The Use of IPO Proceeds

Initial public offering provide large sums of money for companies, and they must make important decision about how to use the IPO proceeds.

Many companies see an initial public offering (IPO) as an opportunity to raise a significant amount of capital. The capital raised through an IPO can open a variety of opportunities for a company. If used correctly, IPO funds can push a company to the next level in terms of growth, product/service offerings, or profitability. However, to use the capital effectively, companies need to have a plan for the capital they raise, and they need to communicate that plan effectively to investors. As a company approaches its IPO, it will be required to file an S-1 with the Securities and Exchange Commission (SEC), which includes required statements about the company’s plans for the use of IPO proceeds. In large part, the exact statement about the use of IPO proceeds isn’t as important as a company’s overall business plan. Investors are looking for companies that are sound enough to give them a solid return on their investment. That being said, analyzing the uses listed by other companies could help prospective IPO companies learn how to effectively communicate with investors and find effective uses for the proceeds of their own future IPOs.

The “use of proceeds” portion of the S-1 is meant to help investors understand the purpose of the IPO as well as the company’s future prospects. However, companies have considerable latitude in how they choose to approach this portion of the S-1. The SEC has some requirements for what companies need to include, but after that each individual firm can decide how much information they are going to share. In order to understand the nuances of this statement, this article will explain the SEC’s requirements, show and explain examples of the various ways in which companies have used IPO proceeds, and explain the different communication strategies firms can use in their use-of-proceeds statements.

SEC Requirements

In order to file for an IPO, the SEC requires companies to disclose all material information about the company, including the company’s plans for the use of IPO proceeds. The SEC has several specific requirements that clearly define the minimum level of disclosure that companies must include in their use-of-proceeds statement.

At a minimum, companies are required to provide a “brief outline” of the various areas in which they plan to use the IPO funds. The term “brief outline” is meant to give companies the latitude to give only a general outline of how they plan to use the funds. For example, companies are allowed to simply state that they will use the funds for “general corporate purposes.” Beyond the general outline, the SEC does require greater detail in several different scenarios. These scenarios can be found in the SEC’s official rules, which are included in the toggle below. For example, if a firm is planning to use the proceeds to fund previously incurred debt or a specific acquisition, then the firm is required to provide more details regarding these planned actions. It is also important to note that the use-of-proceeds statement does not commit a company to that particular course of action. However, if a company anticipates that it could change the use of funds later, it must inform investors of this possibility in the original filing.

SEC Regulation S-K §229.504 (Item 504) Use of proceeds.

The following is from the SEC Regulation S-K, which details the requirements for the S-1 document that companies are required to file before going public:

State the principal purposes for which the net proceeds to the registrant from the securities to be offered are intended to be used and the approximate amount intended to be used for each such purpose. Where registrant has no current specific plan for the proceeds, or a significant portion thereof, the registrant shall so state and discuss the principal reasons for the offering.

Instructions to Item 504:

  1. Where less than all the securities to be offered may be sold and more than one use is listed for the proceeds, indicate the order of priority of such purposes and discuss the registrant’s plans if substantially less than the maximum proceeds are obtained. Such discussion need not be included if underwriting arrangements with respect to such securities are such that, if any securities are sold to the public, it reasonably can be expected that the actual proceeds will not be substantially less than the aggregate proceeds to the registrant shown pursuant to Item 501 of Regulation S-K (§229.501).
  2. Details of proposed expenditures need not be given; for example, there need be furnished only a brief outline of any program of construction or addition of equipment. Consideration should be given as to the need to include a discussion of certain matters addressed in the discussion and analysis of registrant’s financial condition and results of operations, such as liquidity and capital expenditures.
  3. If any material amounts of other funds are necessary to accomplish the specified purposes for which the proceeds are to be obtained, state the amounts of such other funds needed for each such specified purpose and the sources thereof.
  4. If any material part of the proceeds is to be used to discharge indebtedness, set forth the interest rate and maturity of such indebtedness. If the indebtedness to be discharged was incurred within one year, describe the use of the proceeds of such indebtedness other than short-term borrowings used for working capital.
  5. If any material amount of the proceeds is to be used to acquire assets, otherwise than in the ordinary course of business, describe briefly and state the cost of the assets and, where such assets are to be acquired from affiliates of the registrant or their associates, give the names of the persons from whom they are to be acquired and set forth the principle followed in determining the cost to the registrant.
  6. Where the registrant indicates that the proceeds may, or will, be used to finance acquisitions of other businesses, the identity of such businesses, if known, or, if not known, the nature of the businesses to be sought, the status of any negotiations with respect to the acquisition, and a brief description of such business shall be included. Where, however, pro forma financial statements reflecting such acquisition are not required by §§210.1-01 through 210.13-02 (Regulation S-X) of this chapter, including §210.8-05 (Rule 8-05 of Regulation S-X) of this chapter for smaller reporting companies, to be included in the registration statement, the possible terms of any transaction, the identification of the parties thereto or the nature of the business sought need not be disclosed, to the extent that the registrant reasonably determines that public disclosure of such information would jeopardize the acquisition. Where Regulation S-X, including §210.8-04 (Rule 8-04 of Regulation S-X) of this chapter for smaller reporting companies, as applicable, would require financial statements of the business to be acquired to be included, the description of the business to be acquired shall be more detailed.
  7. The registrant may reserve the right to change the use of proceeds, provided that such reservation is due to certain contingencies that are discussed specifically and the alternatives to such use in that event are indicated.
[47 FR 11401, Mar. 16, 1982, as amended at 73 FR 964, Jan. 4, 2008; 83 FR 50211, Oct. 4, 2018; 85 FR 22002, Apr. 20, 2020]

Uses and Applications of IPO Proceeds

While there are a variety of ways a company can choose to use their IPO proceeds, several common areas are listed in most S-1 filings. These areas include general corporate purposes, research and development, growth, acquisitions, and debt repayment. In order to demonstrate how actual companies have included these uses in their prospectuses, below are several citations directly from company filings with the SEC. Most companies include several potential uses in their statements. However, for brevity and simplicity, the examples in this article only include the portions of the statement that mention the specific use of proceeds being discussed. To enable you to easily see each company’s full statement on the use of proceeds, links to the official SEC filings are included in the footnotes.

General Corporate Purposes

One of the most commonly stated uses of IPO proceeds is “general and corporate purposes.” This normally refers to investing the IPO proceeds in areas such as working capital, operating expenses, and capital expenditures. In other words, this is the most general term that companies can use in their use-of-proceeds statement. Using a general term like this can keep a firm’s exact strategy more private and provide flexibility for how the firm chooses to use the capital later on. That being said, many companies also include more specific uses along with this more general term. The examples below demonstrate how some companies might not be ready to commit to specific uses of capital or include terms like “general and corporate purposes” to keep more of their options open.

Snowflake Inc. Use-of-proceeds Statement

The principal purposes of this offering and the concurrent private placements are to increase our capitalization and financial flexibility and create a public market for our Class A common stock. As of the date of this prospectus, we cannot specify with certainty all of the particular uses for the net proceeds to us from this offering and the concurrent private placements. However, we currently intend to use the net proceeds we receive from this offering and the concurrent private placements for general corporate purposes, including working capital, operating expenses, and capital expenditures. We may also use a portion of the net proceeds to acquire complementary businesses, products, services, or technologies. However, we do not have agreements or commitments to enter into any acquisitions at this time. We will have broad discretion over how to use the net proceeds to us from this offering and the concurrent private placements. We may invest the net proceeds to us from the offering that are not used as described above in investment-grade, interest-bearing instruments.1

Airbnb Use-of-proceeds Statement

The principal purposes of this offering are to increase our capitalization and financial flexibility and to create a public market for our common stock.

We currently intend to use the net proceeds from this offering for general corporate purposes, including working capital, operating expenses, and capital expenditures. We may also use a portion of the net proceeds to acquire or make investments in businesses, products, offerings, and technologies, although we do not have agreements or commitments for any material acquisitions or investments at this time.2

Research and Development

Another way that firms can use IPO capital is to fund the creation of new products or services. In many industries, an immense amount of funding is needed to develop a new product or service offering. An IPO can be an efficient way to generate the capital needed to fund these types of development projects. In its prospectus, a company can choose to detail which projects they plan on funding with the funds generated by the IPO. The examples below are of two biotechnology companies who state exactly which products they plan to develop with the capital generated by their IPOs.

Pliant Therapeutics, Inc. Use-of-proceeds Statement

The principal purposes of this offering are to increase our financial flexibility, create a public market for our common stock and facilitate our future access to capital markets.

We currently intend to use the net proceeds from this offering and the Concurrent Private Placement, together with our existing cash, cash equivalents and short-term investments as follows:

  • approximately $90.0 million to fund the clinical development of our lead product candidate, PLN-74809, including for conducting our Phase 2a clinical trials in IPF and PSC;
  • approximately $20.0 million to fund the preclinical development of our early-stage programs in oncology and muscular dystrophy; and
  • the remainder, if any, for additional early-stage research and development activities, business development activities, working capital and other general corporate purposes.

In addition, under our license agreement with UCSF, we are required to pay a sum of $2.4 million, based on the assumed sale of 9,000,000 shares of common stock in this offering and an assumed offering price of $15.00 per share, which is the midpoint of the price range set forth on the cover of this prospectus. We plan to make this payment shortly following the completion of this offering from our existing cash resources.

Based on our current plans, we believe our existing cash, cash equivalents and short-term investments, together with the net proceeds from this offering and the Concurrent Private Placement, will be sufficient to fund our operating expenses and capital expenditure requirements into 2023.3

Forma Therapeutics Holdings, Inc. Use-of-proceeds Statement

We currently intend to use the net proceeds from this offering, together with our existing cash, cash equivalents and marketable securities, as follows:

  • approximately $240 million for the development of FT-4202 in SCD, including completion of our ongoing Phase I clinical trial, the initiation and conduct of our planned, global pivotal Phase II/III clinical trial through Phase III dose selection and hemoglobin, or Hb, futility and Hb improvement, the initiation and conduct of a clinical trial in pediatric SCD and the initiation and conduct of a clinical trial in beta thalassemia through an initial data readout;
  • approximately $15 million for the advancement of FT-7051 in mCRPC through our planned Phase I clinical trial; and
  • the remaining proceeds for research, working capital and other general corporate purposes, including funding pre-approval activities for FT-2102 in AML and the completion of other noncore programs.

Based on our current plans, we believe our existing cash, cash equivalents and marketable securities, together with the net proceeds from this offering, will be sufficient to fund our operating expenses and capital expenditure requirements through the second quarter of 2024.4

Organic Business Growth

Many companies plan to use the capital generated by an IPO to continue growing their business and following their general business plan. This can include a variety of stated uses of IPO funds including investment in working capital, sales and marketing development, or capital expenditures. Each of these uses can generate long-term sustainable growth and development of the business. As is the case with each of the other uses of capital, companies may choose to list these expenditures generally or specifically. The example below shows how a company can state the various uses of capital, including investment in sales and marketing.

ContextLogic Inc. (Wish) Use-of-proceeds Statement

The principal purposes of this offering are to increase our capitalization and financial flexibility and create a public market for our Class A common stock, obtain additional working capital, and facilitate our future access to the public equity markets to allow us to implement our business plan. We currently intend to use the net proceeds received by us from this offering for working capital, operating expenses, sales and marketing expenses to fund the growth of our business, and capital expenditures.5

Future Acquisitions

Another important potential use of IPO proceeds is to acquire another business. Acquisitions are costly and time consuming, and IPOs can generate the capital necessary to successfully purchase another company. If a company does list an acquisition as a potential use of capital, the SEC requires the firm to specify which businesses it is looking to acquire. However, there are two exceptions to this rule. First, if the IPO firm doesn’t have a specific acquisition plan, then the firm still needs to list an acquisition as a possibility. Second, if specifying the company to be acquired could jeopardize the acquisition, then the listing company is not required to name them specifically; however, the company must still specify that it will potentially use funds to make one or more acquisitions.

One type of IPO that is becoming increasingly popular is a “blank check” IPO, or a special purpose acquisition company (SPAC). These IPOs use a shell company to go public, and then use the IPO funds to acquire a private company. This creates an opportunity for some firms to go public that might not have the chance otherwise. Read our associated article for more information about SPAC IPOs.

The first example below demonstrates how a company can use a more generalized statement that refers to the possibility that the company could use IPO capital to fund an acquisition. The second example comes from Diamond Eagle Acquisition Corp. which was a SPAC that was used to take the company DraftKings public. This example includes other portions of the S-1 in order to clarify the company’s plan after the IPO and to clarify the use-of-proceeds statement.

ContextLogic Inc. (Wish) Use-of-proceeds Statement

In addition, we may use a portion of the net proceeds to acquire complementary businesses, products, services, or technologies. However, we have no current understandings, agreements or commitments for any specific material acquisitions at this time. We cannot specify with certainty the particular uses of the net proceeds that we received from this offering. Accordingly, we will have broad discretion in using these proceeds.6

Diamond Eagle Acquisition Corp. S-1 Information and Use-of-proceeds Statement

Business Combination

In connection with the Business Combination, (i) DEAC will change its jurisdiction of incorporation to Nevada by merging with and into DEAC Nevada, with DEAC Nevada surviving the merger and changing its name to “DraftKings Inc.” (referred to in this prospectus as “New DraftKings”), (ii) following the reincorporation, DEAC Merger Sub Inc., a wholly-owned subsidiary of DEAC, will merge with and into DraftKings, with DraftKings surviving the merger (the “DK Merger”) and (iii) immediately following the DK Merger, New DraftKings will acquire all of the issued and outstanding share capital of SBT. Upon consummation of the foregoing transactions, DraftKings and SBT will be wholly-owned subsidiaries of New DraftKings. In connection with the closing of the Business Combination, the currently issued and outstanding shares of DEAC Class A common stock will be exchanged, on a one-for-one basis, for shares of New DraftKings Class A common stock. Similarly, all of DEAC’s outstanding warrants will become warrants to acquire shares of New DraftKings Class A common stock on the same terms as DEAC’s currently outstanding warrants.

[…]

Use of Proceeds

All of the shares of Class A common stock and the PIPE warrants (including shares of Class A common stock underlying such warrants) offered by the Selling Securityholders pursuant to this prospectus will be sold by the Selling Securityholders for their respective amounts. We will not receive any of the proceeds from these sales.

We will receive up to an aggregate of approximately $34,500,000 from the exercise of the PIPE warrants, assuming the exercise in full of all the warrants for cash. We expect to use the net proceeds from the exercise of the warrants for general corporate purposes, which may include acquisitions and other business opportunities and the repayment of indebtedness. Our management will have broad discretion over the use of proceeds from the exercise of the warrants.

There is no assurance that the holders of the warrants will elect to exercise any or all of the warrants. To the extent that the warrants are exercised on a “cashless basis,” the amount of cash we would receive from the exercise of the warrants will decrease.7

Debt Repayment

The next potential use of proceeds is to pay off existing debt. This type of recapitalization could be beneficial for a company and release them from restrictive loan covenants. In this way, lowering the company’s leverage ratio could give management more freedom of operation. Recapitalization could also lower interest payments and thus the overall cost of debt for the firm. There are also a variety of other reasons a company might want to recapitalize including the inability to refinance or changes in the cash flow profile. Many of these reasons to lower debt may be viable and legitimately beneficial for the business. However, using IPO capital to refinance or repay existing debt is normally heavily scrutinized by investors, and research has shown that this use of proceeds leads to poorer long-term stock price performance.8

Hydrofarm Use-of-proceeds Statement

The principal purposes of this offering are to repay existing indebtedness, for acquisitions, for working capital and other general corporate purposes, which may include the hiring of additional personnel and capital expenditures, to establish a public market for our common stock and to facilitate our future access to the public capital markets. We intend to use the net proceeds from this offering to repay borrowings outstanding under the Term Loan Agreement, among certain of our subsidiaries, Brightwood Loan Services, LLC and the other lenders party thereto, which matures on May 12, 2022 and bears an interest rate of LIBOR plus 850 basis points and the Base Rate (as defined therein) plus 750 basis points; provided, that at such time that the Total Net Leverage Ratio (as defined therein) is less than 5.50:1.00, the interest rate shall be LIBOR plus 700 basis points or the Base Rate plus 600 basis points. We also intend to use the net proceeds from this offering to paydown and refinance our borrowings under the Encina Credit Facility, among certain of our subsidiaries, Encina Business Credit, LLC and the other lenders party thereto, which matures on the earlier of (i) July 11, 2022, or (ii) 90 days prior to the scheduled maturity date of the Term Loan Agreement, and bears variable interest rates based on certain U.S. and Canadian-based interest rates plus an applicable margin, which is determined by the average daily amount available for borrowing under the Encina Credit Facility for an applicable period. We also intend to use the net proceeds from this offering to repay the PPP Loan which matures on April 7, 2022 and bears an interest rate of 1% per annum. See “Description of Our Indebtedness” for more information.9

Driven Brands Holdings Inc. Use-of-proceeds Statement

We currently expect to use the net proceeds from this offering and cash on hand to repay in full the outstanding $722 million in aggregate principal amount of indebtedness under the senior credit facilities assumed in the ICWG Acquisition (the “Car Wash Senior Credit Facilities”). The interest rate, maturity date and other terms of the outstanding indebtedness under the Car Wash Senior Credit Facilities are set forth in the section of this prospectus titled “Description of Material Indebtedness.” If the underwriters exercise their option to purchase additional shares from us, we intend to use a portion of the net proceeds therefrom to acquire from certain of our existing stockholders shares of our common stock at the price paid by the underwriters for shares of our common stock in this offering and to use any remaining proceeds for general corporate purposes. None of the existing stockholders we purchase shares from will be an existing employee, executive officer or director or Principal Stockholder of the Company. While we currently have no specific plan for the use of the remaining net proceeds of this offering, we may use a significant portion of these proceeds to implement our growth strategies and generate funds for working capital. We do not have current plans to enter into any specific material merger or acquisition. Our management team will retain broad discretion to allocate the net proceeds of this offering. The precise amounts and timing of our use of any remaining net proceeds will depend upon market conditions, among other factors.10

Other Uses

There are a variety of other ways that companies could choose to use IPO proceeds. These include activities as diverse as charitable community support and tax payments. Companies are not limited to the uses we have stated here. The example below from Doordash illustrates how a company might choose to use IPO proceeds in a less traditional way.

Doordash Use-of-proceeds Statement

We may use a portion of the net proceeds we receive from this offering to fund a $200 million pledge, as part of our Main Street Strong program, to support merchants, Dashers, and local communities.

We may also use a portion of the net proceeds we receive from this offering to satisfy a portion of our anticipated tax withholding and remittance obligations related to the vesting and settlement of RSUs that we have granted. The RSUs that we have granted to date generally vest upon the satisfaction of both service-based and liquidity event-related performance vesting conditions occurring before the award’s expiration date. The service-based vesting condition is generally satisfied by the award holder providing services to us over a four-year period. The liquidity event-related performance vesting condition is satisfied on the earlier of: (i) a sale event for us or (ii) this offering.11

Creating a Use-of-Proceeds Communication Strategy

Once a company has decided how to use IPO funds as part of its overall business strategy, the company needs to decide how to communicate this plan to investors. The first step to creating a communication strategy is to meet the minimum requirements of the SEC, but after that, each firm will need to decide exactly what it wants to communicate with investors. The most important decision for the company is how detailed to be in their description of the use of IPO funds.

Both specific and generalized statements can help a company achieve certain objectives. Companies that choose to be more specific in their use-of-proceeds statements can create investor confidence in the company’s business plan. One study showed that increased specificity in the use of funds statement is “associated with lower IPO underpricing.” In other words, providing more detailed information can help companies capture more capital on the day of their IPO. On the other hand, keeping the use-of-proceeds statement generalized gives firms more flexibility in how they choose to use the funds. This is particularly helpful for firms that don’t have a specific use in mind when a window of opportunity arises to enter the IPO market.

Both strategies also have potential risks involved. Revealing too much information about certain activities could give competitors valuable information. Detailed plans can also tie investors’ expectations to a particular course of action, which might not take place if the company wants to change directions. On the other hand, a lack of specificity could also create more uncertainty among investors, and IPO firms could potentially leave money on the table come the day of their IPO.

Another important aspect of understanding how and what to communicate in the use-of-proceeds statement is to understand the nature of an IPO as a business transaction. In many ways an IPO is a negotiation with potential investors. Many IPO companies already have experience negotiating with investors in previous rounds of funding. However, in the case of an IPO, the investors are not an active voice in the negotiation. In other words, the company is effectively trying to negotiate with what they expect investors are thinking and feeling. Overall, this means that companies need to carefully consider all of the potential factors that could influence investor sentiment.

Conclusion

Because the use-of-proceeds statement is directly tied to a company’s business plan, it is no surprise that academic research has shown the use-of-proceeds statement has the potential to influence a company’s initial stock price and long-term stock price performance.12 If a firm has built a business plan that investors are confident in, IPO proceeds will help the company continue to build success. When asked about the relevance of the use-of-proceeds statement, one CFO responded with the following:

The question on use of proceeds rarely comes up in a roadshow […] as long as [investors] believe in the business and that the business will produce an increase in the share price so they can make money. So long as the use of proceeds doesn’t say anything absurd, like “the CEO is going to buy 25 luxury houses with the proceeds”, companies can pretty much put anything there and it will usually be fine.

As the quote above relates, a firm’s top priority should be to consider whether the IPO funds can be used to further the firm’s overall business plan. Next, a firm needs to create an internal strategy to effectively and efficiently use the IPO proceeds. Finally, a firm needs to communicate its business plan and IPO strategy appropriately with potential investors. By taking these steps, companies have the opportunity to capture more value for their business on the day of the IPO and support better company and stock price performance in the long run.



Resources Consulted


Footnotes

  1. Snowflake Inc. 14 Sep 2020. Form S-1. Page 42.
  2. Airbnb Inc. 16 Nov 2020 Form S-1. Page 111.
  3. Pliant Therapeutics Inc. 2 Jun 2020 Form S-1. Pages 76-77
  4. Forma Therapeutics Holdings, Inc. 8 Dec 2020 Form S-1. Page 76.
  5. ContextLogic Inc. 7 Dec 2020 Form S-1. Page 68.
  6. ContextLogic Inc. 7 Dec 2020 Form S-1. Page 68.
  7. DEAC NV Merger Corp. 23 Apr 2020. Form S-1. Page 49.
  8. Amor, S. B., Kooli, M. “Intended use of proceeds and post-IPO performance.” The Quarterly Review of Economics and Finance, 65, (2017): 168-181. Accessed December 29, 2020. doi:10.1016/j.qref.2016.09.001
  9. Hydrofarm Holdings Group, Inc. 1 Dec 2020. Form S-1. Page 56.
  10. Driven Brands Holdings Inc. 7 Jan 2021 Form S-1/A. Page 68.
  11. Doordash Inc. 7 Dec 2020 Form S-1/A. Page 87.
  12. Amor, S. B., Kooli, M. “Intended use of proceeds and post-IPO performance.” The Quarterly Review of Economics and Finance, 65, (2017): 168-181. Accessed December 29, 2020. doi:10.1016/j.qref.2016.09.001
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Author John Baadsgaard

John grew up in Spanish Fork, Utah. In addition to his Strategy degree, he is also completing minors in statistics and economics. John hopes to bring a uniquely down-to-earth, data driven, as well as big-picture perspective to problem solving and analysis. In his spare time, John also loves exploring mountain peaks, cooking exotic foods, and mastering Chopin etudes. He plans to join LEK Consulting in Houston after graduation.

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