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.

Partner Anna Pinedo joined IFR’s US ECM Roundtable for a panel discussion that assessed the current state of the market, discussed the latest trends and developments, and gave an outlook for the remainder of the year and beyond.  Topics included the state of the IPO market; private capital to public markets; JOBS Act 3.0; SPACs as an alternative to IPO; areas of success; and the convertible bond market renaissance.

Read IFR’s special report on the Roundtable here: https://goo.gl/qJWaqR.

November 7–9, 2018

Location
The Roosevelt Hotel
45 East 45th Street
New York, NY 10017

Celebrating its 50th anniversary, PLI’s annual Institute on Securities Regulation will bring together the nation’s leading securities and corporate legal experts to deliver practical information, insights and real-word strategies and solutions to the challenges facing you and your clients today.

Partner Anna T. Pinedo will speak on the “Financing Issues Facing Late-Stage Private Companies and Smaller Reporting Companies” panel on day one of the conference. Topics will include:

  • Securities law issues in venture rounds and late-stage financings;
  • Liquidity issues for private companies;
  • Advising the IPO candidate on dual-class stock structure;
  • Public and private financings by smaller reporting companies; and
  • Alternative offering options and reverse mergers.

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

In a paper titled “Cashing it In: Private-Company Exchanges and Employee Stock Sales Prior to IPO,” authors David F. Larcker, Brian Tayan, and Edward Watts review the practices of 34 tech and services-related companies as well as data from private secondary markets.

Of the 34 companies, slightly over half allow employees to sell or pledge a portion of their vested equity awards.  Of those allowing sales, two-thirds allow sales back to the company, 40 percent allow sales on a private secondary market, 47 percent allow sales to third parties outside of a private secondary market, and 7 percent allow shares to be pledged as collateral for a loan.  Practice regarding when sales are allowed varies widely, with 41 percent allowing sales during continued employment, 53 percent allowing sales at or around departure from the company, and 77 percent allowing employees to sell following departure.   The authors also studied data from private secondary markets.  The majority of the sellers on such markets are individuals, while there are more institutional purchasers.   Prices tend to be volatile.  Buyers also appear to exact discounts.  Based on a subsample of companies that went public one year following the secondary market sale, the average seller sold at a 39 percent discount to the subsequent IPO price.  Given that little information is available about these transactions and the trends among private companies, the paper provides useful insights.

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.