The SEC announced the next meeting of the Advisory Committee on December 17th, beginning at 9:30 a.m. The committee will focus on the interests and priorities of emerging and smaller public companies. Meetings are open to the public. Please see the notice for additional details: http://www.sec.gov/News/PressRelease/Detail/PressRelease/1370543499940#.VG5iVk10xpB.
Recently, various SEC Commissioners, including Commissioner Stein and Commissioner Gallagher, have addressed issues related to capital formation in their public remarks.
At a Los Angeles County Bar Association conference, both noted that one of the Commission’s most important objectives remains facilitating capital formation, while, of course, preserving important investor protections. In her remarks, Commissioner Stein addressed the transformational changes that have occurred to the “capital formation continuum.” She focused her remarks for the first time on how an issuer might use Regulation A+ as a financing alternative or a stepping stone, and how Rule 506 offerings might continue to provide the flexible financing option that has proven a reliable source of capital for companies at all stages of their growth. She called for “a comprehensive review and rationalization of our capital formation tools…” and suggested that a starting point might be tackling Regulation A+ and making the exemption a flexible option for issuers. In a more recent speech, at the “Live from the SEC” conference, Commissioner Stein acknowledged that “the continuum of capital formation has changed dramatically” and considered the international aspects of crowdfunded and Regulation D offerings. It is encouraging that the Commissioners are discussing the future of Regulation A+ (it’s been nearly a year since the Commission released its very thorough Regulation A+ proposed rules), and discussing financing options as existing on a continuum. Most issuers carefully weigh the costs and benefits of various financing alternatives available to them, and take into account restrictions on resales, disclosure requirements, the ability to use general solicitation or general advertising, and investor comfort or familiarity with the offering format. Rather than considering each exemption (whether existing or proposed) in isolation, taking a more holistic approach is likely to lead to a more robust range of capital formation alternatives.
The SEC has announced that the day prior to its Government Business Forum on Small Business Capital Formation, it will host jointly with the Small Business Administration to highlight additional ways that small businesses may seek to raise funds. See announcement for details regarding the November 19 event: http://www.sec.gov/News/PressRelease/Detail/PressRelease/1370543438456#.VGkj6010ziM.
The SEC also announced the detailed agenda for the Forum on November 20 (see: http://www.sec.gov/info/smallbus/sbforum112014-agenda.htm), which will include discussions regarding private secondary markets, the accredited investor definition, and various breakout sessions.
On November 19, 2014, join Morrison & Foerster for an afternoon of pre-SEC small business forum briefings on the state of legislation, regulation and policy implementation impacting small business finance at the 2014 Growth Capital Summit.
Partner David Lynn will be participating on a panel entitled “JOBS Act: Title II Implementation” and Partner Anna Pinedo will speak on a panel entitled “Challenges for Public Emerging Growth Companies.”
For more information about this event, or to register, please visit http://www.growthcapitalsummit.com/.
A new report released last week by PwC US analyzed the use of non-GAAP measures (NGMs) in IPOs and found that nearly 60% of the IPOs surveyed included at least one NGM, and approximately 95% of IPOs with NGMs included between one and three NGMs in their filing. PwC surveyed over 400 IPOs completed between 2011 and 2013. The most commonly used NGMs related to earnings before interest, income taxes, depreciation and amortization (EBITDA), with Adjusted EBITDA and EBITDA being included in 46% and 19% of filings, respectively. As figure 1 illustrates, a variety of NGMs were found to be used, with the study noting that 22% of IPOs used a NGM that appeared in less than 2% of filings. The report also found that companies in industries such as Banking & Capital Markets, Oil & Gas, Media & Communications, Technology, Asset Management and Real Estate chose to either modify NGMs used by other companies or define their own, making it difficult to compare NGMs between companies, even for those within the same industry. The PwC study supports the SEC’s frequently expressed concern about noncomparability and raises some questions on the analytic usefulness of non-comparable NGMs. The full report can be found here.
Source: PwC US, “How non-GAAP measures can impact your IPO,” October 29, 2014
Source: PwC US, “How non-GAAP measures can impact your IPO,” October 29, 2014
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An academic study titled “The Silicon Valley Venture Capitalist Confidence Index®: Third Quarter—2014” (Mark V. Cannice, Ph. D, Department Chair and Professor of Entrepreneurship and Innovation with the University of San Francisco School of Management) provides interesting insight into professional venture capitalists’ confidence levels and opinions with respect to the future of the high-growth venture entrepreneurial environment in the San Francisco Bay Area over the next 6-18 months. The results of the Silicon Valley Venture Capitalist Confidence Index® for the third quarter of 2014 (based on a September 2014 survey of 33 San Francisco Bay Area venture capitalists) registered a 3.89 on a 5 point scale (with 5 indicating high confidence and 1 indicating low confidence).
The study notes that Silicon Valley venture capitalists’ confidence has fallen in the third quarter of 2014 compared to the index reading of 4.02 for the second quarter of 2014. The paper notes that this decline in sentiment comes amid strong but declining levels of venture-backed IPOs and investment from the previous and year-earlier quarters. The study cites data from an October 17th press release by Thomson Reuters and the National Venture Capital Association that reported 23 venture-backed IPOs valued at $2.6 billion in the third quarter of 2014. Despite this apparent decline in the confidence level of Silicon Valley venture capitalists, several respondents maintain that opportunities for innovation remain strong in sectors such as mobile payments, big data, cloud computing, crypto currency and fintech. The study concludes that the venture capitalists’ confidence levels declined in the third quarter of 2014, ending a two-year upward trend in sentiment due to worries of inflated valuations and broader concerns relating to the VC business model; however, the report finds that a “strong if moderating exit market” for venture-backed businesses still remains, particularly for business that adopt the principles of “disruptive innovation,” helping to keep venture-capitalists confidence at a relatively high level.
The full report can be found here.
For technology and other start-ups, going public can be doubly taxing—literally.
“Traditionally, a pre-IPO company is structured as a C corporation, which is legally subject to two tax layers, the first assessed on income earned by the entity, and then again on historic partners and other shareholders when selling stock or receiving dividends,” says New York-based Morrison & Foerster tax partner Remmelt Reigersman. “Setting up initially as a limited liability company keeps it to one layer—as a pass-through, the entity is not taxed—except that when it comes time to go public, the partnership is treated as a corporation and taxed accordingly.”
While this double dip may appear unavoidable, an innovative technique known as “Up-C” leverages the LLC advantage to help pre-IPO companies achieve significant tax savings and favorable deal economics while preserving control for the founding partners.
“Named after UPREIT, an umbrella structure originated by real estate investment trusts, or REITs, Up-C establishes a new corporation above the historic partnership, which retains all of the business assets—and the LLC tax advantage—as its subsidiary,” says Anna Pinedo, a New York-based Morrison & Foerster securities partner. “The new entity is the one then used for the IPO, downstreaming the proceeds to the LLC.”
As Pinedo explains, Up-C provides upside for everyone. “To maintain control of the business, historic partners must control the PubCo, which is achieved by dual-stock issuance,” she says. “Sold to public investors, Class A shares generate the cash and look after the economic side of the deal, while Class B shares give voting rights in PubCo to the founding partners.”
The deal includes an “Income Tax Receivable Agreement” between the partners and PubCo. “PubCo purchases partnership units from the founders using proceeds from the IPO,” Pinedo explains. “Differing from a traditional stock purchase, this method under Up-C creates a step-up in the tax basis, which in turn permits the partners and PubCo to take significant depreciation and amortization deductions over time. PubCo then pays the founders the majority, typically 85 percent, of the federal and state benefits it has gained from the step-up.”
Complicated, yes, but put to numbers, this translates into some very attractive economics. “Say the tax basis step-up is valued at $300 million, with an annual amortization of $20 million over 15 years,” offers Reigersman. “Assuming a combined federal and state tax rate of 40 percent, that saves PubCo $8 million a year while paying the historic partners $6.8 million annually—or $102 million over time.”
Up-C is not for everyone. “From an administrative and compliance perspective, this structure is far more involved than going public via the traditional route,” Reigersman says. “But for larger companies, especially, it can be very effective.”
This article was originally published in the Fall/Winter 2014 edition of MoFo Tech, available here.
The SEC recently announced that the annual Government-Business Forum on Small Business Capital Formation will be held on November 20th at the SEC in Washington. The morning session of the forum will feature panel discussions on the definition of an accredited investor and secondary market liquidity for securities of small businesses. During the afternoon session, as in prior years, participants will formulate specific policy recommendations. The policy recommendations emerging from the Forum in the past have eventually found their way into proposed or new regulations.