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.
FINRA recently filed proposed rule changes with the SEC addressing when broker-dealers may pay referral fees or otherwise share compensation with persons who are not registered as broker-dealers. The proposed rule changes are subject to the SEC’s approval. If approved, new Rule 2040 and related conforming changes to other FINRA rules will go into effect 45 to 90 days after publication in the Federal Register.
To read more, see our client alert.
Join Morrison & Foerster on October 28, 2014 for our Communications Rules and Public Companies seminar, a part of our MoFo Classics Series. During this session, we will focus on the existing communications safe harbors under the Securities Act available to private companies contemplating an IPO or other financing and those available to seasoned public companies. We will discuss:
- Concerns about press releases and research reports in proximity to an offering;
- Non-deal roadshows;
- Regulation FD;
- The “bad news” doctrine; and
- Research reports.
Registration & Breakfast: 8:15 – 8:30 am EST
Presentation: 8:30 – 9:45 am EST
New York and California CLE credit is pending.
To register for the event, please email Harrison Lawrence at email@example.com
The SEC’s Investor Advisory Committee recommended on Thursday that the definition of “accredited investor” in Rule 501(a) under the Securities Act undergo some significant changes. The Committee was established pursuant to the Dodd-Frank Act with a mandate to consider revisions to the accredited investor standards.
The Committee’s recommendations reflect concerns that the current definition is not protecting investors that meet the financial thresholds from investing in instruments for which they do not have the financial sophistication to evaluate, and, at the same time, excluding investors who are financially sophisticated enough to make their own decisions about private investments from participating in offerings because they do not meet the rule’s financial thresholds. For example, it was suggested that having a FINRA Series 7 license is a good indicator that a potential investor is capable of assessing the risks of an investment in a private placement, notwithstanding whether that individual met the financial thresholds.
The Committee also recommended that the SEC consider allowing third parties to determine accredited investor status, rather than placing the burden solely on issuers, and that more protections be put in place for non-accredited investors allowed to purchase in Rule 506 offerings pursuant to the advice of a purchaser representative. The Committee noted that purchaser representatives may have conflicts of interests with their non-accredited investor clients and may not have a clear legal obligation to act in those investors’ best interests.
On October 14, 2014 at 11:00 am EST, Morrison & Foerster Of Counsel Scott Ashton and Partner Brian Bates will participate in an IFLR Webinar on cross-border private placements. The cross-border private placement market continues to grow, providing non-U.S. issuers with an opportunity to raise capital from U.S. insurance companies, pension funds and other institutional investors, as well as European institutions. The robust market, which is nearing $50 billion in the U.S. alone, has attracted issuers across industries and jurisdictions that seek to diversify their funding or supplement their bank lending and raise longer-term debt. In this webinar, speakers will discuss:
- The global private placement market and recent trends;
- Market participants;
- Documentation requirements;
- Traditional covenants and model forms;
- Marketing process;
- Ratings and the NAIC; and
- Secondary transfers.
Morrison & Foerster is offering participants 1.0 New York CLE credit for attendance.
To register for this event, please click here: https://www.brighttalk.com/webcast/570/119473.
Last week, the SEC Staff posted the following C&DI relating to Rule 147 compliance when an issuer uses its own website in connection with a securities offering.
Question: Can an issuer use its own website or social media presence to offer securities in a manner consistent with Rule 147?
Answer: Issuers generally use their websites and social media presence to advertise their market presence in a broad and open manner so that information is widely disseminated to any member of the general public. Although whether a particular communication is an “offer” of securities will depend on all of the facts and circumstances, using such established Internet presence to convey information about specific investment opportunities would likely involve offers to residents outside the particular state in which the issuer did business.
We believe, however, that issuers could implement technological measures to limit communications that are offers only to those persons whose Internet Protocol, or IP, address originates from a particular state or territory and prevent any offers to be made to persons whose IP address originates in other states or territories. Offers should include disclaimers and restrictive legends making it clear that the offering is limited to residents of the relevant state under applicable law. Issuers must comply with all other conditions of Rule 147, including that sales may only be made to residents of the same state as the issuer. [October 2, 2014]