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In a paper titled, “IPO Lockup Expirations: A Persistent Anomaly of Scale,” author Kevin Green reviews the decline in stock prices following the expiration of lockup agreements relating to initial public offerings.  Green reviewed all IPOs from 1988 to 2014 and then observed the trading activity around the lockup expiration.  Despite the availability of information to market participants regarding the timing of IPO lockup expirations, trading activity around the time of lockup expirations still is anomalous. Trading activity significantly increases following lockup expiration.  The stock price for non-VC backed IPOs declines modestly leading up the the lockup expiration compared to VC-backed IPOs, and rebounds in a five-day window following lockup expiration.  However, for VC-backed IPOs, there was a substantial decline in the period immediately prior to the lockup expiration. Short selling activity spikes immediately prior to lockup expirations (which demonstrates, among other things, borrow availability) and then falls below average pre-lockup expiration levels. Short sellers do not appear to be able to predict correctly which VC-backed IPOs will decline post-IPO expiration.  Green concludes that market inefficiencies play a role but the abnormal returns are sensitive to the size of the capital investment.  Limits on the capital deployed or on the scalability of the investment may explain why the abnormal return patterns persist.

Authors Brian Broughman and Jesse Fried study founder control in their paper titled, “Do Founders Control Start-Up Firms that Go Public?”  In their paper, the authors observe that many founders of startups lose control through the process of raising capital from venture capital funds.  The authors debunk the notion that founders regain control over their companies in connection with their companies’ IPOs (referred to as the “call option on control” theory).  The research shows that the frequency of founder-CEO control at the IPO is around 20% during the sample period considered.  After three years following the IPO, 25% of founder-CEOs exit the CEO position for the companies that are still public.  The authors also considered voting control held by the founder-CEO.  Their research showed that the average founder voting power is 11.1% at the time of the IPO and 6.3% three years following the IPO.  Founder voting power was higher for those companies that had received less pre-IPO financing, had undertaken fewer rounds of VC financing, undertook an IPO more quickly from receipt of initial VC financing, and had dual-class structures.   Based on the review of more than 18,000 startups that received initial VC financing between 1990 and 2012, the authors concluded that it is highly unlikely that a founder will reacquire even modest control at the IPO that would be durable (lasting more than three years).

 

Congress has passed the Economic Growth, Regulatory Relief, and Consumer Protection Act, which principally addresses financial regulatory measures.  The legislation also includes a number of securities law related provisions.  For example, Section 503 requires that the SEC review the findings and recommendations of the annual SEC Government-Business Forum on capital formation and address the findings and recommendations publicly.  Section 504 expands the Section 3(c)(1) exception under the Investment Company Act to include venture capital funds that have up to 250 investors and $10 million in aggregate committed capital contributions and uncalled capital.  Section 507 raises the Section 701 threshold to $10 million and indexes the threshold to inflation going forward.  Section 508 allows reporting companies to rely on Regulation A.  Rule 509  provides closed-end funds listed on a national securities exchange and certain interval funds to benefit from the same securities offering and other provisions available to operating companies.  After the Small Business Credit Availability Act was passed modernizing the securities offering and communications related provisions for BDCs, there had been concern that closed-end funds had been forgotten.

See the firm’s Legal Update here.