In a recent paper titled “Unicorn Stock Options – Golden Goose or Trojan Horse?” Anat Alon-Beck analyzes the issues arising in connection with stock-based compensation awarded to employees of unicorns given the trend toward remaining privately held longer and the deferral of IPOs, which traditionally served as the principal liquidity opportunities for employees.

The paper notes that for many Unicorn employees, choosing between exercising their options or forfeiting them is difficult.  Valuations for unicorns may be high, so paying the cash exercise price and meeting the tax obligations may be difficult for an employee.  Even if the employee were to exercise, the underlying stock would still be illiquid.  Moreover, for many employees that choose to leave their companies, the standard option terms provide for a limited period of 90 days or so during which departing employees must make a decision whether to exercise.  Given information asymmetries, employees may not have a well-formed view regarding the value of the stock.  Many of these factors appear, according to the author, to be contributing to the high turnover among unicorns.

The author notes that stock-based compensation models were premised on the fact that most entrepreneurial companies had a lifetime of four years or so to IPO.  With an extended timeline to IPO, the author suggests that it may be necessary to formulate a new approach to compensation.  Possible alternatives may include: longer vesting periods, longer periods in which to exercise when an employee departs, back-end loaded options and greater reliance on RSUs.  However, each such alternative has its limitations.  As a result, the author contends that regulatory reform is needed.  First, the author calls for changes to the Exchange Act Section 12(g) threshold to include employees in the holder count and more rigorous information requirements for companies under Rule 701.  Given that the SEC’s Concept Release relating to Rule 701 and Form S-8 generally reflects a predisposition for less disclosure and greater flexibility, the article provides an interesting counterpoint.  As the author notes, current regulations did not contemplate the growth of unicorns and, while increased flexibility for stock-based compensation grants may be useful, it does not address the information disparities or the lack of liquidity for employees and other optionholders.

Thursday, October 4, 2018
1:00 p.m. – 2:00 p.m. EDT

Interest in the formation of business development companies, especially private BDCs, remains high. BDCs have also recently been in the spotlight as a result of significant changes to the regulatory framework affecting them. During the session, Partner Anna T. Pinedo and Counsel Brian D. Hirshberg will provide a brief overview of the legal and regulatory requirements applicable to BDCs generally, and focus on recent developments.

Topics will include:

  • The 40 Act requirements applicable to BDCs;
  • The tax treatment and diversification requirements;
  • The registration process;
  • Using a BDC to address Volcker Rule constraints;
  • Statutory changes affecting leverage and related rating agency actions; and
  • Different approaches to structuring private BDCs.

West LegalEdcenter will provide CLE credit.

For more information, or to register, please visit the event website.

Securities and Exchange Commission Chair Clayton addressed attendees at the Nashville 36|86 Entrepreneurship Festival regarding the Commission’s capital formation agenda.  Clayton noted that the Commission has taken a number of steps to reduce the regulatory burdens for smaller companies, pointing to the amendments to the definition of “smaller reporting company,” the recently adopted disclosure modernization and simplification amendments to Regulation S-K and Regulation S-X, and the Division of Corporation Finance’s guidance extending the confidential submission process for registration statements to non-emerging growth companies.  That being said, Clayton outlined his views regarding the need to reverse the decline in the number of public companies that has occurred over the last two decades.  While many would contend that there is sufficient private capital available to fund the growth of promising privately held emerging companies, Clayton once again noted that “Main Street investors” generally are foreclosed from investing in high quality private companies.

Clayton noted that the Commission is considering suggestions and comments made at a Commission roundtable regarding supporting smaller public company secondary market liquidity.  Of course, the roundtable did not address changes to the regulatory framework for equity research, which most smaller public companies would observe is the key to secondary market liquidity.

He noted that the Commission intends to consider the thresholds that trigger Sarbanes-Oxley Section 404(b) auditor attestation.  Clayton used the example of biotech companies with little or no revenue that must devote considerable resources away from research and development and toward professional fees related to the attestation process.  This is interesting as JOBS Act 3.0 currently contains a measure that would provide for a Section 404(b) exemption for “low-revenue” issuers, such as biotech companies.  Perhaps the bill will inspire the Commission.  Chair Clayton also noted that the Staff of the Commission is working on a recommendation to expand the ability to “test the waters” to non-emerging growth companies.  This measure also would be addressed if JOBS Act 3.0 were to be passed.

Chair Clayton also discussed revisiting the exempt offering framework.  This has come up a few times in public remarks and also is included in the Commission’s regulatory flexibility agenda.  Clayton mentioned a “comprehensive review of our exemptive framework to ensure that the system, as a whole, is rational.”  He suggested a number of questions that may be raised in a concept release to be issued by the Commission, such as whether we have overlapping securities offering exemptions that may create confusion for companies, and whether we have gaps in the exempt offering framework.  He also noted that consideration ought to be given to the rules that “limit who can invest in certain offerings” and to expanding the focus to taking into account “the sophistication of the investor, the amount of the investment, or other criteria rather than just the wealth of the investor.”  Finally, he mentioned examining integration issues.

2018 has seen an increase in private companies accessing the private markets through private company liquidity programs.  Nasdaq Private Markets recently released a report showing an increase of 74% in total number of private liquidity programs between 1H2017 and 1H2018.  The 33 programs completed in the first half of 2018 have a total program volume of $10 billion.  This is a 37% increase in total program volume over the first half of 2017.  Twenty of these private liquidity programs were structured as third-party tender offers, while the remaining 13 were share buybacks.

Breaking down the programs by number of eligible shareholders shows that 33% of programs are completed by companies with less than 100 eligible shareholders, 33% by companies with 100-250 eligible shareholders, 24% by companies with 250-500 eligible shareholders, and 10% by companies with over 500 eligible shareholders.  Additionally, 50% of companies completing private liquidity programs are valued at over $1 billion.  Nasdaq’s report leads us to conclude that a broader range of companies have turned to private liquidity programs than in recent years.

Nasdaq’s report is available here.

 

Fintech companies continue the global trend of companies choosing to remain private longer and raising large amounts of capital through private channels.  A recent CB Insights report covered the financing trends of fintech companies for the first half of 2018.  As of the date of the report, there were 29 fintech unicorns valued at $84.4 billion globally.  The second quarter of 2018 valued five fintech companies at unicorn status (over $1 billion).  Three of these new unicorns are based in the United States.

U.S. fintech companies raised $3.2 billion in new capital over 146 deals in the second quarter of 2018, bringing the total number of deals for the first half of the year to 303, raising approximately $5.3 billion.  Compared to Q2 2017, last quarter’s total capital raised increased over 52%.  Not surprisingly, later-stage capital raises made up over 83% of deals in the second quarter, raising approximately $2.7 billion over 74 deals.

There was only one IPO exit by a fintech unicorn in the U.S. in the second quarter of 2018, which raised $874 million.  Globally, M&A exits accounted for approximately 85% of fintech company exits, with 39 M&A transactions, while there were only seven fintech IPOs completed in the first half of 2018.

For more information, read CB Insights’ Global Fintech Report Q2 2018.

Large, late stage private capital raises for privately held companies continue to be the preferred method of financing growth for many new companies, particularly those in the tech sector.  A recent analysis conducted by data provider CB Insights examined what the industry calls “mega-deals” or “private-IPOs,” which are private placements raising over $100 million in proceeds.  These deals, which have a median deal size of $160 million, have largely contributed to the emergence of unicorns, or private companies valued at over $1 billion.  This trend in private capital raising has become more prevalent since the enactment of the JOBS Act in 2012, which has made it easier for companies to remain private longer.

A closer look at the data compiled by CB Insights shows that, over the last five years in the United States, over 90% of capital raises for private companies were later stage or mezzanine investments.  These deals have raised over $300 billion in capital for companies, with $151.7 billion of these deals fitting into the rubric of “private-IPOs.”  Based on the CB Insights analysis, it would appear that transaction volumes for 2018 are on pass to surpass those in 2017.  While legislators contemplate the capital formation-focused package of legislation that has been dubbed “JOBS Act 3.0,” and consider measures to make going public more compelling, it’s clear that there is no shortage of private capital to finance promising companies.

Thursday, August 2, 2018
1:00 p.m. – 2:00 p.m. EDT

With companies remaining private longer, their stockholder base often becomes more widely dispersed. More and more privately held companies are facing interesting challenges in communicating effectively with various stakeholders, without violating securities laws. During this session, Partner Anna Pinedo will address the following:

  • Private company information rights;
  • Rule 701 disclosures for employees;
  • Information requirements in connection with stockholder liquidity programs;
  • Sharing company information in connection with financing rounds;
  • Communicating with investment professionals;
  • Communications and social media policies for private companies; and
  • Blackout/insider trading policies for private companies.

For more information, or to register for this session, please visit the event website.

On July 18, 2018, the Securities and Exchange Commission issued a concept release soliciting public comment on potential ways to modernize compensatory offerings and sales of securities, consistent with investor protection. Specifically, the concept release requests comment on aspects of Rule 701 under the Securities Act of 1933 and on Form S-8. This Legal Update highlights key questions raised by the concept release and practical considerations for public and private companies.

On June 12, 2018, Partner Anna Pinedo participated in a panel discussion titled “Hello Private Capital” at the Wall Street Journal’s CFO Network 2018 Annual Meeting in Washington D.C., which focused on the trend of companies toward deferring their IPOs and remaining private, the public policy concerns arising as a result, the effect on the IPO market, the availability of investment opportunities for retail investors, new legal challenges for large private companies, and valuation considerations.

In his most recent testimony in Congress, the Securities and Exchange Commission Chair once again focused on retail investors.  Chair Clayton cited a number of statistics regarding the level of retail participation in the capital markets.  He noted that at least 51 percent of U.S. households are invested directly or indirectly in the U.S. capital markets.  Chair Clayton noted that the recently released strategic plan has as a cornerstone a focus on retail investors.  Addressing a frequent theme, Chair Clayton commented on the decline in the number of U.S. public companies.  He also noted the impediments to investment in private companies by “Main Street investors,” which impediments limit Main Street investor participation in the growth of many successful private companies.

Addressing the Commission’s plans, Chair Clayton noted that the Commission will consider final amendments to the smaller reporting company definition and the thresholds that trigger Sarbanes-Oxley Section 404(b) auditor attestation requirements.  He mentioned that the Commission also will focus on the possible expansion of testing the waters to companies other than emerging growth companies, the disclosure effectiveness initiative, modernization of various Industry Guides, and amendments to the financial information requirements for guarantors and acquired businesses.  Chair Clayton also discussed the rulemaking required of the Commission to amend Rule 701 and Regulation A.  He commented on the success of Regulation A and generally solicited offerings made under Rule 506(c) and noted that the Division of Corporation Finance is considering ways to harmonize and streamline the exempt offering rules in order to enhance their clarity and ease of use.

Chair Clayton also addressed the rulemaking mandates contained in the Small Business Credit Availability Act relating to the securities registration and communication requirements for BDCs and in the Economic Growth, Regulatory Relief, and Consumer Protection Act relating to the securities registration and communication requirements for closed-end funds.  Finally, he noted the Commission’s remaining Dodd-Frank Act rulemaking mandates relating to executive compensation rules and the specialized disclosure rules.  The full text of the prepared testimony may be found here.