Emerging Growth Companies

Citibank’s recently released year-end report on depositary receipts (DR) reported that in 2017, $15.6 billion of DR capital was raised across 65 deals, which was a 126% year-over-year change in total capital raised versus 2016 and a 91% year-over-year change in number of capital raisings. The European, Middle East and Africa region saw a total of 28 deals, raising $4.4 billion; the Asia-Pacific region raised $7.0 billion across 29 deals; and the Latin America region raised $4.2 billion across 8 deals.

The report also notes that DR IPOs raised $9.4 billion in 2017, which was a 145% change from 2016.  24 issuers were able to take advantage of JOBS Act accommodations to complete their IPOs.  There was also $6.2 billion of DR follow-on activity in 2017, which was a 101% change from 2016.  $12.8 billion was raised in American depositary receipts (ADR) and $2.8 billion was raised in global depositary receipts (GDR).

The energy, software and services and the financial services sectors were the top three sectors for DR IPOs in 2017 raising $1.57 billion, $1.54 billion and $1.48 billion respectively.  For follow-on offerings, the top three sectors included financial services, raising $1.87 billion, pharmaceuticals/biotech, raising $1.43 billion, and software and services, raising $681 million.

For additional 2017 DR trends, see Citi’s annual report: https://depositaryreceipts.citi.com/adr/common/file.aspx?idf=4354

On August 25, 2016, the SEC’s Division of Corporation Finance (“Corp Fin”) updated its Financial Reporting Manual by making the following changes:

  • Adding a new section describing communications with Corp Fin’s Office of Chief Accountant (“CF-OCA”).
  • Clarifying that questions regarding the application of guidance on abbreviated financial statements to a predecessor entity should be directed to the CF-OCA (Section 2065).
  • Making corresponding changes in light of the Compliance and Disclosure Interpretations (“C&DIs”) relating to the omission of financial information from draft and filed registration statements (Sections 10220.1 and 10220.5).
    • The updates to Section 10220.1 refer to recently issued Securities Act C&DI Question 101.4 and note that Securities Act C&DI Question 101.05 addresses similar matters for non-EGC issuers.  Question 101.04 clarifies that an EGC may omit from its draft registration statements interim financial information that it reasonably believes it will not be required to present separately at the time of the contemplated offering.  Question 101.05 clarifies that an issuer that is not an EGC may omit from its draft registration statements interim and annual financial information that it reasonably believes it will not be required to present separately at the time it files its registration statement publicly.  For more information regarding Questions 101.01 and 101.05, see our prior blog post.
    • The updates in Section 10220.5 refer to FAST Act C&DI Question 2, which clarifies that an EGC may omit financial statements of other entities from its filing or submission if it reasonably believes that those financial statements will not be required at the time of the offering.

The updates to the Financial Reporting Manual are available here.

The IPO Task Force seems to have come together again.  The Center for Capital Markets released a letter dated August 22, 2017 addressed to the Treasury Secretary setting out a few suggestions, which are quite similar to those that had been advanced a few years ago, and that have as their objective increasing the number of public companies.  The suggestions include:

  • Extending the Title I JOBS Act on-ramp accommodations from five to ten years for EGCs and reviewing the EGC definition;
  • Making the JOBS Act accommodations available to all issuers, not just EGCs;
  • Modernizing the Sarbanes-Oxley internal control over financial reporting requirements;
  • Modernizing securities disclosure requirements;
  • Addressing the rules related to shareholder proposals and regulating proxy advisory firms;
  • Promoting equity market structure changes that enhance liquidity for EGC and small cap stocks; and
  • Incentivizing research coverage.

A bit of additional commentary on these suggestions is offered in the letter, which may be found here: http://www.centerforcapitalmarkets.com/wp-content/uploads/2017/08/Follow-Up-Letter-to-July-28-Roundtable-on-Access-to-Capital.pdf?x48633

Practical Law Company recently reviewed trends in the U.S. IPO market for the first half of 2017.  In the first five months of 2017, 46 IPO issuers identified themselves as emerging growth companies (EGCs). Under the JOBS Act, EGCs are able to confidentially submit draft registration statements prior to a public filing. Of the 46 EGC IPOs issuers, all but one submitted draft registration statements to the SEC. The first public filing followed, on average, 141 days after their draft filing. 12 of the 46 EGC IPO issuers were foreign private issuers (FPIs) and also submitted confidential draft registration statements.

Of the 46 EGC IPO issuers, 31 included two years of audited financial statements. For EGCs, including two instead of three years of audited financial statements is permitted under the JOBS Act. 14 EGC issuers included three years of audited financials, opting not to take advantage of the JOBS Act accommodation. Six FPIs elected to prepare their financial statements following the International Financial Reporting Standards (IFRS), while the other six opted for the US’s Generally Accepted Accounting Principles (GAAP).

To read Practical Law’s full article, click here.

Amongst other limitations, an issuer will cease to be considered an “emerging growth company” as defined in Section 2(a)(19) of the Securities Act and unable to take advantage of the accommodations for such issuers set forth in the Jumpstart Our Business Startups Act if it has issued more than $1.0 billion of non-convertible debt securities over a rolling three-year period (not limited to completed calendar or fiscal years).  In general, all non-convertible debt securities issued over the prior three-year period, whether outstanding or not, are required to be counted against the $1 billion debt limit.  “Non-convertible debt” in this context means any non-convertible security that constitutes indebtedness, whether issued in a registered offering or not.  In calculating whether an issuer exceeds this $1 billion debt limit, the SEC Staff has interpreted all non-convertible debt securities issued by an issuer and any of its consolidated subsidiaries, including any debt securities issued by such issuer’s securitization vehicles, to count against the $1 billion debt limit.  As a result, asset-backed securities that are considered non-recourse debt and consolidated on a parent issuer’s financial statements for accounting purposes should be included when calculating the applicability of the $1 billion debt limit.  However, the SEC Staff does not object if an issuer does not count debt securities issued in an A/B exchange offer, as these debt securities are identical to (other than the fact that they are not restricted securities) and replace those issued in a non-public offering.

During 2016, there were relatively few companies that completed initial public offerings (“IPOs”). Some commentators attribute the dearth of IPOs in 2016 to volatility arising from, among other things, Brexit and the U.S. Presidential election. Others point to the continuing trend of successful companies remaining private longer and continuing to benefit from attractive valuations in private financing rounds without facing the burdens associated with becoming Securities and Exchange Commission (“SEC”)-reporting companies.

In this year’s survey, we consider the characteristics of the emerging growth companies (“EGCs”) that completed IPOs and the corporate governance, compensation and other practices adopted by them. Specifically, we examined the filings of (i) the approximately 680 EGCs (on an aggregated basis) that completed their IPOs in the period from January 1, 2013, through December 31, 2016, and (ii) the 100 EGCs (on a standalone basis) that completed their IPOs during the year ended December 31, 2016. The survey focuses on EGCs that have availed themselves of the provisions of Title I of the Jumpstart Our Business Startups Act (“JOBS Act”). This year is anticipated to be a more active year for IPOs. Our objective is to provide data that will be useful to you in assessing whether your company’s current or proposed corporate governance practices are consistent with EGC market practice.

Read the 2017 review.

Recently, the Investor Responsibility Research Center Institute (IRRCi) published a follow-up to its initial 2012 study on “controlled” companies, entitled “Controlled Companies in the Standard & Poor’s 1500: A Follow-up Review of Performance & Risk.”  A “controlled” company is one in which more than 50% of the voting power for the election of directors is held by an individual, a group or another company (Nasdaq Equity Rule 5615(c)(1) and NYSE Listed Company Manual §303A.00).  The follow-up study analyzes the long-term performance and risk profiles of controlled companies in the S&P 1500 Composite Index as of July 31, 2015.  Some key findings include:

  • The number of controlled companies in the S&P 1500 decreased by 8% between 2012 and 2015.
  • Nearly 70% of controlled companies operated in one of three sectors: Consumer Discretionary (40%), Industrials (16.2%) and Consumer Staples (12.4%).
  • From 2005 to 2015, the average market cap of controlled companies increased from $8.3 billion to $20.6 billion.
  • Controlled companies with multiple classes of stock underperformed compared to non-controlled companies with respect to total shareholder returns, revenue growth, return on equity and dividend payout rations.  However, controlled companies outperformed non-controlled companies with respect to return on assets.
  • Director tenures at controlled companies were longer than at non-controlled companies.  The proportion of controlled companies where board members averaged at least 15 years of board service was more than 17% higher than at non-controlled companies.  Almost 80% of controlled companies also had no new nominees on their boards – roughly 10% higher than at non-controlled companies.
  • Women and minority directors were less common at controlled companies compared to non-controlled companies.
  • A lower proportion of board members had financial expertise at controlled companies compared with non-controlled companies.
  • Average CEO pay at controlled companies with a multi-class capital structure was three times higher (by approximately $7.2 million) than at single-class controlled companies and was more than 40% higher (by approximately $3.3 million) than at non-controlled companies.

The follow-up study references our recent survey of 580 emerging growth companies (“EGCs”) that completed IPOs between 2013 and 2015, entitled “Getting the Measure of EGC Corporate Governance Practices: A Survey and Related Resources.”  The follow-up study found that IPOs of companies with multiple classes of voting stock has increased in absolute numbers but declined in percentage terms over the study period (2012-2015) and that the size of these offerings has soared and, as such, investors’ market exposure to their potential risks appears to be rising.  In contrast, our EGC survey found that the percentage of EGC IPOs involving controlled companies declined slightly in 2015 (16.9%) compared to the period between 2013 and 2014 (17.1%) and the percentage of EGC IPOs involving multi-class capital structures increased in 2015 (18.1%) compared to the period between 2013 and 2014 (13.8%).  In addition, the existence of a multi-class capital structure does not necessarily mean by itself that a company is controlled.  There are other trends among EGCs (including controlled and non-controlled companies) that are generally beneficial for shareholders, such as a decrease in “super majority” shareholder voting provisions (71% in 2015 compared to 75% in 2013-2014), a decrease in provisions permitting shareholder action by written consent (25% in 2015 compared to 51% in 2013-2104), and an increase in separation of the CEO and Chairman positions (67% in 2015 compared to 60% in 2013-2104).

The IRRCi follow-up study is available at: http://irrcinstitute.org/wp-content/uploads/2016/03/Controlled-Companies-IRRCI-2015-FINAL-3-16-16.pdf.

Our EGC survey is available at: http://media.mofo.com/docs/pdf/150507-EGC-Survey/#?page=0.

Our 2016 survey, Getting the Measure of EGC Corporate Governance Practices, provides an overview of the choices made by EGCs that undertook initial public offerings during 2014 and 2015 insofar as capital structure, exchange listing, governance policies and procedures, board composition, compensation, and various other matters. A number of charts and resources accompany this year’s survey.

Read the 2016 review.

The SEC recently proposed amendments to require disclosure of whether employees and directors of public companies are permitted to hedge or offset any decrease in the market value of equity securities granted to them as part of a stock-based compensation plan or that are held by them.  The proposed amendments were necessary in order to implement Section 14(j) of the Exchange Act, as required by Section 955 of the Dodd-Frank Act.  In its proposing release, the SEC indicates that it intends to apply the disclosure requirement to smaller reporting companies and EGCs.  The release notes that consideration was given to exempting or delaying the application of the proposed amendments for EGCs.

In the analysis of costs and benefits, the proposing release notes that employees and directors of EGCs potentially face greater downside price risk than those of non-EGCs, thereby making disclosures relating to hedging activities by employees and directors more valuable to shareholders and potential investors.  The analysis also estimates that the compliance costs for EGCs than for seasoned issuers (already preparing Compensation Disclosure & Analysis sections and complying with more rigorous executive compensation disclosure requirements) will be higher.  For example, the release notes that EGCs may incur costs associated with formulating hedging policies for the first time and preparing required related disclosures.

The proposed rule is subject to a 60-day comment period.  The final rule will detail the fiscal year in which issuers must begin to comply with the requirements of Section 14(j) of the Exchange Act.

Today the House of Representatives approved several bills including these two, which we have previously commented on:

H.R. 4569, the Disclosure Modernization and Simplification Act, sponsored by Rep. Scott Garrett (R-NJ).  This bipartisan bill will help investors navigate lengthy and confusing company disclosures by allowing public companies to submit a summary page of all material information included in annual Securities and Exchange Commission (SEC) filings.  The bill directs the SEC to also simplify financial reporting requirements for small and emerging growth companies.

H.R. 4200, the Small Business Investment Companies Advisers Relief Act, sponsored by Rep. Blaine Luetkemeyer (R-MO).  H.R. 4200 amends the Investment Advisers Act of 1940 to reduce unnecessary regulatory costs and eliminate duplicative regulation of advisers to Small Business Investment Companies, which are professionally-managed investment funds that finance small businesses.