On May 24, 2016, the Biotechnology Innovation Organization (BIO) published a study, “Emerging Therapeutic Company Investment and Deal Trends,” which collects ten years of data to identify trends affecting “emerging therapeutic companies” (“ETCs”). ETCs are companies that are (1) developing therapeutics with a lead drug in research and development (“R&D”), or (2) have a drug on the market, but have less than $1 billion in sales at the time of the transaction.
The study focuses on venture capital, initial public offerings (“IPOs”), follow-on public offerings, licensing, and acquisitions.
Venture Capital Trends
Venture funding reached a record high of $6.8 billion during 2015, which included the largest biotech venture capital deal on record, raising $446 million. The study also found that Series A financing nearly doubled from 2014 to 2015. The study found that nearly 70% of venture capital funding in 2015 went to early-stage companies and nearly $2 billion was invested in oncology companies. Although oncology companies were successful in obtaining venture capital funding, the study found that funding was inconsistent across disease areas, as companies in certain disease areas have not rebounded well since the financial crisis.
The study found that IPOs for ETCs were strong during 2015, with 39 companies going public. The study found that a positive effect of the JOBS Act has been the increase in the average amount raised per IPO for R&D stage companies from $68 million in 2012 to $90 million in 2015. Another trend that the study identified was that the clinical development stage that ETCs are in at the time of their IPOs has shifted in recent years. In the years approaching the financial crisis, there were no Preclinical or Phase I company IPOs in the United States, yet during 2012 to 2015, there were 34 such IPOs. According to the study, this shift in IPO activity may represent an increased preference for investing in early-stage companies. When considering the disease type for companies that have obtained IPO financing, the study noted that neurology companies raised $1.05 billion, the highest amount of capital across disease type.
The study also found that: (1) during 2014 to 2015, follow-on public offerings by ETCs increased from $8.9 billion to $16.1 billion; and (2) licensing proved to be a critical aspect of capital raising (reaching a record high of $7.1 billion) and an alternative investment strategy to acquisitions, as 38% of all ETCs partnered during 2015.
A copy of the study is available at: https://www.bio.org/sites/default/files/BIO_Emerging_Therapeutic_Company_Report_2006_2015_Final.pdf
Yesterday, May 24, 2016, the Staff of the Securities and Exchange Commission published a Small Entity Compliance Guide that is intended to help issuers navigate the changes to the Exchange Act Section 12(g) threshold in light of the JOBS Act and the FAST Act and the adoption by the Commission on May 3, 2016 of rules implementing the mandates of those two acts.
The Small Entity Compliance Guide provides an overview of the new Section 12(g) thresholds triggering registration, the new “held of record” definition, and the rules related to termination of registration.
Here is a link to the guide: https://www.sec.gov/info/smallbus/secg/jobs-act-section-12g-small-business-compliance-guide.htm.
On May 13, 2016, the SEC issued new Compliance and Disclosure Interpretations (“C&DIs”) on Rules 100 (Crowdfunding Exemption and Requirements), 201 (Disclosure Requirements), 204 (Advertising) and 205 (Promoter Compensation) of Regulation Crowdfunding. Highlights of the C&DIs include the following:
- Information not constituting an offer of securities may be disseminated by an issuer prior to the commencement of an offering.
- The investment limits under Rule 100(a)(2) apply to all investors, including non-natural persons.
- If an offering is conducted during the period from inception until 120 days after reaching the annual balance sheet date for the first time, the issuer must include a balance sheet as of a date in that period, which may be the inception date. For an offering conducted more than 120 days after the issuer’s first annual balance sheet date, the date of the most recent annual balance sheet determines the period for which statements of comprehensive income, cash flows and changes in stockholders’ equity must be provided.
- An issuer may advertise the “terms of the offering,” but any such advertising that is made other than through communication channels provided by the intermediary on the intermediary’s platform will be limited to notices that include no more than the information described in Rule 204(b). “Terms of the offering” is defined to include the amount of securities offered, the nature of the securities, the price of the securities and the closing date of the offering period.
- The limitation on advertisement under Rule 204(b) applies only when the advertisement includes any of the “terms of the offering.”
- When an issuer is compensating a third party to promote the issuer’s offering outside of the intermediary’s communication channels, third-party communications need to comply with the notice requirements of Rule 204(b).
The SEC also published its Small Entity Compliance Guide for Crowdfunding Intermediaries, Small Entity Compliance Guide for Issuers and Small Entity Compliance Guide for Funding Portals. In these guides, the SEC summarizes, among other things, the registration and disclosure requirements, prohibited activities and applicable safe harbors for crowdfunding intermediaries and the registration and disclosure requirements, limits on advertising and promoters, restrictions on resales, exemption from Exchange Act Section 12(g) and bad actor disqualification for issuers.
The C&DIs are available at: https://www.sec.gov/divisions/corpfin/guidance/reg-crowdfunding-interps.htm
The Small Entity Compliance Guide for Crowdfunding Intermediaries is available at: https://www.sec.gov/divisions/marketreg/tmcompliance/cfintermediaryguide.htm
The Small Entity Compliance Guide for Issuers is available at: https://www.sec.gov/info/smallbus/secg/rccomplianceguide-051316.htm
The Small Entity Compliance Guide for Funding Portals is available at: https://www.sec.gov/info/smallbus/secg/rccomplianceguide-051316.htm
In a structure commonly referred to as an “up‑C,” an existing LLC or other partnership form undertakes a public offering through a newly formed corporation, which is structured as a holding company that owns an interest in the LLC. Traditionally, if the owners wanted to undertake a public offering of the entity’s securities, the owners would re-organize the LLC or partnership as a corporation and offer and sell that company’s common stock to the public in the offering. Increasingly, owners are employing the up‑C structure as an alternative. Use of the up‑C approach allows the LLC or other entity to undertake a public offering, albeit through a holding company, while maintaining the partnership status for the LLC, where the principal assets and operations of the business remain. This structure is particularly attractive to private equity-backed companies because it maintains many of the tax benefits of a partnership, offers an ongoing exit strategy, and enables the sponsors to preserve some control over the business.
For more information, see our “Practice Pointers on the Up-C Structure” available at: http://www.mofo.com/~/media/Files/Articles/2016/05/160500PracticePointersUpCStructure.pdf
With the enactment of the Jumpstart Our Business Startups (JOBS) Act of 2012, private companies have the ability to defer an IPO and SEC reporting, and remain private longer than at any time in the past. One result, however, is that shareholders and employees of these companies now face a much longer wait time for public liquidity, a fact that negatively impacts private company capital formation and job creation. The RAISE Act, which was signed into law on December 4, 2015, establishes Section 4(a)(7) under the Securities Act of 1933, a new federal securities exemption for resales of unregistered securities by private company shareholders seeking to obtain pre-IPO liquidity.
Section 4(a)(7) clears away much of the previous uncertainty around resales of private company shares, such as whether employees exercising vested options could simultaneously sell the underlying common stock and use those proceeds to cover their option exercise and income tax costs. Section 4(a)(7) transactions are also exempt from state law, eliminating the need to work through the complexities created by inconsistent state resale exemptions. In order for a seller to rely on Section 4(a)(7), all buyers must be accredited investors, the seller cannot generally solicit investor interest, and the seller cannot be a “bad actor” as defined under the exemption. In addition, the exemption requires that a range of disclosure, from the name of the company to two years of US GAAP financial statements, be provided to sellers and buyers in order for the exemption to be available to sellers.
To get a sense of whether private companies would be willing to provide the required disclosures under this new law, we analyzed each of the secondary liquidity programs facilitated by our technology platforms during the past two years ($3.2 billion in total transaction volume) to determine whether the level of disclosure provided by private companies in those programs would have satisfied the information requirements under Section 4(a)(7). We found that the majority of the Section 4(a)(7) disclosure requirements had in fact been made available by issuers in those programs. Most interestingly, we found that private companies provided two years of US GAAP financial statements to shareholders using our platform in 75% of liquidity programs. The complete results of our analysis, available here, led us to believe that private companies sponsoring a liquidity event will likely be willing to provide the required disclosures necessary to satisfy the new exemption.
In addition, based on NASDAQ Private Market’s discussions with key Congressional members and staff involved in the drafting and passage of the RAISE Act, we compiled a series of frequently asked questions regarding the new safe harbor, available here, to help provide clarity around the requirements of the new safe harbor, which we believe to be a pivotal development for private companies and their shareholders.
Annemarie Tierney is the Vice President, Head of Strategy and New Markets at NASDAQ Private Market.
On May 23, 2016, the House passed H.R. 4139, the Fostering Innovation Act, by voice vote. The bill had passed the House Financial Services Committee on March 2, 2016.
H.R. 4139 proposes to extend the temporary auditing exemption for emerging growth companies for five years, in order for EGCs to comply with Section 404(b) of the Sarbanes-Oxley Act. This bill serves as a way of alleviating the burdensome costs that smaller public companies incur when having to comply with Section 404(b). This would, in turn, allow these companies to focus their resources on growth, rather than on these compliance costs.
Financial Services Committee Chairman Jeb Hensarling commented on the passing of this and other bills and stated: “I believe most of us would agree that our economy works better for all Americans when small businesses can focus on creating jobs rather than navigating bureaucratic red tape.”
While H.R. 4139 passed with strong bipartisan support, Investor Advocate Rick Fleming had urged members of Congress to vote against it. In a letter to Speaker of the House, Paul Ryan, and to Minority Leader, Nancy Pelosi, Fleming warned that passing H.R. 4139 would “chip away” at the protections set in place by Sarbanes-Oxley, ones set in place as a “second set of eyes” in order to prevent another scandal that would affect American investors. Additionally, Fleming states that H.R. 4139 would further compound the complexity of U.S. securities laws/reporting requirements by creating another category of issuer.
On May 17, 2016, Fortune Magazine published an article by Geoff Colvin, “Take This Market and Shove It,” examining the growing trend of companies staying private rather than opting for an IPO. The article notes that while the total number of U.S. companies continues to grow, the number that are traded on stock exchanges has plunged 45% since peaking 20 years ago, and that IPOs, once an indicator of U.S. business dynamism, dried up after the dot.com bust in 2000 and have never fully recovered, even though today’s economy is far larger. The article provides various explanations for why some public companies are returning to private ownership and many other companies are simply staying private, while public companies are increasingly becoming fewer and bigger. Although going or staying private allows companies to invest for the long-term and focus on their businesses rather than Wall Street expectations, the article notes that another important driving force has been the increasing fear of activist investors. Other significant factors noted by the article include the following:
- A decreasing reliance of companies on physical assets (e.g., factories and machinery), resulting in a decreasing reliance on IPOs for broad-based financing.
- All-time low interest rates, resulting from a savings glut and easy monetary policies across the globe, and the tax deductibility of interest payments.
- The high costs associated with going public. Underwriting and registration costs average 14% of the funds raised and offerings are usually underpriced by on average 15% in order to produce a first-day “pop.” Public companies also face additional rules, notably those imposed by the Sarbanes-Oxley of 2012 and the Dodd-Frank Act. In addition, public company disclosures are replete with information for competitors to study.
- The ability of PE firms to provide broad managerial advice to private companies. In addition, public companies suffer from the so-called agency problem (the misalignment of owners and managers), which does not arise in private companies because the majority owners are usually either the managers themselves or members of a powerful board of directors.
- Private ownership is also attractive to managers because executive compensation is not publicly reported.
The article also refers to an informal online survey indicating that 77% of CEOs think it would be easier to manage their company if they were private rather than public and that only 8% of CEOs thought that they did not have all of the cash they needed to fund investments.
A copy of the article is available at: http://fortune.com/going-private/
On May 16, 2016, the North American Securities Administrators Association (NASAA) released for public comment its proposed model rule and uniform notice filing form for crowdfunded offerings. The proposed model rule would require the filing with the regulators of participating states a short form with basic information about the issuer and the crowdfunded offering, along with the payment of a filing fee and the filing of a consent to service of process. The uniform notice filing form permits the incorporation by reference of documents filed with the SEC on EDGAR and includes a consent for service of process within the form itself. Issuers would file the form in those participating states where the issuer holds its principal place of business or where 50% or greater of the aggregate amount of the crowdfunded offering has been purchased by residents of the participating state. Alternatively, issuers can opt to file all materials filed with the SEC in connection with the crowdfunded offering, together with a completed consent to service of process on Form U-2.
The NASAA’s notice of request for public comment on its proposed model rule is available at:
On May 17, 2016, the staff of the SEC Division of Corporation Finance (the “Staff”) issued 12 new Compliance & Disclosure Interpretations (“C&DIs”) on the use of non-GAAP financial measures, which has recently been an area of concern for the SEC. The C&DIs cover a variety of topics, including compliance with Rule 100(b) of Regulation G, compliance with Item 10(e) of Regulation S-K, and the use of EBIT and EBITDA. Highlights of the C&DIs include, among other things, the following guidance:
- Certain adjustments, although not explicitly prohibited, may violate Rule 100(b) of Regulation G because they cause the presentation of the non-GAAP measure to be misleading.
- A non-GAAP measure be misleading if it is presented inconsistently between periods.
- Non-GAAP measures that substitute individually tailored revenue recognition and measurement methods for those of GAAP could violate Rule 100(b) of Regulation G.
- The prohibition under Item 10(e) of Regulation S-K of adjusting a non-GAAP financial performance measure to eliminate or smooth items identified as non-recurring, infrequent or unusual is based on the description of the charge or gain that is being adjusted.
- Item 10(e) of Regulation S-K recognizes that certain non-GAAP per share performance measures may be meaningful from an operating standpoint. Whether per share data is prohibited depends on whether the non-GAAP measure can be used as a liquidity measure, even if management presents it solely as a performance measure.
- The deduction of capital expenditures from the GAAP financial measure of cash flows from operating activities would not violate the prohibitions in Item 10(e)(1)(ii) of Regulation S-K. However, companies should provide a clear description of how this measure is calculated, as well as the necessary reconciliation, should accompany the measure where it is used.
- Although whether a non-GAAP measure is more prominent than the comparable GAAP measure generally depends on the facts and circumstances in which the disclosure is made, the Staff would consider the following examples of disclosure of non-GAAP measures as more prominent:
- Presenting a full income statement of non-GAAP measures or presenting a full non-GAAP income statement when reconciling non-GAAP measures to the most directly comparable GAAP measures;
- Omitting comparable GAAP measures from an earnings release headline or caption that includes non-GAAP measures;
- Presenting a non-GAAP measure using a style of presentation that emphasizes the non-GAAP measure over the comparable GAAP measure;
- A non-GAAP measure that precedes the most directly comparable GAAP measure;
- Describing a non-GAAP measure as, for example, “record performance” or “exceptional” without at least an equally prominent descriptive characterization of the comparable GAAP measure;
- Providing tabular disclosure of non-GAAP financial measures without preceding it with an equally prominent tabular disclosure of the comparable GAAP measures or including the comparable GAAP measures in the same table;
- Excluding a quantitative reconciliation with respect to a forward-looking non-GAAP measure in reliance on the “unreasonable efforts” exception in Item 10(e)(1)(i)(B) of Regulation S-K without disclosing that fact and identifying the information that is unavailable and its probable significance in a location of equal or greater prominence; and
- Providing discussion and analysis of a non-GAAP measure without a similar discussion and analysis of the comparable GAAP measure in a location with equal or greater prominence.
- A registrant should provide income tax effects on its non-GAAP measures depending on the nature of the measures.
- If a company presents EBIT or EBITDA as a performance measure, such measures should be reconciled to net income as presented in the statement of operations under GAAP.
A copy of the new C&DIs is available at: http://www.mofo.com/~/media/Files/PDFs/160518NonGAAPCDIs.pdf