The financing environment for startup companies in the technology sector has changed substantially over the last few years. As evidenced by findings in CB Insights’ latest report, The 2020 Tech IPO Pipeline, tech companies have raised more funding than ever before by accessing the private venture markets. These startups reach unicorn status well before completing an initial public offering or other exit.

Source: CB Insights

While private capital formation continues to rise exponentially, IPO levels have remained relatively stagnant since numbers dropped in 2015. The CB Insights report noted that 22 tech IPOs were completed in 2019. Compared to 19 IPOs in both 2018 and 2017, tech IPO numbers have not seen dramatic increases since dropping to 16 in 2015 from 33 in 2014. The median amount of private venture capital tech startups raise prior to an IPO has significantly increased between 2012 and 2019. In 2019, tech companies raised a median of $281 million prior to going public, compared to $239 million in 2018 and $64 million in 2012. In aggregate, tech companies have raised $26.3 billion in 209 deals in 2019, compared to $21.9 billion in 235 deals in 2018. By contrast, 2012 saw 111 private venture capital raises in the tech sector, yielding $1.6 billion in proceeds—a fraction of 2019 levels.

Not only are tech companies raising large sums of private capital, they are doing so through larger deals, including “mega-rounds”, which are capital raises of $100 million or more. Tech companies in the IPO pipeline completed 102 mega-rounds in 2019, compared to 68 in 2018. The number of tech mega-rounds has surpassed the number of tech IPOs.

Source: CB Insights

The volatility associated with next year’s U.S. election is anticipated to limit the window for companies, in and out of the tech sector, to complete an IPO. This will likely continue the trend of companies raising funds through the private markets, and also considering alternatives to the IPO, such as a direct listing or M&A transaction.

Yesterday, the Securities and Exchange Commission approved FINRA’s proposed amendments to its Corporate Financing Rule, which are intended to modernize, simplify, and streamline the rule.  FINRA’s amendments address, among other things, (1) filing requirements; (2) filing requirements for shelf offerings; (3) exemptions from filing and substantive requirements; (4) underwriting compensation; (5) venture capital exceptions; (6) treatment of non-convertible or non-exchangeable debt securities and derivatives; (7) lock-up restrictions; (8) prohibited terms and arrangements; and (9) defined terms.  FINRA states that these changes should lessen the regulatory costs and burdens associated with compliance.

See the SEC order, with the amendment.  A Legal Update will follow.

The Office of the Advocate for Small Business Capital Formation published its annual report to the Committee on Banking, Housing and Urban Affairs of the U.S. Senate and the Committee on Financial Services of the US House of Representatives as required by the Exchange Act.  2019 was the first year of operations for the Office and, as indicated by the Report, many of the activities during the year were focused on outreach and investor education.  The Report provides a number of useful statistics, including statistics on the amounts raised from July 1, 2018 through June 30, 2019 from data collected by the SEC’s Division of Economic and Risk Analysis, and how the offering methodology used varies by geography.

Source: Office of the Advocate for Small Business Capital Formation


Source: Office of the Advocate for Small Business Capital Formation

The Report also provides interesting data regarding the pool of accredited investors—13% of US households currently qualify as accredited investors—and geographic dispersion of investors based on household income and net worth.  The report also addresses the late-stage market, as well as the issues facing smaller reporting companies.

The Report concludes by setting forth the Office’s recommendations relating to the SEC’s Concept Release, the definition of accredited investor, retail access to pooled investment vehicles, an exemption for finders, potential updates to the Regulation CF framework and continued scaling of the disclosure obligations for smaller reporting companies.

We previously blogged about the recent AICPA conference. At the conference, representatives from the Office of Chief Accountant also shared some views regarding the discontinuation of LIBOR. The Staff of the OCA joined in the July 2019 statement with the SEC Staff from the Division of Corporation Finance, the Division of Investment Management and the Division of Trading and Markets on LIBOR discontinuation. Since, the Staff of the OCA has been following emerging accounting issues related to LIBOR discontinuation. In particular, OCA Staff has been providing guidance relating to the treatment of cash flow hedge accounting involving LIBOR-based interest payments. The Staff pointed out that until the FASB accounting standards update relating to reference rate reforms become effective, the prior Staff guidance on testing the probability and the effectiveness of cash flow hedges that involve LIBOR-based interest payments remains relevant.

The speaker also addressed accounting for amendments to preferred stock that have periodic dividend payments based on a LIBOR rate. Specifically, the fact pattern that was addressed by the OCA Staff in a recent interpretation, which may have broad applicability, involved perpetual preferred stock instruments that are equity in legal form and classified in permanent equity by the issuer. For at least a portion of the life of the instrument, dividend payments on the instrument are based on a LIBOR rate. The sole business purpose of the amendments undertaken by the issuer will be to designate a replacement dividend rate index for LIBOR (in this case, the Secured Overnight Financing Rate – “SOFR”) upon the cessation of LIBOR. No cash will be exchanged in connection with the amendment of the terms. The first question that OCA Staff considered was whether the change represented a modification or extinguishment. The Staff did not object to the issuer applying a qualitative approach, in which the issuer assessed the business purpose for the amendments and the effect of the changes on an investor’s economic interests, which led to a conclusion that the amendments should be treated as a modification. The OCA Staff also addressed whether there was any accounting recognition on the modification date, which would result in the recognition of an increase in fair value of the modified instrument upon modification. Given that the modification was made solely to address LIBOR cessation and that the market is aware of this development and likely is pricing in the effect of LIBOR cessation for any LIBOR-based instrument, the fair value immediately prior to the modification would already consider the impact of the anticipated cessation event, minimizing any potential increase in fair value as a result of the modification the sole business purpose of which was to amend fallback language. The Staff did not object to the conclusion by the issuer that there is no recognition of any change in fair value as a result of the modification in the fact pattern presented.

Yesterday, the Division of Corporation Finance (CorpFin) of the SEC released CF Disclosure Guidance: Topic No. 8, Intellectual Property and Technology Risks Associated with International Business Operations (Guidance). The Guidance aims to assist public companies in evaluating intellectual property (IP) and technology risks related to their international operations, assessing their materiality, and drafting useful disclosures, consistent with their obligations under the federal securities laws and our principles-based disclosure regime.

CorpFin encourages companies to assess risks related to the potential theft or compromise of their technology, data or IP (including technical data, business processes, data sets or other sensitive information) in connection with their international operations, as well as how the realization of these risks may impact their business, financial condition, results of operations, reputation, stock price and long-term value. CorpFin notes that companies that conduct business in certain foreign jurisdictions, house technology, data and IP abroad, or license technology to joint ventures with foreign partners may have more significant exposure to these IP and technology risks than domestic companies. For instance, companies may suffer direct intrusion by foreign actors, including state-controlled or state-affiliated actors, in the form of cyber intrusions into computer systems and physical theft through corporate espionage. Technology, data and IP may also be stolen or compromised via indirect routes, including where companies are required to compromise protections or yield rights to technology, data or IP in order to conduct business in or access markets in a foreign jurisdiction. CorpFin cites as examples: (i) patent license agreements that allow foreign licensees to retain rights to improvements on the relevant technology, including the ability to sever such improvements and receive a separate patent; (ii) foreign ownership restrictions, such as joint venture requirements and foreign investment restrictions that potentially compromise control over a company’s technology and proprietary information; (iii) unusual or idiosyncratic terms favoring foreign persons, including those associated with a foreign government, in technology license agreements, such as access and license provisions as conditions to conducting business in foreign jurisdictions; and (iv) regulatory requirements that restrict the ability of companies to conduct business, unless they agree to store data locally, use local services or technology in connection with their international operations, or comply with local licensing or administrative approvals that involve the sharing of IP.

According to CorpFin, in assessing and disclosing risks related to the potential theft or compromise of technology and IP, companies should consider the following questions, which may serve as a useful checklist in drafting Form 10-K risk factors, with respect to their present and future operating plans:

  • Is there a heightened risk to your technology or IP because you have or expect to maintain significant assets or earn a material amount of revenue abroad?
  • Do you operate in an industry or foreign jurisdiction that has caused, or may cause, you to be particularly susceptible to the theft of technology or IP or the forced transfer of technology? Do you believe that your products have been, or may be, subject to counterfeit and sale, including through e-commerce?
  • Have you directly or indirectly transferred or licensed technology or IP to a foreign entity or government, such as through the creation of a joint venture with a foreign entity? Do you store technology or IP locally in a foreign jurisdiction? Are you required to use equipment and services provided by a state actor, including equipment or services that could result in a reduction in protections?
  • Have you entered into a patent or technology license agreement with a foreign entity or government that provides such entity with rights to improvements on the underlying technology and/or rights to continued use of the technology following the licensing term, including in connection with a joint venture?
  • Are you subject to a requirement that foreign parties must be controlling shareholders or hold a majority of shares in a joint venture in which you are involved, or are you involved in a joint venture that is subject to foreign ownership restrictions or requirements that a foreign party retain certain ownership rights?
  • Have you provided access to your technology or IP to a state actor or regulator in connection with foreign regulatory or licensing procedures, including but not limited to local licensing and administrative procedures?
  • Have you been required to yield rights to technology or IP as a condition to conducting business in or accessing markets located in a foreign jurisdiction?
  • Are you operating in foreign jurisdictions where the ability to enforce rights over IP is limited as a statutory or practical matter?
  • Do you conduct business in a foreign jurisdiction or through a joint venture that may be subject to state secrecy or other laws, such as those limiting or prohibiting the export of data or financial documentation? Are you able to readily produce data or other information that is housed internationally in response to regulatory requirements or inquiries?
  • Have conditions in a foreign jurisdiction caused you to relocate or consider relocating your operations to a different host nation? Have you considered related material costs, such as costs to train new employees, establish new facilities and supply chains, and the impact of any related gaps or lags in production, manufacture and/or export of your products?
  • Do you have controls and procedures in place to adequately protect technology and IP from potential compromise or theft? Do these policies and procedures enable you to identify risks and incidents, analyze the impact on your business, respond expediently, appropriately and effectively when incidents occur and repair any damage caused by such incidents? Are your controls and procedures designed to detect: (i) malfeasance by employees, contractors or other insiders who may have access to your technology and IP; (ii) industrial, corporate or other espionage events; (iii) unauthorized intrusions into commercial computer networks; and (iv) other forms of theft and cyber-theft of your technology and IP?
  • What level of risk oversight and management does the board of directors and executive officers have with regard to the company’s data, technology and IP and how these assets may be impacted by operations in foreign jurisdictions where they may be subject to additional risks? What knowledge do these individuals have about these risks and what role do they have in responding if and when an issue arises?

A copy of the Guidance is available here.

On December 19, 2019, the Staff of the Division of Corporation Finance (the “Staff”) released guidance detailing the process to be followed by companies that choose to submit confidential treatment applications. In March 2019, the Securities and Exchange Commission adopted amendments that allow companies to omit confidential information that is commercially sensitive and the disclosure of which would result in competitive harm (determined on the basis of the same standard always used in connection with confidential treatment requests) from most exhibits without filing confidential treatment applications. As a result, most companies have since chosen to rely on the amended provisions and have not submitted a confidential treatment application. However, for those companies that either choose to use the traditional application method or are unable to rely on the amended provision, the Staff’s guidance details the application submission process that should be followed as an alternative method. The application must include an unredacted copy of the agreement containing the confidential information, justify the time period for which confidential treatment is sought and explain why disclosure of the confidential information is unnecessary for the protection of investors. Companies that previously have obtained a confidential treatment order which is about to expire must file a short-form application to continue to protect the confidential information from public release.

A link to the Staff guidance can be found here.

FINRA’s rules relating to equity IPOs, on spinning and withholding and IPO allocations, which came into effect following the dot-com bust, were recently amended. The amendments to Rule 5130, relating to restrictions on the purchase and sale of initial equity public offerings, and Rule 5131, relating to IPO allocations and distributions, will become effective on January 1, 2020. FINRA issued Regulatory Notice 19-37 to provide guidance to member firms. The amendments, which are intended to modernize the rules and address practical and operational issues arising from the current rules, will require member firms to update their questionnaires and related policies and procedures. As detailed in the Regulatory Notice, the changes include, among other things, the following:

• Alternative conditions to satisfy the foreign investment company exemption;
• Exemptions for US and foreign employee retirement benefit planes meeting specified conditions;
• Exclude foreign offerings (Reg S offerings), independent allocations to non-US persons by foreign non-member firms that participate in underwriting syndicates and in SPAC offerings;
• Expand the “family investment vehicle” definition;
• Exclude sovereign entities that own broker-dealers from the restricted persons under Rule 5130;
• Clarified the provisions relating to issuer-directed securities;
• Exclude specified transfers to family members from the Rule 5131 public announcement requirement relating to lock-up agreements; and
• Codified guidance regarding the disclosure of a lock-up agreement release or waiver in a publicly filed registration statement.

A public announcement is required for a release of an IPO lock-up agreement for officers and directors at least two business days before the release or waiver except when the release or waiver is for a transfer that is not for consideration and where the transferee has agreed in writing to be bound by the same lock-up agreement terms. The exception has now been extended to transfers to “immediate family members” that agree in writing to the same lock-up terms. The rule amendments also codify the guidance that the public announcement requirement is satisfied to the extent that the release is disclosed in a publicly filed registration statement for a follow-on offering.

Today, the Securities and Exchange Commission voted to approve a proposing release for comment that would amend the definition of “accredited investor,” as well as amend the definition of “qualified institutional buyer.”

Amendments to the accredited investor definition have been discussed for many years now. The Dodd-Frank Act in 2010 amended the definition in certain respects and required that the SEC consider the definition. In 2015, the SEC Staff released its Report on the Review of the Accredited Investor Definition, which recommended changes. That was followed by recommendations from the SEC’s Advisory Committee on Small and Emerging Companies, the Investor Advisory Committee, and the annual SEC Government-Small Business Forum sessions. Most recently, as we have blogged about, the SEC solicited comment on the definition in its Concept Release on Harmonization of Securities Offering Exemptions. Despite the almost decade-long dialogue regarding the definition, today’s open meeting was not without controversy.

The changes put forth in the proposing release would have the effect of broadening the potential universe of individuals and entities that might qualify as accredited investors. This seemed to raise concerns among some at today’s meeting regarding investor protection, the supposed lack of transparency of the private markets, and, at the other extreme, whether there is a need for any “wealth” component in such a definition. That said, the proposed amendments to the accredited investor definition would add new categories of natural persons based on professional knowledge, experience, or certifications and would leave intact the income/assets tests. The proposed amendments would also add new categories of entities, including a “catch-all” category for any entity owning in excess of $5 million in investments. In particular, the proposed amendments to the accredited investor definition would:

  • add new categories to the definition that would permit natural persons to qualify as accredited investors based on certain professional certifications and designations, such as a Series 7, 65 or 82 license, or other credentials issued by an accredited educational institution;
  • with respect to investments in a private fund, add a new category based on the person’s status as a “knowledgeable employee” of the fund;
  • add limited liability companies that meet certain conditions, registered investment advisers and rural business investment companies to the current list of entities that may qualify as accredited investors;
  • add a new category for any entity, including Indian tribes, owning “investments,” as defined in Rule 2a51-1(b) under the Investment Company Act, in excess of $5 million and that was not formed for the specific purpose of investing in the securities offered;
  • add “family offices” with at least $5 million in assets under management and their “family clients,” as each term is defined under the Investment Advisers Act; and
  • add the term “spousal equivalent” to the accredited investor definition, so that spousal equivalents may pool their finances for the purpose of qualifying as accredited investors.

In addition, the SEC is proposing to amend the QIB definition to avoid inconsistencies between the entities eligible for accredited investor status and those eligible for QIB status.

The proposed amendments are subject to a 60-day public comment period before they can be adopted by the SEC. The proposing release is available here.

In a recent publication, the Public Company Accounting Oversight Board (“PCAOB”) Staff shares some initial observations regarding Critical Audit Matters (“CAMs”) implementation.

The Staff commented on the significant investment of resources devoted to identification of the CAMs, drafting of the CAMs descriptions, which began months prior to the fiscal year end, the involvement of the national office teams with subject matter expertise in identifying the CAMs and in the drafting process, and the interactions with audit committees.  The Spotlight (available here) includes some statistics:

In a paper commissioned by the NYU Stern School of Business, Distinct Impact of Environmental and Governance News on Food Stocks, the authors, which includes Mayer Brown’s Carlos Juarez, examine the impact of events and news related to a company’s connection to climate change, and the impact on financial returns in order to determine the costs of investing in these assets. The paper suggests that investors seem to be less concerned with sustainability related to the larger companies, over $20 billion in market capitalization, than they are with their relatively smaller competitors. Consequently, investors seem to punish smaller firms for negative news more than they reward such firms for positive news.

The authors’ research also indicates that investors in general do identify and separate environment-related positive news from negative news and seem to give a similar push in those respective directions however marginal. Finally, the study also provides evidence that environmentally positive resolution to food companies’ issues seems to be perceived better than negative news. This indicates a consciousness in the overall market regarding the ESG factor, especially for palm-oil-related news.