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LAWYER Od Hne F Aig T Across Finish Making Chance Thegood It of Acceptable Terms December 2007 n Volume 11 n Number 12 From the EDITOR LAWYER Bumps on the Road to an IPO: Structuring Provisions to Anticipate Issues in Pre-IPO Convertible Bonds B Y J A M E S H . B A LL, JR. & A nd R E W F . F O WL E R Securities in the ElectronicAge James H. Ball, Jr. is a partner and Andrew F. Fowl- line to an IPO still faces a few significant er is a senior associate in the New York office of challenges in its path. In some cases, even Milbank, Tweed, Hadley & McCloy LLP. The views aggressive hedge funds specializing in ven- expressed in this article are those of the authors and do not necessarily reflect the views of the ture capital investments can be unwilling to firm. Contacts: [email protected] or afowler@ provide traditional debt financing to private milbank.com. Wall Street Wall companies in the development stage, which often face regulatory, product development Convertible bonds have long been a sta- or litigation challenges that can delay their ple on the corporate finance menu, offering development and, in extreme cases, even the benefits (and risks) of both equity and threaten their continued operation. When debt to issuers and investors alike. Among investors are willing to look past the risks to companies which are preparing to leave the rewards, and make financing available, the development stage and are considered they often demand interest rates which are strong candidates for a lucrative initial prohibitive and which put a drain on liquidi- public offering (“IPO”) in the next few ty at the worst possible time in the issuer’s life years, the pre-IPO convertible bond has cycle. For many such issuers, obtaining the taken center stage as a versatile financing financing necessary to sustain the last burst tool. Traditionally, convertible bonds have of momentum to get to an IPO may only blended the characteristics of equity and be made possible through the use of a pre- debt and have been used by issuers to raise IPO convertible bond, which will have a sig- capital without immediately diluting earn- nificantly lower interest rate than would be ings or adding leverage to a balance sheet. CONTINUED ON PAGE 3 The pre-IPO convertible bond serves simi- lar purposes but with added benefits to the late development stage issuer which would Article REPRINT otherwise be unable to secure financing on Reprinted from the Wall Street Lawyer. acceptable terms. Copyright © 2007 Thomson/West. For In many instances, an issuer which has a more information about this publication good chance of making it across the finish please visit www.west.thomson.com ARTICLE REPRINT Wall Street Lawyer Table of CONTENTS © 2007 Thomson/West. This publication was created to provide you with accurate and authoritative information concerning the subject matter covered, however it may not necessarily have been prepared by persons licensed to practice law in a particular jurisdiction. The publisher Free Service for Subscribers is not engaged in rendering legal or other professional advice, and this publication is not a substitute for the Online Editions Now Available advice of an attorney. If you require legal or other expert advice, you should seek the services of a competent West Legalworks is pleased to announce that this attorney or other professional. newsletter is now available on the Internet to Subscribers of the print edition. For authorization to photocopy, please contact the Copyright Clearance Center at 222 Rosewood Drive, The online version offers additional interactive capabilities Danvers, MA 01923, USA (978) 750-8400; fax (978) that enhance the usefulness of your subscription including 646-8600 or West’s Copyright Services at 610 Opperman Search features for current and archived articles and Drive, Eagan, MN 55123, fax (651)687-7551. Please Links to other information and Westlaw® cases. outline the specific material involved, the number of copies you wish to distribute and the purpose or format To take advantage of this service, of the use. please visit www.glwnewsletters.com/register.asp For subscription information, please contact the publisher to register or call 800.308.1700. at: [email protected] Editorial Board ALEXANDER C. GAVIS MICHAEL P. JAMROZ JOSEPH MCLAUGHLIN Vice President & Associate General Counsel Partner, Financial Services Sidley Austin, LLP CHAIRMAN: Fidelity Investments Deloitte & Touche New York, NY JOHN F. OLSON JAY B. GOULD STANLEY KELLER WILLIAM MCLUCAS Gibson, Dunn & Crutcher Pillsbury Winthrop Shaw Pittman LLP Edwards Angell Palmer & Dodge LLP Wilmer Cutler Pickering Hale & Dorr, LLP Washington, DC San Francisco, CA Boston, MA Washington, DC ADVISORY BOARD: JOSEPH A. GRUNDFEST CARY I. KLAFTOR BROC ROMANEK Professor of Law, Stanford Law School Vice President, Legal & Government Affairs, General Counsel, Executive Press, and Editor BRANDON BECKER and Corporate Secretary TheCorporateCounsel.net Wilmer Cutler Pickering Hale & Dorr, LLP MICALYN S. HARRIS Intel Corporation Washington, DC VP, General Counsel and Corporate Secretary JOEL MICHAEL SCHWARZ Winpro, Inc. BRUCE W. LEPPLA Attorney, U.S. Government BLAKE A. BELL Lieff Cabraser Heimann & Bernstein, LLP Simpson Thacher & Bartlett PROF. THOMAS LEE HAZEN San Francisco, CA STEVEN W. STONE New York, NY University of North Carolina – Chapel Hill Morgan Lewis LLP SIMON M. LORNE Washington, DC STEVEN E. BOCHNER ALLAN HORWICH Vice Chairman Chief Wilson Sonsini Goodrich & Rosati Schiff Hardin LLP Legal Officer LAURA S. UNGER Palo Alto, CA Chicago, IL Millennium Partners, L.P. Former SEC Commissioner and Acting Chairman EDWARD H. FLEISCHMAN TERESA LANNACONI MICHAEL D. MANN JOHN C. WILCOX Linklaters Partner, Department of Professional Practice Richards Kibbe & Orbe Senior VP, Head of Corporate Governance New York ,NY KPMG Peat Marwick Washington, DC TIAA-CREF JOEL ROTHSTEIN WoLFSON Banc of America Securities LLP Wall Street Lawyer Please address all editorial, subscription, and other correspondence to the publishers at [email protected] West Legalworks For authorization to photocopy, please contact the Copyright Clearance Center at 222 Rosewood Drive, Danvers, MA 01923, USA (978) 750-8400; fax (978) 646-8600 or West’s Copyright Services at 610 Opperman Drive, Eagan, MN 55123, fax (651) 687-7551. Please outline the specific material involved, the number of copies you 395 Hudson Street, 6th Floor wish to distribute and the purpose or format of the use. New York, NY 10014 West Legalworks offers a broad range of marketing vehicles. For advertising and sponsorship related inquiries or for additional information, please contact Mike Kramer, Director of Sales. Tel: 212-337-8466. Email: [email protected]. This publication was created to provide you with accurate and authoritative information concerning the subject matter covered. However, this publication was not necessarily prepared by persons licensed to practice law in a particular jurisdication. The publisher is not engaged in rendering legal or other professional advice, and this publication One Year Subscription n 12 Issues n $468.00 is not a substitute for the advice of an attorney. If you require legal or other expert advice, you should seek the services of a competent attorney or other professional. (ISSN#: 1095-2985) Copyright is not claimed as to any part of the original work prepared by a United States Government officer or employee as part of the person’s official duties. 2 December 2007 n Volume 11 n Issue 12 associated with a conventional bond issued by the The Case of the Missed Milestone same company. Especially in the later development stage, investors are more content to trade interest For many development stage companies, there now for the potentially unlimited equity upside as- are often milestones which, if reached in a timely fashion, will be indicative of a profitable path sociated with the conversion, typically at favorable toward success. Achievement of these goals will rates, of the pre-IPO convertible bond into shares of increase, and in some cases guarantee, the issuer’s a public company down the road. If all goes accord- ability to complete its IPO within the timeline en- ing to plan, the issuer will conduct an IPO within visioned by the original deal structure and value the timeline contemplated by the terms of the bond proposition. Conversely, a failure to reach such and investors will convert at a favorable premium. milestones, while not necessarily evidence of out- There are many significant legal issues impli- right failure, will delay the completion of the IPO cated by pre-IPO convertible bonds, including, and move back investors’ potential exit window. among many others: the risk of integration of Some typical milestones for the pre-IPO com- public and private offerings under the federal se- pany include initial regulatory or licensing ap- curities laws; Section 16 short-swing profit and provals, which are followed by achievement of a critical mass of subscribers or a certain size of ownership issues; the scope and substance of customer base, (or for a manufacturer, produc- anti-dilution protections; dealing with the rights tion of a certain number of units of its product.) of investors in previous financing rounds; and last As noted below, counsel should work with bank- but far from least, the overriding need to ensure ers and others familiar with the fundamentals of that the viability of the IPO is never jeopardized. an issuer’s business plan, since the synergies of the These topics are important, but we wish to fo- relevant factors can also define whether or not a cus here on the mechanisms that counsel to the company’s plan achieves full potential. From the issuer, investors and the placement agent can put investors’ standpoint, the key is to ask what are in place to address the bumps on the road that a the most important steps required for the issuer’s pre-IPO issuer may face.
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