Private Companies

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A recent research report published by Goldman Sachs reviews private market value creation compared to public market creation.  Echoing the trends noted in other publications, the report notes the increasingly important role of venture capital as an asset class.  The growth in venture funding has contributed to companies remaining private longer.  The report notes that among the top twenty unicorn companies 11 funding rounds on average were undertaken.  In recent years, the number of mega-rounds (over $100 million raised) has grown steadily. Historically, from 1995 to 2017, value creation in the public markets has been greater than in the private markets. In 2017 to 2018, the public markets underperformed the private markets.  IPO value (change in aggregate market capitalization) declined 8% on average versus the S&P 500.  Private Market gains for companies going public over the last five years was 33% higher than for companies going public on average for the last 25 years. Based on the amount of private capital available for investment, this trend shows no signs of abating.

In a recent report, the Nasdaq Private Market (NPM) provided data regarding transaction activity for private company securities.  On NPM, the total sponsored liquidity program value increased from $3.2 billion in 51 programs in 2017 to $12.0 billion in 79 programs in 2018. There were 46 third-party tender offers in 2018 compared to 23 in 2017.  There were 33 company repurchase programs in 2018 compared to 28 in 2017.  The NPM platform also continues to host more repeat programs, suggesting that private companies now are incorporating liquidity programs into their plans.  Interestingly only 38% of the programs were for unicorns.  This suggests that companies are using sponsored liquidity programs earlier in their growth.  The report also highlights another trend, which we too have observed, which is that more companies are conducting programs immediately following “mega-rounds” (rounds in which $100 million or more was raised).  This suggests new investors may be eager to see companies take steps to clean up their capitalization tables.  NPM also provides some insight on the discounts for common stock sales versus recently completed preferred round valuations.  The discounts associated with common stock sales seemed to have narrowed which, taken together with the significant increase in third-party tenders, suggests that institutional investors are becoming more comfortable with purchases through private secondary market platforms.

In a recently published white paper Andrew Kroculick and Julia Brezing of Nasdaq Private Market provide an overview of the auction processes supported by the Nasdaq Private Market.  Auctions may be a useful alternative to the more traditional private tender offer.  Particularly given concerns related to information asymmetries, an auction or an auction-based component to a tender may offer some advantages.

Access the white paper here.

In a recent paper titled, “Public or Private Venture Capital?” author Darren M. Ibrahim compares the relative benefits associated with reliance on private capital to fund start-ups and emerging companies with “public” venture capital in the form of securities exchanges like the London Alternative Investment Market, or AIM. The author looks at three such venture exchanges, the AIM, the German Neuer Markt, or NM, and Hong King’s Growth Enterprise Market, or GEM. The author did not use the Toronto Venture Stock Exchange because most of the listed companies are not technology-based companies. None of the three exchanges examined has proven as successful an approach to funding emerging companies as has the US venture capital model. The paper notes that in connection with investing in earlier stage companies, there are information asymmetry issues as well as agency costs. The author notes that, in part, the failures of each such exchange may be attributed to the manner in which these exchanges addressed information asymmetries and agency issues. In the case of the exchanges, corporate and securities law requirements were relied upon. In the US venture model, VCs rely on private contractual arrangements and staged financings to reduce asymmetries. Over time, the US venture model has proven to be more effective in funding successful growth companies. Proponents of capital markets reforms regularly recommend that US policymakers consider venture exchanges despite the lack of success of venture exchanges outside the United States. See full report here: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3266756

In a recent paper, “Scaling Up: the Implementation of Corporate Governance in Pre-IPO Companies,” authors David F. Larcker and Brian Tayan review governance practices and how these evolve in the lead-up to an IPO. The authors studies 47 companies that completed IPOs from 2010 to 2018. On average, the companies in the sample set were nine years old at the time of their IPO. Though the authors note that there was great variability among the sample set in terms of the governance systems that were in place at the time of their IPOs, they were able to observe a number of common milestones. Almost all of the companies said they became focused on corporate governance in connection with planning for an IPO and that process, on average, began three years prior to the IPO. Also, generally at that time, the companies recruited their first independent directors. On average, prior to the IPO, companies added three independent directors. Approximately 77% of the sample set had a staggered board at the time of IPO. In approximately 53% of the surveyed companies, the founder served as the CEO at the time of the IPO. Those companies that brought in a non-founder CEO prior to the IPO did so in order to address some perceived managerial or commercial problem. The CFO who took the company public was on average hired three years prior to the IPO. Given the growth in the number of unicorns and the increasingly dispersed ownership of pre-IPO companies, it is surprising that governance practices have not changed much for these companies and that pre-IPO institutional holders do not press for more significant governance changes. The full paper can be accessed here: https://www.gsb.stanford.edu/faculty-research/publications/scaling-implementation-corporate-governance-pre-ipo-companies

A registered direct offering (RDO) is a public offering of securities that is sold on a best efforts basis by a placement agent that is engaged by the issuer to introduce the issuer to potential purchasers. An RDO is generally targeted to a select number of accredited and institutional investors, although it may be sold to non-accredited investors. Issuers find RDOs an attractive option when they are seeking to test the market or conduct an offering without attracting much market attention.

In this Lexis Practice Advisor® Top 10 Practice Tips, we provide 10 practice points relating to RDOs.

More companies continue to raise large sums of capital through late-stage or pre-IPO private placements as they prepare, or in some cases delay, going public. Tech companies are among the most highly-valued of these private companies. A recent study by CB Insights looked at the capital raised by tech companies that went public in 2018. It was found that, on average, these companies raised over $103.0 million in pre-IPO funding. This is almost 2.5 times more than capital raised in 2017, in which tech companies raised $41.9 million, on average, before their IPOs. Xiaomi Corporation and Spotify Ltd raised the most capital pre-IPO with $3.4 billion and $2.3 billion of funding secured, respectively. 2019 promises to continue the trend of larger pre-IPO financings, with companies that have raised as much as $16.9 billion poised to go public next year.

In a speech yesterday, Securities and Exchange Commission Chair Jay Clayton provided an overview of the Commission’s significant accomplishments in 2018.

Chair Clayton noted his approach to the Reg Flex agenda and the setting of more realistic rulemaking priorities.  In the last year, he noted that the Commission advanced 23 of the 26 rules on the Commission’s near-term agenda.  Among the key accomplishments in 2018, Chair Clayton cited the Commission’s work with regard to proposed Regulation Best Interest.  With respect to capital formation, Chair Clayton noted the Commission’s amendments to the smaller reporting company definition and the disclosure effectiveness related updates.

In terms of priorities for 2019, Chair Clayton again cited completion of the Commission’s work on proposed Regulation Best Interest as one of the most important projects.

Chair Clayton also pointed to proxy plumbing as another key objective for 2019.  Addressing regulation of proxy advisory firms, Chair Clayton noted that “there should be greater clarity regarding the division of labor, responsibility and authority between proxy advisors and the investment advisers they serve. We also need clarity regarding the analytical and decision-making processes advisers employ, including the extent to which those analytics are company- or industry-specific. On this last point, it is clear to me that some matters put to a shareholder vote can only be analyzed effectively on a company-specific basis, as opposed to applying a more general market or industry-wide policy.”

Chair Clayton cited changes in the capital markets and reaffirmed the commitment to review initiatives “to facilitate access to capital for issuers and to make sure Main Street investors have the best possible mix of investment opportunities.”  Based on prior comments, this would appear to allude to opportunities to invest in private companies, including unicorns.  The Commission also is considering expanding test the waters communications to non-emerging growth companies, evaluating quarterly reporting requirements, and streamlining or harmonizing securities offering exemptions.  He noted that the staff is working on a concept release to solicit input about key topics, including whether the accredited investor definition is appropriately tailored to address both investment opportunity and investor protection concerns.

Chair Clayton noted that the Commission is monitoring three risks:  (1) the impact to reporting companies of the United Kingdom’s exit from the European Union, or “Brexit”; (2) the transition away from LIBOR as a reference rate for financial contracts; and (3) cybersecurity.  Among other things, the Commission staff will focus on disclosures related to Brexit risks.  Chair Clayton noted that he “would like to see companies providing more robust disclosure about how management is considering Brexit and the impact it may have on the company and its operations.”  Chair Clayton also noted that the transition away from LIBOR is a significant risk for many market participants—whether public companies who have floating rate obligations tied to LIBOR, or broker-dealers, investment companies or investment advisers that have exposure to LIBOR.  Finally, he commented on cybersecurity.  The full text of yesterday’s remarks can be found: https://www.sec.gov/news/speech/speech-clayton-120618.

The recently published PwC and CB Insights’ MoneyTree Report provides insights on financing trends through the third quarter of 2018.  In Q3 2018, U.S. companies raised $28 billion in venture financing despite a drop in number of deals in the most recent quarter.  The dollars raised in Q3 2018 reached in a two-year high, which is attributable to large financing for unicorns, including Peleton, WeWork and Uber.  The Internet and Healthcare sectors were the most active sectors.  Much of the Healthcare sector activity related to digital health fundraising, including transactions for Peleton as noted above, as well as transactions for Oscar Health, 23andMe, Essence Group Holdings and One Medical Group.  Among the largest deals completed in the quarter were transactions for autotech companies, Lucid Motors and Zoox. During the quarter, sixteen companies achieved Unicorn status, bringing the number of unicorns to 119.