Legal’s Role in IPOs
Latham & Watkins is a leading IPO law firm in the United States. In 2020, the law firm completed 77 global IPOs and helped its clients raise over $34 billion. To compare Latham to a big four accounting firm, PwC assisted 42 IPO companies in 2020—raising just over $26 billion. Although accounting firms have a significant impact on the capital markets, statistics like these show that law firms also play a substantial role in helping companies go public. So, what is it the lawyers do?
Law firms draft IPO documents, assist in structuring the securities, conduct due diligence, and obtain the necessary regulatory approvals. This article is an overview of the role law firms, laws, and regulations play in shaping IPOs for companies, as well as the importance of establishing early an in-house counsel.
Companies seeking to go public are willing to pay law firms significant sums of money. In fact, U.S. companies annually pay more than companies in any other country for legal fees as a percentage of revenue—as shown by the accompanying chart.
In 2020, the average amount of accounting and legal fees for IPO companies was roughly $0.59 million and $1.11 million respectively. DoorDash raised over $3.37 billion on its IPO and spent around $1.7 million on legal fees. For the past 10 years, data suggests that IPO companies spend anywhere from .5% to 1.5% of the total proceeds on accounting and legal fees, with the greater portion relating to legal fees. Small business owners may wonder how going public is even possible given the astronomical fees these large services firms charge. Fortunately, banks usually offer bridge loans for expenses related to the public offering, and the capital raised from the public offering can make the fees seem like pocket change.
Underwriters, accountants, and lawyers demand high fees to assist in the technical work of helping companies go public. The rest of the article will discuss why lawyers’ ability to assist companies in avoiding legal liability in the United States is so valuable.
Various federal laws have been enacted to regulate the capital markets. For example, the Securities Act of 1933, the Jobs Act of 2012, and the Sarbanes-Oxley Act of 2002, to name a few, aim to protect investors and the public from fraud and to instill confidence in the public’s capital. The SEC is charged with enforcing these laws. In addition to the federal laws, states have also enacted laws to prevent financial misrepresentation in companies looking to go public. These laws are commonly known as Blue Sky Laws, and they are regulated by each state’s securities commissioner. Hence, lawyers are needed to help the aspiring public company comply with laws and regulations as well as to help the company avoid liability for actions brought against them for failing to comply with the law. In addition to the fees and penalties for failing to comply with these laws, the SEC may issue subpoenas, investigate, or require testimony—all of which can take a lot of time for legal counsel.
Lawyers assist companies with going public in the safest way possible. A good law firm can help the company with structuring securities and disclosing the necessary information for investors. A law firm may also assist in drafting the prospectus and other SEC-required documents. Ultimately, a law firm advises its clients on the legal responsibility that they bear, especially those that arise after becoming a publicly traded organization.
Emerging Growth Companies
The designation of a company as an Emerging Growth Company (EGC) is intended to make going public easier for smaller businesses. The Securities Act of 1933 outlines ways in which companies can file for going public as an emerging growth company. For example, if a company has total annual gross revenues lower than $1.07 billion during the most recent fiscal year and has not sold common equity securities since 2011, it may need to provide less extensive disclosures, provide only two years of audited financial statements (rather than three), and may use test-the-waters communication with qualified institutional buyers. Lawyers help ensure that the aspiring public company is aware of the EGC route to public and its necessary disclosures.
The SEC has disclosure rules for public companies, including Regulation FD (fair disclosure). For example, when a company reveals material information to individuals or entities, the company must also make those disclosures available to the public. These laws for new publicly traded companies affect management teams and require a different mentality than when privately owned. Executives who once could freely share whatever information they desired must now be aware of how their communications are disseminated to avoid SEC penalties and lawsuits. Again, lawyers can help avoid these costly mistakes by advising management teams and helping the business avoid other legal risks.
In addition to filing the S-1, 10-K, and prospectus documents, the proxy statement is a document regulated by the SEC that is an annual obligation once a company is public. The proxy statement talks about the composition of the board of directors, management’s salaries, option plans for directors, and other declarations made by management, including litigation risks. Significant legal issues may arise from failure to disclose the proxy statement (and other documents) on time or from failure to provide accurate information. Thus, this is another way that lawyers assist throughout the life of the public company.
Prior to an IPO, hiring the right General Counsel team is crucial to the company’s success. If the company seeking to go public operates in a heavily regulated industry, finding attorneys who have dealt with extensive regulatory challenges will prove invaluable. In other cases, companies may depend heavily on patents or licenses, in which case finding an expert intellectual property attorney or patent attorney is wise.
Above all, the General Counsel will interact with the executive team and board. Thus, the General Counsel will need to serve as a strategic business partner in addition to providing legal advice. Most investors demand a strong, credible executive team that is prepared to face the growing pains of going public, and exceptional lawyers are crucial for the company’s credibility and confidence.
Law firms and in-house counsel teams are crucial to navigating the complex legal world. Significant costs await those who neglect to hire the right law firm and in-house counsel to protect the company from big mistakes. Although the fees of going public are large, the costs of failing to comply with the SEC regulations and with other laws will prove more costly. From filing documents with the SEC to disclosing information to the public, having a lawyer by management’s side will prove invaluable every step of the way for publicly traded companies.