In November 2018, SIFMA published another primer in its recently introduced series on capital formation–this one titled “An exploration of the IPO process and listings exchanges”. The primer provides interesting statistics on IPO trends.

The primer notes the decline in the number of US listed companies.  The number of listed companies peaked in 1996 at 8,090, but is down to 4,336 at the end of 2017, or a 46 percent decline during this period.  The number of IPOs in 1996 was 860 and that was down to 173 in 2017. Deal value is also down from 1996 to 2017.  US IPOs represented only 10 percent of total global IPOs in 2017 but averaged 51 percent in the 1990s.  The decline in small cap IPOs (deal value less than $2 billion) also is well documented.  Small cap IPOs peaked in 2000 at 382, and reached a trough in 2008 with 37.  The average was 153 from 2000 to 2017, with a three-year average of 124.

The primer explores a number of theories underlying the decline in IPOs.  Among these, the primer cites the decline in equity research coverage.  Interestingly the number of research analysts has declined 10 percent from 2012 to 2016.  Budgets have declined 51 percent from 2008 to 2016 at the largest investment banks.  Whereas the average company with a market cap of $500 million or less used to have three to four analysts, now the number of analysts is down to one or two. While the last version of JOBS Act 3.0 would have required a study on research for EGCs, little attention has otherwise been directed to address the role of research coverage in the decline of smaller IPOs

A recent E&Y report notes strong IPO activity in the first nine months of 2018, with 166 completed IPOs, which raised $44.4 billion.  This compares to 179 for the full year in 2017, which raised $40.4 billion.  AXA Equitable Holdings was the largest IPO of the first nine months of 2018.  For the first nine months of 2018, VC and sponsor-backed IPOs represented only 29 percent of all IPOs, which is a five-year low for financial sponsor-backed IPOs.  During this nine-month period, financial sponsor-backed IPOs accounted for 38 percent of total capital raised in the public market, which is down from 72 percent over the prior five years.  Foreign private issuer IPOs were at an all-time high in 2018.  There were 46 IPOs during the nine-month period.  Median IPO proceeds for IPO issuers during the period was $142 million.  Healthcare remained the most active sector for IPOs.  Approximately $6.2 billion was raised in Healthcare IPOs in the first nine months of the year.  Tech companies were the second most active and raised $13.7 billion.

The report also addresses the usage of EGC IPO accommodations.  Approximately 91 percent of the EGCs that have filed since the JOBS Act became effective have relied on confidential submission.  The median number of days for EGCs from IPO Registration statement submission date to IPO was 112 days.  A notable change cited in the E&Y report is that in 2018, 56 percent of new EGCs chose to adopt new accounting standards using private company effective dates.  This may be a result of perceived challenges associated with the new standards for revenue recognition, leases, and credit losses. For the period from 2013 through 2018 (9/30), 96 percent of EGCs provided reduced executive compensation disclosures, 80 percent provided two years of audited financials, and 24 percent adopted new accounting standards based on private company effective dates.

Since the financial crisis, the IPO market has been somewhat volatile, but in the last few quarters, the market has shown growth. A recent Audit Analytics report notes a number of factors that may contribute to the relatively slow rate of growth of the IPO market, including the abundant availability of private capital (both equity and, increasingly, debt), the overcorrection of the market for historically high IPO valuations, and M&A exits.

Based on data provided in the report, there have been 1,758 IPOs since 2008. 66% of these IPOs were completed after the enactment of the Jumpstart Our Business Start Ups (JOBS) Act.  At the time of this post, there have been 27 IPOs withdrawn in 2018, according to Nasdaq.  The report also notes that there has been a 46% decline in the number of SEC registrants.

Both regulators and Congress have taken steps to ease the burden of accessing the public capital markets.  For example, the report highlights the expanded ability to submit draft registration statements confidentially to all companies, which took effect in July 2017.  Based on Audit Analytics data, the report noted that EGCs made up 70% of all IPOs in the first quarter of 2017, and now EGCs make up almost 90% in 2018.  IPO costs are one of the main reasons for companies deferring their IPOs.

Shifting focus to unicorns, Audit Analytics reported that these companies, which are valued at over $1 billion, made up only 7% of all IPOs in the first quarter of 2018.  In 2017, 10 unicorns went public, which represented 2% of all IPOs completed and in 2016, 11 unicorns went public, representing 5% of all IPOs.

Audit Analytics also looked at total IPO proceeds raised by year, as shown above.  Post JOBS Act, IPO proceeds seemed to steadily increase and then dropped again significantly in 2015 and 2016.  Based on their data, the report notes that the second and third quarters are the strongest for IPO activity, which leads us to believe that 2018 will finish on a positive trajectory.

Read Audit Analytics’ full report for more.

Even before the Trump tweet, discussions regarding interim reporting requirements for U.S. public companies had been ongoing for several years.  In fact, going back to 2015, the Securities and Exchange Commission’s Advisory Committee on Small and Emerging Companies considered the advantages and disadvantages associated with discontinuing quarterly reporting.  In 2016, the Director of the Commission’s Division of Corporation Finance addressed the issue in a speech in Europe, noting that, “The United Kingdom has stopped mandating that companies provide quarterly financial reports to investors. Lately, some commentators have asked the Commission to re-think the need for quarterly reporting by U.S. issuers, which has been a staple of the U.S. regulatory system since 1970, advocating that this frequency leads to short-term thinking by investors and company management. These commentators note that financial reporting that focuses on short-term performance is not conducive to building sustainable businesses because it steers management to focus on short-term goals and performance.”  Flash forward a few years, and Title XXII Section 2201 of the JOBS Act 3.0 requires that the Securities and Exchange Commission conduct an analysis regarding the costs and benefits of quarterly reporting on Form 10-Q, especially for emerging growth companies.  This provision may have been influenced by a report published by various trade groups, including SIFMA, about which we recently blogged.  In that trade group report, a recommendation is made that emerging growth companies be given the option to issue a press release with their quarterly results rather than be required to file a quarterly report on Form 10-Q.  The trade group report states that quarterly reports have become longer and more detailed, and therefore producing such reports has become more expensive.  In the trade group report, the focus was on costs and reporting burdens.

At the same time, the debate relating to quarterly earnings guidance has been reinvigorated.  Some have argued that quarterly reporting distracts managers from focusing on long-term goals and observe that public companies are all too concerned with short-term gains at the expense of long-term investments. The same commentators have focused in particular on the potential detrimental effects of providing quarterly earnings guidance.  Perhaps these concerns are overstated.  It seems that over time, fewer and fewer companies continue to provide quarterly earnings guidance.  According to a recent study, approximately one-third of public companies issue quarterly earnings guidance.  Nonetheless, in a piece titled “Short-Termism is Harming the Economy,” Jamie Dimon and Warren Buffett joined the Business Roundtable in calling for companies to refrain from giving quarterly guidance. The National Association of Corporate Directors and the National Investor Relations Institute joined in the call to eliminate earnings guidance. However, the Business Roundtable report does not advocate terminating the filing of quarterly reports on Form 10-Q.  Regardless of whether quarterly reports on Form 10-Q are mandated or not, it would still be the case that companies would report quarterly results.  The two issues—quarterly filings and quarterly guidance—appear to have been conflated making it more difficult to parse the real issues.

In a very early morning tweet, the President chose to comment on the requirement to file quarterly reports on Form 10-Q. (See the tweet here.)  We noted in a prior post that the House JOBS Act 3.0 bill already included a requirement that the Securities and Exchange Commission conduct a study regarding the costs and benefits associated with quarterly filing requirements, especially for emerging growth companies. Not clear whether a tweet asking the Commission to study this will change the dynamic.

A number of capital formation-related bills passed in the House this week with bipartisan support.  These include:

  • H.R. 5877, the “Main Street Growth Act,” sponsored by Rep. Tom Emmer (R-MN), which would amend the Securities Exchange Act of 1934 to allow for the registration of venture exchanges with the Securities and Exchange Commission.
  • H.R. 5970, the “Modernizing Disclosures for Investors Act,” sponsored by Rep. Ann Wagner (R-MO), which would require that the Commission no later than 180 days after enactment provide a report to Congress with a cost-benefit analysis of emerging growth companies’ use of Form 10-Q and recommendations for decreasing costs, increasing transparency, and increasing efficiency of quarterly financial reporting by emerging growth companies.
  • H.R. 6139, the “Improving Investment Research for Small and Emerging Issuers Act,” sponsored by Rep. Bill Huizenga (R-MI) , which would require the Commission to carry out a study to evaluate the issues affecting the provision of and reliance upon investment research into small issuers, including emerging growth companies and pre-IPO companies

There are a number of legislative proposals making their way through the House, including: H.R. 5054, the Small Company Disclosure Simplification Act of 2018, which provides EGCs and smaller reporting companies an exemption from xBRL requirements (referred to in our prior blog post), H.R. 6035, the Streamlining Communications for Investors Act, which is a measure that would direct the Securities and Exchange Commission to amend Rule 163 under the Securities Act in order to allow underwriters and dealers acting by or on behalf of a WKSI to engage in certain communications, and a measure that would direct the Commission to increase and align the smaller reporting company definition and the non-accelerated filer financial thresholds, and a measure requiring the Commission to conduct a study with respect to research coverage of small issuers before their initial public offerings.

All of these bills emanated from the recommendations contained in the report prepared by SIFMA and other trade associations titled “Expanding the On-Ramp: Recommendations to Help More Companies Go and Stay Public,” which we blogged about previously.

The Financial Services Committee has passed H.R. 6035 with some bipartisan consensus.  This measure is similar in scope to the amendments to Rule 163 of the Securities Act that the Commission had proposed a few years ago and never adopted.  Given the fact that most follow-on offerings are conducted on a wall-crossed basis these days, it would make sense to allow underwriters acting on a WKSI’s behalf to approach investors even prior to the WKSI filing an automatic shelf registration statement.

Today, the House Financial Services Committee advanced six bills for House consideration, including H.R. 5054, H.R. 5756, and H.R. 5877.

H.R. 5054, the Small Company Disclosure Simplification Act of 2018, which was introduced by Representative David Kustoff (R-TN), the “Small Company Disclosure Simplification Act of 2018” provides a voluntary exemption for emerging growth companies and other smaller companies from the requirements to use Extensible Business Reporting Language (xBRL) for financial statements and other periodic reporting.  The bill passed 32-23.

H.R. 5756, to require the Securities and Exchange Commission to adjust certain resubmission thresholds for shareholder proposals, which was introduced by Representative Sean Duffy (R-WI), H.R. 5756 requires the Securities and Exchange Commission to adjust certain resubmission thresholds for shareholder proposals.  The bill passed 34-22.

H.R. 5877, the Main Street Growth Act, which was introduced by Representative Tom Emmer (R-MN), the “Main Street Growth Act” amends the Securities Exchange Act of 1934 to allow for the registration of venture exchanges to provide a venue which will allow qualifying companies one venue in which their securities can trade.  The bill passed 56-0.

A number of industry groups, including SIFMA, have joined to put forward recommendations to promote capital formation and assist more companies in going public or remaining public.  Many of the measures suggested in the report have been presented previously, whether in the U.S. Treasury Report on capital markets or in bills introduced in, or passed by, the House Financial Services Committee.  For example, the group suggests:

  • That for issuers that meet the EGC definition, extending the on-ramp provisions of Title I of the JOBS Act from five to ten years;
  • Amending Section 5 of the Securities Act in order to extend the ability to test-the-waters to non-EGC issuers;
  • Extending the Sarbanes-Oxley Section 404(b) exemption from five to ten years for lower revenue EGCs;  and
  • Simplifying or eliminating the “phase out” provisions relating to EGC status.

The report also addresses research related issues and suggests:

  • Amending the Securities Act Rule 139 safe harbor to eliminate the Form S-3 eligibility prong;
  • Allowing research and banking colleagues to attend pitch meetings and reviewing the Global Research Analyst Settlement; and
  • Studying the factors impacting the decision of most firms not to publish pre-IPO research.

Finally, the report addresses other measures, such as regulation of proxy advisory firms, short-selling, the baby shelf restrictions for smaller issuers, and financial reporting and market structure matters, not as closely tied to the IPO market.

Authors Michael Dambra, Laura Casares Field, Matthew T. Gustafson and Kevin Pisciotta recently published a paper, “The Consequences to Analyst Involvement in the IPO Process: Evidence Surrounding the JOBS Act,” which reviews research analyst involvement post-JOBS Act in offerings.  The authors consider whether participation by affiliated analysts in securities offerings affects their research by evaluating analyst activity relating to EGCs.  The control group used are non-EGC issuers.  The authors conclude that pre-IPO participation increases analyst optimism resulting in less accurate reports.  While the paper presents interesting data regarding the value of research, it is difficult to gauge the differences that were observed pre- and post-JOBS Act in research involvement.  Compliance policies for firms, including many not subject to the analyst settlement, prevent analyst participation in the offering process.  There has been little to no practical effect from the JOBS Act relaxation of certain research activities in relation to EGCs.  To the extent that there is greater “optimism” with respect to EGCs, it is difficult to isolate and attribute such sentiment to analyst involvement.