Companies undergoing an initial public offering (“IPO”) are required to register with the Securities and Exchange Commission (“SEC”). The registration process includes filing many registration statements and can be complicated. Each year EY publishes a report highlighting significant trends related to the IPO registration statements. This article summarizes many important aspects of the EY publication that we believe will be most helpful as you contemplate an initial public offering.
To read the original report, use the following link: EY, Trends in US IPO registration statements.
It is important to note that the 2017 figures included in the EY publication do not include October, November, and December of 2017. Throughout this article when we refer to 2017 data we are referring to the numbers in the EY report which only include up until September 30, 2017.
General IPO Trends
2017 saw an increase in both the number of IPOs filed in the U.S. and the money raised by those IPOs. In the first nine months of 2017 there were 113 IPOs that collectively raised $27.4 billion, compared to 112 IPOs that raised $21.3 billion in all of 2016. This is especially positive news when considering that prior to 2017, the US market had seen a decline in IPOs. This decline in IPOs seemed to be a result of the increased availability of private capital, frequency of public companies acquiring emerging private companies, regulatory changes empowering companies to stay private longer, and apprehension regarding going public due to previously unsuccessful IPOs (e.g., Twitter, Fitbit). For more information on the possible explanations for a decline in IPOs in the U.S., read the following article: Fall of the IPO and its implications on your company.
Among the many potential reasons for the resurgence of IPOs in 2017, EY highlights the strong US stock market and the SEC’s focus on spurring IPOs as two of the main reasons.
A steadily growing stock market is exactly what companies considering an IPO want to see. During 2016, the US stock market was volatile and the public was uncertain of the US political environment and monetary policy. Consequently, the U.S. saw a continuing decline in IPOs during 2016. On the other hand, US stock markets hit record highs in 2017 and the year was also marked by a stable monetary policy, which enabled the number of IPOs to rebound.
Under its new chairman Jay Clayton, the SEC is focusing on increasing the attractiveness of the US public markets. In 2017, this focus took the form of the SEC accepting draft registration statements from all public companies for nonpublic review. This policy will allow companies to submit draft statements without certain financial information and will hopefully make the registration process less burdensome. Previously only emerging growth companies (“EGCs”) and certain foreign-private issuers could submit registration statements for nonpublic review.
Specific IPO Trends
- Snap Inc. had the largest IPO of 2017 at $3.4 billion, the largest IPO since Alibaba ($25 billion) in 2014.
- Since the Jumpstart Our Business Startups (“JOBS”) Act was legislated in 2012 the majority of IPOs have been issued by EGCs, and 2017 was no exception. During 2017, EGCs comprised 86% of IPOs.
- In 2017, 40% of IPOs were sponsor backed1—the lowest percentage of the last five years.
- 24% of the IPOs during 2017 were cross-border offerings, comprising 16% of the total capital raised and tying for the highest percentage of cross-border IPOs in the last five years.
- The median annual revenue for companies that completed an IPO in 2017 was $125 million, up from $84 million over the previous five years.
- The median proceeds raised in an IPO during 2017 was $128 million.
- In 2017, health care (32%), technology (16%), real estate (11%), oil and gas (9%), and financial services (7%) were the industries with the highest number of IPOs, totaling 75% of IPOs.
Trends in Registration Statements
Emerging Growth Companies
87% of all IPOs since 2013 were issued by emerging growth companies. EGCs are provided with many elections to simplify the disclosure portion of the IPO registration process. EGCs generally take an à la carte approach to these elections on their registration statements; few make every election allotted to them, but the majority of EGCs make at least one election. These elections include filing confidentially, providing reduced executive compensation disclosure, providing only 2 years of audited financial statements, providing reduced selected financial data, adopting new accounting standards using private company effective dates, and many others.
The most common election among EGCs was the election to defer an auditor attestation of the company’s internal controls over financial reporting. Nearly every EGC that has completed an IPO since 2013 has made this election. The election to provide reduced executive compensation disclosures was almost as common; during 2017, 94% of EGC filers elected to reduce their compensation disclosures. This percentage was down from 2016, when 100% of EGCs elected to reduce executive compensation disclosures on their IPO registration statements.
Filing confidential IPO registration statements is also a common practice for EGCs. Since the JOBS Act was legislated, 89% of EGCs who have undergone an IPO filed their registration statements confidentially. While this does generally lessen the initial reporting burden, filing confidentially lengthens the median time it takes to go public. In 2017, the median number of days between when a company initially submitted its registration statements and when it completed the IPO was 106 days for non-EGC companies that filed publically compared to 124 days for EGCs that filed confidentially.
A majority of EGCs take advantage of the election to provide two years of audited financial statements rather than the normally required three years. During 2017, 71% of EGCs made this election. This seems to be an especially popular election for smaller companies: 80% of companies that reported revenues of less than $100 million made this election. Companies in the health care, oil and gas, and real estate industries made this election most frequently, with 83%, 83%, and 71%, respectively, making the election. Additionally, many EGCs elect to present less than five years of selected financial data disclosures. Of the EGCs that elected to provide only two years of audited financial statements, 89% of those companies also elected to present reduced selected financial data disclosures. On top of that, 71% of EGCs that presented three years of audited financial statements elected to provide reduced selected financial data disclosures.
The final election mentioned by EY is the option to adopt new accounting standards using private company effective dates. This election was much more common in 2017 than it was in 2016. During 2017, 32% of EGCs elected to use private company effective dates compared to 18% in 2016.
Most commented areas
EY highlights six general pitfalls that produced the most comments from the SEC. The areas were substantially complete registration statement, pro forma financial information, predecessor entity determination, cheap stock considerations, segment disclosures, and non-GAAP financial measures.
Substantially complete registration statement
Companies often experience delays in their offerings when they submit incomplete registration statements. The SEC will only review registration statements that are substantially complete, with no differentiation being made between public and nonpublic review filings. Substantially complete registration statements include all information, exhibits, financial statements, and disclosures required unless otherwise permitted by the SEC.
Pro forma financial information
Pro forma financial information is common in registration statements. Pro forma financial information is financial data that is meant to reflect the anticipated effects of major events like an acquisition or a stock offering on a company’s financial statements. Because pro forma information requires estimation and judgment, it is an area of focus for the SEC. Management should determine if their registration statements will require pro forma information and plan accordingly to ensure their pro forma information complies with Article 11 of Regulation S-X.
Predecessor entity information
Many IPOs involve companies that have gone, or will go (prior to their IPO) through complex transactions such as multiple-step acquisitions or carve-outs. Under these circumstances it is important that companies correctly identify which of the entities involved in the transactions qualifies as a predecessor entity as defined by Rule 405 of Regulation C. As part of the registration statements, the registrant will be required to provide the same information regarding predecessor companies that they are required to provide for themselves.
Cheap stock considerations
Cheap stock2 continues to be an area of focus for the SEC. Companies should be aware of the SEC scrutiny on valuations of their stock payments issued within a 12-month period prior to an IPO. It is important that companies considering an IPO in the near future obtain independent valuation of their stock value in order to avoid any cheap stock issues. See our article on Cheap Stock for more information on this topic.
The SEC has issued many comments regarding companies’ segment disclosures. Companies should carefully evaluate disclosures they are making for the first time, as they will receive heightened scrutiny by the SEC.
Non-GAAP financial measures
Companies cannot present non-GAAP financial measures in a way that may be misleading or portrays them as more reliable or accurate than GAAP financial measures. The SEC has increased its focus on compliance with the regulations regarding non-GAAP financial measures. Thus, companies should pay close attention to the disclosure requirements regarding non-GAAP measures.
Management’s discussion and analysis
Management’s discussion and analysis (MD&A) was the area that received the most SEC comments in both 2016 and 2017. These comments consisted of the SEC asking for further specification or clarity regarding the results of their operations, additional drivers that may have significantly affected operations, or the components of expenses and provisions. The SEC has also increased its focus on specific metrics in the MD&A section, asking management to disclose the key metrics used to evaluate the business.
Risk factors should be specific to each company’s circumstances. The SEC frequently questions risk factors that can be applied to any public company. Companies also often receive comments questioning whether the risk factors included in the registration statements are exhaustive based on publically available information.
Signatures, exhibits and agreements
Many SEC comments relate to whether or not exhibits, consents, audit reports, or management signatures are complete or adequate. Specifically, the SEC often questions whether material contracts have been omitted from the registration statement.
Terms of offering
It is important that a company clearly outline the terms of its offering, specifically when an offering includes multiple classes of securities, warrants, or convertible securities. The SEC has increased the number of comments requesting that companies disclose the security structure of their offerings as well as the conversion features of the securities being offered.
Use of proceeds and dilution disclosures
As part of their registration statements companies are required to explain the intended use of the proceeds they will receive from the offering. The SEC may request additional details regarding the intended use of the proceeds if they feel a company is being vague or not clearly explaining the major uses of the proceeds.
The SEC also has two emerging areas of focus: new accounting standards and cybersecurity.
New accounting standards
With many significant standards becoming effective in the next few years, namely the new revenue recognition standard effective January 1, 2018, the SEC will be closely monitoring disclosures regarding the effects of new accounting standards on companies and their financial statements. Many of the SEC comments focus on companies that are providing boilerplate disclosures instead of providing sufficient information about how the new accounting standard will affect the entity.
Chairman Clayton has established cybersecurity as one of his focuses going forward in light of recent security breaches. The SEC will likely monitor disclosures related to cybersecurity risks or any incidents a company may have been involved in.
Finally, EY notes other trends, including restatements during the IPO process, trends in voluntary material weakness disclosures and regulation S-X waiver requests.
Restatements during the IPO process
Approximately 6% of companies that went public during the five-year period ended September 30, 2017 reported one or more restatement of their financial statements in their IPO registration statements. The following table summarizes the most restated areas.
Voluntary material weakness disclosures
In 2016 and 2017, roughly a quarter of all IPO registration statements included disclosures of one or more weakness in their internal controls. A material weakness is defined as “a deficiency, or a combination of deficiencies, in ICFR such that there is a reasonable possibility that a material misstatement of the registrant’s annual or interim financial statements will not be prevented or detected on a timely basis.” Companies that are going public are not required to disclose material weaknesses in their registration statements. However, many do so in order to avoid surprising investors in the future with undisclosed material weaknesses. The following table summarizes the five material weaknesses most often disclosed in registration statements during 2016 and 2017.
Regulation S-X waiver requests
Companies may request waivers or modifications to their financial reporting requirements under Rule 13-3 of Regulation S-X when raising capital. For example, if a required statement is burdensome to provide but not useful to investors a company may request permission from the SEC to omit the statement or provide alternative information. The new SEC administration has indicated that it is receptive to working with companies making waiver requests under Rule 13-3.