. I was curious whether Twitter would break out the number of unaccredited shareholders in its prospectus, but it doesn't. To be fair, I don't suggest it has to: the regulations don't require it, at least as far as I know.
We know Twitter was approaching that magic 500 number when JOBS was passed, but JOBS changed the rules regarding counting: employee stockholders who gain their shares via vesting of stock options don't count in the tally. Presumably once Twitter excluded these stockholders it was well under the 500 unaccredited threshold. But it would be interesting to know.
Ever had that experience of presenting a paper at a conference and coming home to a front-page WSJ article on your topic? Me neither. Until now! The paper I presented at the Kentucky symposium (which was amazing-- I felt honored to be in such company) was very much a work in progress. It asks a simple question: did the JOBS Act affect underwriter IPO fees? The question I'm still mulling over is whether we would expect it to. And behold, this morning I awoke to an article on Twitter's underwriting fees!
Telis Demos' WSJ article focuses on Twitter's "squeezing" its underwriting banks in two ways: first, by securing a $1 billion credit line from its bankers, and second, by negotiating a discount on the underwriting fee itself. Taking the second point first, in a firm-commitment IPO the underwriter buys the shares from the company at a discount, and then turns around and sells them to the public at full price. That discount, also called the gross spread, is the underwriter's overt compensation, and there's been a lot of literature about how it clusters at 7% for small and mid-sized IPOs.
The Journal reports that the banks' spread is 3.25%--not as low as Facebook's 1.1%, but pretty low. Suprisingly low? That's the question. Everyone agrees that as IPOs get bigger, the spreads should decline. It's just not that much more expensive to market a big deal versus a small deal, so economies of scale kick in. So is Twitter's low spread the function of its size, or has it really put the squeeze on the banks?
I examined U.S. IPOs from the passage of the JOBS Act through July 27, 2013. My sample excludes banks, S&Ls, REITs, ADRs, unit issuers, and closed-end funds. One problem is that Twitter is a really big IPO, with few comparables out there. During that period no emerging growth companies launched a Twitter-sized IPO (remember, Twitter is an EGC). The very biggest EGCs ranged from $430-630 million, and that spread averaged 5.67%. So 3.25% is obviously a much cheaper IPO price tag, but that could just be economies of scale kicking in.
Besides Facebook, there is one big non-EGC IPO, Zoetis, that raised north of $2.2 billion. Its spread was 3.7%. Which could suggest that perhaps Twitter did snag a deal--half the offering size, and yet a smaller discount rate. But that's just one data point, and a non-EGC company to boot. Hardly apples to apples.
Moreover, there's a lot going on with underwriting fees. As the WSJ article points out, Twitter also got what might be a sweetheart deal on its loan terms. And it might be that issuers are willing to pay more for sector expertise, or analyst coverage, marketing prowess, or plain old reputation. There's also the presence of underpricing, which may act as sub rosa compensation. And the fact that you may not want to pay rock bottom for underwriting--I don't remember anyone particularly highlighting the 1.1% spread during the fallout from Facebook's IPO debacle. But one wonders if you can cut the spread too low.
Watch for more from me on this topic once I can revise my draft. And let me know if you have any thoughts.
IPOs are hard and expensive. IPOs expose issuers to all kinds of liability pre- and post-IPO and require ongoing disclosure. The JOBS Act opened up the capital raising world by lifting private placement restrictions, most notably the ban on "general solicitation." Usha announced it just the other day here. I wondered if anyone would ever have an IPO after the ban was lifted here. So why is Twitter going through an IPO?
The alternative for Twitter is a private placement with general solicitation under Rule 506 (Reg D). But, the comparison isn't IPO v. new 506, it's the "emerging growth company" IPO v. new 506. As Usha pointed out, Twitter took advantage of the confidential registration provision of the emerging growth company exemptions. Here is a blog post from Bob Thompson summarizing other items in the registration statements that an emerging growth company can avoid. But, the registration process is still a pain, and it's still very expensive.
In a "new" 506 private placement, Twitter could tweet about its private placement all day long (unlike in an IPO pre-filing and pre-effective date) as long as it only sold to "accredited investors." I'll go out on a limb and say that most IPO shares will be sold to "accredited investors," a definition that has gone unchanged for quite a long time. With all that freedom and the same capital raising potential, it seems like a no-brainer. The only hitch would be the expanded 2000 shareholder rule. Twitter already has 2000 employees, so the probability that the number of shareholders would exceed 2000 is pretty high. But let's put that aside for now.
Even without the 2000 shareholder rule, the general solicitation 506 may not be a great idea from the perspective of the current owners of Twitter -- the VCs, the founders, the insiders. One of the benefits of an IPO is that it creates liquidity for the pre-IPO owners; in other words, they can cash out. For the founders and other early executives, the ability to cash out at least part of your holding is a great option; for the venture capital firms backing the IPO firm, cashing out is a must. However, if the shares are not registered, then shareholders would have to sell the restricted securities themselves under Rule 144, which is going to put a 1% of the public float condition on affiliates/control persons, which may encompass executives and large shareholders. Twitter's S-1 leaves blank how many shares individuals plan on selling in the IPO, but 4 officers own over 1% (Evan Williams owns 12%) and five VCs own over 5%. And, the purchasers of those shares would take them as restricted shares, so the price would be discounted for that. For cashing out, IPOs, even with lock-ups, are the better route.
"Our financial results will fluctuate from quarter to quarter, which makes them difficult to predict" (FB); "If we fail to effectively manage our growth, our business and operating results could be harmed" (GOOG);"If we are unable to maintain and promote our brand, our business and operating results may be harmed" (both); "Our corporate culture has contributed to our success, and if we cannot maintain this culture as we grow, we could lose the innovation, creativity and teamwork fostered by our culture, and our business may be harmed" (GOOG); "Our intellectual property rights are valuable, and any inability to protect them could reduce the value of our products, services and brand" (GOOG); "We are currently, and expect to be in the future, party to intellectual property rights claims that are expensive and time consuming to defend, and, if resolved adversely, could have a significant impact on our business, financial condition or operating results" (GOOG), etc.But here's a good one, which actually appears in some other S-1s, including Yelp's:
We have incurred significant operating losses in the past, and we may not be able to achieve or subsequently maintain profitability.That's definitely not puffery. There is also language about San Francisco earthquakes (also in Yelp's), and NOLs and anti-takeover devices. Perhaps those last two things may go together before the articles of incorporation are amended.
You've probably heard by now that Twitter tweeted news of its confidential submission of an S-1 for SEC review. DealProfessor Steven Davidoff laments this JOBS-Act-enabled secrecy. Broc Romanek has some thoughts, including a reflection on the amusing question of the meaning of "..." in the context of corporate communication.
I've been doing some empirical research on IPOs (of which more later) that cleared up a misunderstanding I'd had about the emerging growth company IPOs. I'm posting about it in case others labored under the same misconception. I had thought that if a company filed a confidential S-1, it was never seen--a free look, so that the first public S-1 was a polished S-1. But that's not the case. When the first official S-1 is filed, any prior confidential S-1s and amendments must be disclosed. Immediately following the JOBS Act, draft registration statements were disclosed as an exhibit to the public S-1. Now the SEC has a DRS tag to identify them. The net effect is of disclosure delayed, not disclosure denied--as long as the company eventually files a public S-1.
Unpersuaded by the reassurance that everything in the draft S-1 will eventually come out, Davidoff writes:
Yet there might be value in having the regulator’s critique of a company’s I.P.O. occurring more or less simultaneously in the public eye. For example, both Zynga and Groupon received pushback from the agency over their accounting methods. This arguably allowed the investing public to better assess the financial results...But for Zynga and Groupon, the experience probably wasn’t so great, because it led to sharp criticism of their filings and put their stock offerings on a back foot. In both cases, the S.E.C. process raised warning signs that turned out to be accurate about these companies.
But if Zynga and Groupon had used JOBS' confidential S-1 filing, the market would eventually have learned about the SEC's concerns about their accounting. I guess the question is one of how much momentum matters in a public offering, whether bad news at the outset is somehow worse than bad news once the ball is rolling. The Google IPO certainly suggests that little setbacks along the way can have a big cumulative effect, even if the IPO is a hot one.
I'm wondering if others have an opinion on this. Is disclosure delayed disclosure denied?
DealProfessor Steven Davidoff wrote a piece on SPACs yesterday that seemed unduly harsh to me. Admittedly I have a something of a soft spot for this odd duck entity, having written two papers about it (here and here).
Steven's main beef is that SPACs are good for their promoters and for hedge funds that invest in them, but maybe not for the average Joe. Let's examine those claims.
Silver Eagle Acquisition Corp.'s recent $325 million IPO is the launching point for the piece. Steven takes SPAC promoters to task for claiming, like their private equity cousins,
up to 20 percent of the equity mostly for finding the target company. The fee is similar to that of a private equity firm, as is the idea of picking a company, but a SPAC is not as safe or rewarding as private equity. SPAC investors take all of the risk in one company instead of a portfolio of companies held by a private equity firm.
As we show, however, the recent trend in SPACs has been to condition some of the 20% equity promoters receive on certain performance targets. In that respect Silver Eagle seems to be at the low end, with an "earnout" of 5% of the total equity contingent upon the stock reaching levels of $12.50 and $15.00. Many recent SPACs tie up considerably more (or all) of the promoter's equity.
Next Steven offers a little history: "In the 1980s, they were rife with fraud, and briefly disappeared from Wall Street in the wake of stricter federal regulation. But, like zombies, they reappeared in the mid-2000s. Before the credit crisis, these vehicles accounted for nearly 25 percent of all I.P.O.’s."
Steven paints with too broad brush. The 1980s were a time of bad hair, legwarmers, peerless teen movies, and blank check companies that indeed operated sketchily at best. But the SPAC was an invention of the 90s that strove to differentiate itself by offering two notable features: 1) it gave shareholders and up or down vote on any proposed acquisition, and 2) a trust account that kept shareholders' money safe. The promoters couldn't access the money unless and until the vote had occurred, and even if the acquisition was approved, they could elect to redeem their shares and get (most of) their cash back. Indeed, even if a majority of shareholders voted for the acquisition, if a lower threshold (say 25%) of the shareholders redeemed their shares, then the acquisition would fail. This supermajority veto set up unintended consequences that the form had to evolve to deal with, but the point is, SPACs have mechanisms in place to rein in the promoters.
SPACs only have 2-3 years to make an acquisition; otherwise they have to liquidate and return their cash to shareholders. Steven is absolutely right that this sets up the incentive for poor 11th hour acquisition choices. But SPACs' trust account offers unique downside protection that makes it hard to compare them with a typical stock. For example, Steven calls one SPAC's 6% return unspectacular, which is true. But that return was on a stock that promised to redeem the $10 shares for $9.97. A 6% return on a stock where the most you're guaranteed to lose is 3 cents might not be a bad deal, all things considered.
In sum, SPACs are good for promoters, but if shareholders don't like the acquisition the promoters propose, they can exit. And the trust account may offer a safe haven attractive enough to compensate for reduced return.
Over the years people have asked me what I think of SPACs as an investment, and I confess I'm still not sure. They fascinate me as in example of creative contract design that evolved quickly as the market changed. But I haven't invested any of my own money in SPACs. Then again, I'm a pretty boring, index fund investor, so you can't extrapolate too much from that!
I've been thinking about IPOs, and the potential lack thereof, quite a bit in connection with my next project. Today's WSJ decribes the current IPO market as hot:
U.S.-listed companies and their financial backers have sold $19.6 billion in stock this year, putting the IPO market on track for one of its biggest years since the financial crisis, according to Dealogic. Just 25% of this year's deals have priced below companies' expectations, the lowest since 2009.
How much of the new action is due to the JOBS Act? Not much, says DealProf Steven Davidoff. He recounts the Act's failure to do increase small IPOs:
The act was intended to help spur a moribund market in small I.P.O.’s. But for offerings that raised less than $100 million, there were actually fewer after the JOBS Act. According to Dealogic, there were an average of 15 such I.P.O.’s per quarter in the year before the new law versus an average of 13 per quarter the year after.
Which begs the question: how many IPOs (small or large) should there be, anyway? And what, if anything can or should the government do about it?