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 will attempt to summarize important aspects of the EY publication that we think will be most helpful as you contemplate an initial public offering.
To read the original report, use the following link: EY, Trends in U.S. IPO Registration Statements.
Please note that the 2019 figures included in the EY publication do not include October, November, and December of 2019. Throughout this article when we refer to 2019 data, we are referring to the numbers in the EY report which only include up until September 30, 2019.
General IPO Trends
2019 saw a decrease in the number of IPOs filed in the U.S. from the previous year, but an increase in the money raised by those IPOs. In all of 2018, there were 209 IPOs that raised $52.5 billion. In the first nine months of 2019, only 126 IPOs had been completed but they raised $44.2 billion. That’s an average of about $350.8 million per IPO compared to only $251.2 million per IPO in 2018. Still, the number of IPOs in the first nine months of 2019 has decreased by 24% compared to the same time period in 2018. A significant portion of the capital raised to date in 2019 also came from a wave of household name “unicorns” launching in the second quarter.
The decline in IPOs over the last two decades seems to be a result of several factors. These include the 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). Companies that have conducted IPOs more recently were larger and more mature because they were able to stay private for longer. For more information on the possible explanations for a decline in IPOs in the U.S., read the following article: Decline of the IPO and the Implications for Your Company.
Under the leadership of Chairman Jim Clayton, the SEC has recently taken steps to make the U.S. public capital markets more attractive and increase capital formation. In 2018, the SEC changed the definition of a Smaller Reporting Company (SRC), and in 2019, the SEC extended some EGC (Emerging Growth Company) accommodations to non-EGCs.
Under the new definition of an SRC, more companies will qualify for disclosure relief. To be considered an SRC, a company must have a public float less than $250 million or have annual revenue less than $100 million and a public float less than $700 million. SRCs can provide scaled disclosures, and a recent proposal would exempt SRCs with less than $100 million in revenue from the requirement to obtain an audit of the internal control over financial reporting (ICFR) even after they are no longer an EGC.
In addition, the SEC extended some EGC accommodations to non-EGCs. Now, non-EGCs may also hold “test-the-waters” discussions about possible securities offerings with certain institutional investors before filing a registration statement. EGCs are newly public companies that had annual gross revenues less than $1.07 billion in the last fiscal year and had not sold any common equity securities as of December 8, 2011. A company can be an EGC for up to five years after completion of an IPO unless its annual gross revenues exceed $1.07 billion, it becomes a “large accelerated filer” (according to Exchange Act Rule 12b-2), or it has issued more than $1 billion in non-convertible debt in the past three years. EGCs have several accommodations available to them.
Specific IPO Trends
- Since the Jumpstart Our Business Startups (“JOBS”) Act was legislated in 2012, the majority of IPOs have been issued by EGCs, and 2019 was no exception. During 2019, EGCs comprised 90% of IPOs.
- In 2019, 55% of IPOs were financial sponsor-backed, which is relatively consistent with the prior two years. However, the amount of money raised from financial sponsor-backed IPOs only made up 53% of the total capital raised in IPOs, compared to 68% over the previous five years.
- 28% of the IPOs during 2019 were cross-border offerings, comprising only 14% of the total capital raised. Cross-border offerings comprised 33% of the total capital raised from 2014 – 2018.
- The median annual revenue for companies that completed an IPO in 2019 was $111 million, down from $129 million in 2018 and $133 million in 2017.
- The median proceeds raised in an IPO during 2019 was $151 million, compared with a median of only $122 million in each of the past two years.
- In 2019, health care (38%), technology (34%), financial services (7%), oil and gas (4%), and real estate (3%) were the industries with the highest number of IPOs, totaling 86% of IPOs.
Trends in Registration Statements
Emerging Growth Companies
Since 2014, 90% of all IPOs 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.
Filing confidential IPO registration statements is a common election for EGCs. Since the JOBS Act was legislated, the vast majority of EGCs who have undergone an IPO filed their registration statements confidentially. While this does generally lessen the initial reporting burden, filing confidentially has historically lengthened the median time it takes to go public. However, the expansion of the nonpublic review program to all companies has brought the median number of days between when a company initially submits its registration statements and when it completes the IPO to 125 days for both EGC and non-EGC companies in 2019. The nonpublic review program allowed all companies to submit draft registration statements for nonpublic review starting in 2017.
Another common election, selected by 74% of EGCs since 2014, has been to provide only two years of audited financial statements instead of three. Even more commonly, EGCs have elected to provide reduced executive compensation disclosures. From 2014 – 2019, 98% of EGC filers elected to reduce their compensation disclosures. EGC filers only need to provide compensation disclosures for three named executive officers instead of the usual five.
Since 2014, 28% of EGCs have elected to adopt new accounting standards using private company effective dates to give them more time to adopt major new standards. This election has become more and more common. From 2018 – 2019, 59% of EGCs have chosen this election, compared to 16% of EGCs from 2014 – 2017. Recently, major new accounting standards about leases and credit losses have become effective. EGCs are using this election to give themselves an additional year to implement these standards. However, other EGCs choose not to make this election, which may be a sign that they are trying to make their financial statements comparable to other public companies for their investors.
Common IPO Accounting and Reporting Pitfalls
EY highlights six general pitfalls that produced comments from the SEC: substantially complete registration statement, financial statements of other entities, pro forma financial information, predecessor entity determination, valuation of share-based payments, 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.
Financial statements of other entities
If a registrant has recently acquired or probably will acquire a significant business, it is required to provide the financial statements for these businesses. Registrants must also provide financial statements of significant equity method investees. The SEC rules provide formulas to determine significance, but they can be complex. If a company is considering an IPO, it should evaluate these requirements since these financial statements will also need to be prepared and audited. For more information on significance, read SEC Significance Tests: Overview.
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 such as 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.
Valuation of share-based payments
The SEC staff frequently challenges the valuation of share-based payments issued in the twelve months prior to an IPO. At this time, the anticipated IPO price is significantly higher than the fair value of the security. The AICPA does have a guide available to help value private company securities called Valuation of Privately-Held-Company Equity Securities Issued as Compensation. Additionally, companies considering an IPO should obtain independent valuations of the fair value of securities in the months leading up to an IPO.
Non-GAAP financial measures
Companies cannot present non-GAAP financial measures in a way that may be misleading or that portrays them as more reliable or accurate than GAAP financial measures. In addition, the SEC staff has recently challenged the appropriateness of non-GAAP measures that contain individually tailored accounting principles that could be misleading. 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.
In addition to these six general pitfalls, EY outlines the five areas within registration statements that receive the most comments (shown in Table 1).
|Comment rank for the 12 months ended 30 June|
|Management’s discussion and analysis||1||1|
|Signatures, exhibits, and agreements||4||4|
|Related party transactions and disclosures||5||*|
Management’s discussion and analysis
Management’s discussion and analysis (MD&A) was the area that received the most SEC comments in both 2018 and 2019. These comments consisted of the SEC asking for further specification or clarity regarding the results of 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 publicly available information and information found elsewhere in the document.
If the registration statement is long and complex, registrants must provide a summary of the information. Registrants should consider the key aspects of the offering and highlight those in the prospectus summary. Many SEC comments ask registrants to balance the positive and negative information provided.
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.
Related party transactions and disclosures
The SEC comments on this topic often question the consistency and completeness of disclosures about related party transactions. Registrants are required to describe both actual and proposed related party transactions greater than $120,000 since the beginning of the last fiscal year, as well as transactions in which the party had or will have a direct or indirect material interest. The registrant should describe both the quantitative and qualitative terms of the transactions.
The SEC also has three emerging areas of focus: leases, phase-out of LIBOR, and Brexit.
Although there have not been many SEC comments about the application of the new leases standard yet, EY expects comments to increase as this standard goes into effect for more companies. Up to this point, most comments relate to the completeness of disclosures.
Phase-out of LIBOR
In 2021, the London Interbank Offered Rate (LIBOR) will phase out, and EY expects the SEC staff to question registrants’ disclosures related to this transition. Some of the disclosures that may be necessary are the risks of the transition, the status of company efforts, and material exposures to LIBOR that the company can identify but not quantify.
EY expects that SEC officials will be looking for robust disclosures about the effects of Brexit, specific to each company.
Finally, EY notes other trends, including restatements during the IPO process and trends in voluntary material weakness disclosures.
Restatements during the IPO process
Approximately 4% of companies that went public during the first nine months of 2019 reported one or more restatements of their financial statements in their IPO registration documents.
Voluntary material weakness disclosures
In 2019, about 40% of all IPO registration statements included disclosures of one or more weaknesses 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.
|Ranking||Material weakness area|
|1||Lack of personnel with appropriate experiences in U.S. GAAP or SEC reporting|
|2||Financial statement close process|
|3||Information technology general controls|
Over the past two decades, there has been a decline in the number of IPOs. The SEC has responded by providing incentives such as accommodations for EGCs and has even extended some of these accommodations to non-EGCs in 2019. In their article, EY highlighted six general IPO pitfalls as well as the five most commented issues. EY also pointed out three emerging areas of focus which relate to current changes in accounting standards or in the global economy.