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Home , Common stock, Initial public offering, Market capitalization, NYSE American, Prospectus (finance), Public company

FREQUENTLY ASKED QUESTIONS ABOUT INITIAL PUBLIC OFFERINGS

Initial public offerings (“IPOs”) are complex, time-consuming and implicate many different areas of the law and practices. The following FAQs address important issues but are not likely to answer all of your questions.

• Public have greater visibility. The media Understanding IPOS has greater economic incentive to cover a public than a private company because of the number of seeking information about their What is an IPO? . An “IPO” is the initial by a company • Going public allows a company’s employees to of its securities, most often its common . In the in its growth and success through stock , these offerings are generally registered options and other -based compensation under the , as amended (the structures that benefit from a more liquid stock with “Securities Act”), and the shares are often but not an independently determined fair market . A always listed on a national securities exchange such may also use its equity to attract as the (the “NYSE”), the and retain and key personnel. NYSE American LLC or one of the markets (“Nasdaq” and, collectively, the “exchanges”). The What are disadvantages of going public? process of “going public” is complex and expensive. • The IPO process is expensive. The legal, Upon the completion of an IPO, a company becomes and printing costs are significant and these costs a “public company,” subject to all of the regulations will have to be paid regardless of whether an IPO is applicable to public companies, including those of successful. the Securities Exchange Act of 1934, as amended (the “Exchange Act”). • Once an IPO is completed, a company will incur higher costs as a public company, including What are advantages of going public? the significant compliance requirements of the Sarbanes-Oxley Act of 2002 (“Sarbanes-Oxley”) and • The most obvious reason to go public is to raise the Dodd-Frank Reform and Consumer . Unlike a private offering, there are no Protection Act of 2010 (“Dodd-Frank”). restrictions imposed on a company with respect to offerees or how many securities it may sell. The • Ther e is much more public scrutiny of a funds received from the securities sold in an IPO company after an IPO. Once a company is public, may be used for common company purposes, such certain information must be disclosed, such as as , research and development, compensation, financial information and material retiring existing indebtedness and acquiring other agreements. companies or . How does the JOBS Act change the IPO process? • Going public creates a public market for a company’s securities. Liquidity is important for existing and Since at least the dotcom bust of the early 2000s and future investors, and provides an exit strategy for accelerating after the passages of Sarbanes-Oxley and venture and fund investors. Dodd-Frank, leaders and commentators have observed that the regulatory requirements to be met • Following an IPO, a company should have greater in to finance companies in the United States access to capital in the future. Once a public market have become overly burdensome and discourage is created, a company may be able to use its equity . In the aftermath of the financial in lieu of or more costly financings. crisis of 2008, national attention shifted to job creation Later-stage R&D companies and companies with near- and the backlash against over-regulation brought term milestones may also decide to access the public about by Dodd-Frank. In April 2012, the Jumpstart Our markets through an IPO. Business Startups Act (the “JOBS Act”) was enacted, There are a number of kinds of companies that which reflects many of the legislative initiatives that do not yet have an operating history but may seek had been discussed for several years. The JOBS Act to go public in order to pursue their strategic plans, adopted the following provisions that affect capital including: formation: • investment trusts (“REITs”), including • An “IPO on-ramp” for a new category of , mortgage REITs, are formed to take advantage of “emerging growth companies,” that offers a number opportunities to purchase distressed or undervalued of benefits, including confidentialE S C Staff review of mortgage-related securities and equity REITs that draft IPO registration statements, scaled disclosure seek to acquire specific kinds of real estate. requirements, no restrictions on “test-the-waters” communications with qualified institutional buyers • Special purpose acquisition vehicles (“SPACs”), a (“QIBs”) and institutional accredited investors more recent type of blind pool offering, are shell before and after filing a registration statement, and or blank-check companies that have no operations fewer restrictions on research (including research but go public with the intention of merging with or by participating underwriters) around the time of acquiring a company with the proceeds of the IPO, an offering (all of which will be discussed in greater subject to approval. detail below). • Business development companies (“BDCs”) are entities • An amendment to the Securities Act (informally that go public to fill the perceived need for capital referred to as Regulation A+) permitting for smaller businesses. companies to conduct offerings to raise up to $50 million in any 12-month period through a “mini- What is an “emerging growth company” or “EGC”? registration” process similar to that provided for The JOBS Act establishes a new process and disclosures under Regulation A. for IPOs by a new class of companies referred to as • Higher securityholder triggering thresholds for “emerging growth companies” or “EGCs.” An EGC reporting obligations under the Exchange Act. is an issuer (including a foreign private issuer) with total annual gross of less than $1.07 billion • Removal of the prohibition against general (adjusted from $1 billion in March 2017, and subject to solicitation and general advertising in certain inflationary adjustment by the SEC every five years) private placements. during its most recently completed fiscal year.1 The • A new exemption under the Securities Act for SEC Staff has stated in its General Applicability FAQs offerings. that -backed and registered investment The JOBS Act offers an issuer new possibilities for companies do not qualify as EGCs; however, BDCs can structuring its capital raise. qualify as EGCs. 1 In its Frequently Asked Questions of General Applicability What types of companies go public? on I of the JOBS Act (issued on April 16, 2012, updated on May 3, 2012 and September 28, 2012, and collectively Any company seeking greater access to capital may referred to herein as the “General Applicability FAQs”), decide to go public. Companies with revenues and the SEC Staff specified that the phrase “total annual profits or a shorter path to profitability are more gross revenues” means total revenues of the issuer (or a likely to have successful IPOs than companies predecessor of the issuer, if the predecessor’s financial without revenues or that are in a development stage, statements are presented in the registration statement for the most recent fiscal year), as presented on the income particularly in difficult economic environments. A statement in accordance with U.S. generally accepted company seeking increased visibility and liquidity accounting principles (“GAAP”). If a foreign private may also decide to go public. Depending on its size issuer is using International Financial Reporting Standards and business, a public company may have from two to (“IFRS”) as issued by the International Accounting 20 analysts covering its stock. Standards Board as its basis for presentation, then the IFRS number is used for this test. Because an Research and development-based companies, issuer must determine its EGC status based on revenues including pharmaceutical and technology companies, as expressed in U.S. dollars, the SEC Staff indicates that a with strong valuations but little current revenue may foreign private issuer’s conversion of revenues should be based on the as of the last day of the fiscal decide to go public to fund -term, costly R&D. year.

78 2 Morrison & Foerster LLP Capital Markets How long can an issuer maintain EGC status? ceases to be an EGC to continue to be treated as an EGC Status as an EGC is maintained until the earliest of: through the earlier of: the date on which the issuer consummates its IPO pursuant to that registration • the last day of the fiscal year in which the issuer’s statement, or the end of the one-year period beginning total annual gross revenues are $1.07 billion or more; on the date the company ceases to be an EGC. • the last day of the issuer’s fiscal year following the fifth anniversary of the date of the first sale of When should a company go public? common equity securities of the issuer pursuant There is no right answer or right time. It depends on to an effective registration statement under the a company’s need for cash or liquidity to pursue its Securities Act (for a debt-only issuer that never strategic plans. There is a market consensus that there sells common equity pursuant to a Securities Act is a “window” when companies, often particular types registration statement, this five-year period will not of companies, can effect IPOs. Whether the window run); is open or closed depends on overall economic • any date on which the issuer has, during the prior conditions and appetite for . For example, three-year period, issued more than $1 billion in in the dotcom boom of the late , many technology non-convertible debt; or companies had ideas but no revenues and certainly no • the date on which the issuer becomes a “Large profits. SPACs became popular in the 2000s because, Accelerated Filer,” as defined in the ES C’s rules. unlike blind pools before them, public investors in the SPACs had rights to approve the proposed acquisitions If an EGC loses its status as an emerging growth and the IPO proceeds had to be returned if a suitable company, the status cannot be reestablished. investment was not found within a specified period, With regard to the $1 billion debt issuance test, the usually two years. After the dotcom bust and since the SEC Staff clarified in the General Applicability FAQs current economic downturn, investors are looking for that the three-year period covers any rolling three- companies with more revenues and actual profits or a year period and is not limited to completed calendar relatively quick path to profitability. or fiscal years. The SEC Staff also noted that it reads “non-convertible debt” to mean any non-convertible What is the IPO process? that constitutes indebtedness (whether issued The public offering process is divided into three in a registered offering or not), thereby excluding periods: debt or facilities. The debt test references debt “issued,” as opposed to “issued and outstanding,” so • Pre-filing. The pre-filing period is the period from that any debt issued to refinance existing indebtedness the determination to proceed with a public offering over the course of the three-year period could be to the filing of a registration statement with the ES C. counted multiple times. However, the SEC Staff also This is also generally called the “quiet period,” and indicated in the General Applicability FAQs that it a company is usually subject to limitations on its will not object if an issuer does not double count the public communications. See “What is the quiet period?” principal amount from a and the and “What are ‘testing-the-waters’ communications by principal amount from the related Exxon Capital or on behalf of an EGC?” exchange offer, as it views the subsequent exchange • Waiting or pre-effective. The waiting or pre-effective offer as completing the capital-raising transaction. An period is the period from the date of the filing of the issuer also should count any debt securities offered by registration statement to its “effective date.” During or through a vehicle to the extent that the this period, a company may make oral offers and securitization vehicle is consolidated for accounting certain written offers, but may not enter binding purposes. agreements to sell the offered security. See “What is the waiting period?” What happens if an EGC loses its status as an EGC • Pricing and post-effective. The post-effective period is during its IPO? the period from the date the registration statement The Fixing America’s Surface Transportation Act (the has been “declared effective” by theE S C to the “FAST Act”) amends Section 6(e)(1) of the Securities completion of the offering. See “What happens after Act in order to provide a grace period permitting an the SEC has completed its review?” issuer that qualified as an EGC at the time it made its first confidential submission of its IPO registration statement and subsequently during the IPO process

3 The underwriters will market the IPO shares, set IPO Team the (in consultation with the company) at which the shares will be offered to the public and, in a “firm commitment” , purchase the shares from Who is involved in an IPO? the company and then re-sell them to investors. In order to ensure an orderly market for the IPO shares, Going public requires retaining the proper external after the shares are priced and sold, the underwriters advisors. An IPO team will include a lead underwriter are permitted in many circumstances to engage in and potentially co-managing underwriters, an certain stabilizing transactions to support the stock. See independent auditing firm with significant public “What actions may underwriters take after pricing?” company experience, outside legal counsel, a transfer agent and a financial printer. A company may also want to hire a public relations firm. What do the co-managers do? A company should also have an internal IPO team in Co-managers are underwriters who agree to purchase place. Key members of this internal team will include a substantial portion of a company’s shares and who the company’s president, CEO, CFO, general counsel, are involved in drafting the and marketing controller and an investor relations or public relations the offering. Companies typically choose co-managers manager. that have distribution capabilities or analyst coverage that is complimentary to those of the managing underwriter. What does the managing underwriter do?

A company will identify one or more lead underwriters What do the auditors/accountants do? that will be responsible for the offering process. A company chooses an underwriter based on its Accountants prepare and the financial statements expertise, including the knowledge and following of of a company or other entities or that must its research analysts, the breadth of its distribution be included in an IPO registration statement. Other capacity, and its overall . The company services provided by the accountants during the offering should know the answers to the following questions, process include assisting a company in preparing the at a minimum: other financial portions of the prospectus, such as the summary financial information, selected financial • Does the investment bank have strong research in its information, capitalization and dilution tables, and any industry? required financial statements, and working • Is its distribution network mainly institutional or with the company to identify any problems associated ? with providing the required financial statements in order to seek necessary accommodation from the SEC. • Is its strength domestic, or does it have foreign The accountants will also provide a “comfort letter” distribution capacity? to the underwriters. See “What financial information is Depending on the size of the offering, a company required to be included in the registration statement?” and may want to include a number of co-managers in order “What is a ‘comfort letter’?” to balance the lead underwriters’ respective strengths and weaknesses. What does legal counsel do? A company should keep in mind that underwriters A company’s in-house and outside legal counsel play have at least two conflicting responsibilities—to important roles in completing the IPO. A company’s sell the IPO shares on behalf of the company and to counsel: recommend to potential investors that the purchase of the IPO shares is a suitable and worthy investment. • has principal responsibility for preparing the In order to better understand the company—and to registration statement, prospectus, stock exchange provide a defense in case the underwriters are sued application and any confidential treatment requests; in connection with the IPO (see “Who may also be liable • communicates with the SEC and the stock exchanges under the Securities Act?”)—the underwriters and their on a company’s behalf, responding to any comments counsel are likely to spend a substantial amount of they may have; time performing business, financial and legal “due • negotiates an underwriting agreement with the diligence” in connection with the IPO, and making sure underwriters and their counsel; and that the prospectus and any other offering materials are consistent with the information provided.

80 4 Morrison & Foerster LLP Capital Markets • pr epares various other documents, including stock analyst is permitted to engage in communications with plans, a company’s post-IPO certificate of an EGC’s management when other employees of the and bylaws, committee charters, investment bank, including the investment bankers, board minutes relating to the IPO and any required are present.2 consents, waivers and legal opinions. Depending on its size and type of business, a Underwriters’ counsel undertakes legal due company can expect to have between two and 20 diligence during the offering process and reviews analysts covering its stock although smaller companies the registration statement and prospectus with may not have any analyst coverage. The analysts will the company, its counsel and the underwriters. regularly publish recommendations with respect to Underwriters’ counsel also: the company based on their analyses of the company’s • negotiates the underwriting agreement with a financial condition and results of operations. Analyst company and its counsel; coverage/publicity may result in introducing the company to potential customers and business partners, • negotiates the “comfort letter” with a company’s as well as reinforcing the company’s advertising and accountants; and product-branding initiatives. • submits the underwriting agreement, registration statement and other offering documents for review What does the financial printer do? to the Financial Industry Regulatory Authority A company’s financial printer will print and distribute (“FINRA”). drafts the prospectus to the working group as well as Company’s counsel and underwriters’ counsel will providing copies of the prospectus to the underwriters also coordinate the closing of the transaction. for distribution to investors. The printer will also file (or confidentially submit) the registration statement and What role do research analysts play? prospectus with the SEC through the SEC’s EDGAR system. While the company should seek a financial Generally, research analysts will cover the company printer with conference facilities, days at the once it becomes public, increasing the company’s printer are no longer as common as they were in the visibility. The JOBS Act permits a -dealer past because of the use of email, specialized websites to publish or distribute a research report about an and video and audio conference calls. EGC that proposes to register an offering under the Securities Act or has a registration statement pending, and the research report will not be deemed an “offer” What does the transfer agent do? under the Securities Act, even if the broker-dealer will A transfer agent coordinates the issuance and tracking participate or is participating in the offering. Since the of the company’s stock certificates. Unlike a private dotcom bust of the early 2000s, the courts, the SEC and company, a public company’s outstanding stock can FINRA have imposed significant restrictions on the be traded many times during each business day. The role of the research analyst and research’s relationship agent also maintains a list of the individuals and with investment bankers. The JOBS Act now prohibits entities to whom the shares are issued and some agents any self-regulatory (“SRO”), such as provide additional services that are useful to public FINRA, and the SEC from adopting any rule or companies, such as administering certain aspects of regulation that would restrict a broker-dealer from stock option plans and acting as inspectors of election participating in certain meetings relating to EGCs. at shareholder meetings. Further, no SRO or the SEC may adopt or maintain any rule or regulation prohibiting a broker-dealer from What other professionals are involved in an IPO? publishing or distributing a research report or making A company may hire a public relations firm for the a public appearance with respect to the securities of IPO. The public relations firm will help to ensure an EGC following an offering or in a period prior to that the company’s communications with the general of a lock-up (see “What types of provisions are public as well as its target market during the offering contained in the underwriting agreement?”). The JOBS Act period are consistent with the SEC’s rules, while also removes restrictions on who within an investment bank can arrange for communications between research 2 See “Frequently Asked Questions about Separation of analysts and prospective investors in connection with Research and ” at http://www. an EGC IPO, permitting investment bankers to be mofo.com/files/Uploads/Images/Frequently-Asked- Questions-about-Separation-of-Research-and-Investment- involved in those arrangements. Further, a research Banking.pdf.

5 continuing to generate in the company and its require conversion or . The underwriters business. In preparing for an IPO, the company should may also advise the company whether a discuss with the public relations firm the nature of the or is appropriate in order for the communications planned during the offering period company’s stock to at an attractive price for its and identify any items that might constitute gun industry and size after the IPO. jumping. See “Pre-IPO Disclosures.” • A company must also address other matters, including:

Pre-Filing Matters – board structure; – recruiting directors; – board and management committees and member What corporate steps should be taken to prepare for criteria; an IPO? – whether to retain additional senior management; Most companies must make legal and operational – identifying, disclosing and/or terminating related changes before proceeding with an IPO and begin party transactions; and those changes well before the organizational meeting. A company cannot wait to see if its IPO is likely to – directors’ and officers’ liability . be successful prior to implementing most of those changes. Should a company review its compensation policies and principles prior to the IPO? • Many corporate governance matters, federal securities law requirements (including Sarbanes- A company should undertake a thorough review of Oxley) as well as applicable exchange requirements its compensation scheme for its directors and officers, must be met when the IPO registration statement particularly its use of equity compensation. is filed, or a company must commit to satisfy them • Systematizing compensation practices. Compensation within a set time period. A company’s certificate decisions should be made more systematically— of incorporation and bylaws will likely need doing so may require: amendment as well. However, many corporate governance requirements are not applicable to – establishing an independent compensation foreign private issuers although home country committee of the , as required requirements are often required to be disclosed. by Dodd-Frank and the exchanges; • A company proposing to list securities on an – using formal market information to set exchange should review that exchanges’ financial compensation; and requirements as well as its governance – establishing a regular equity compensation grant requirements before determining which exchange cycle. to choose. • Confirming accounting and treatment. A company • A company should consider adopting anti- should be sure that the Internal Revenue Code defenses, such as a staggered board of directors or a (“Code”) Section 409A used to establish . The underwriters should be stock value for stock option purposes is consistent involved in these discussions so that the company with that used for purposes. avoids adopting any anti-takeover measure that The company should also consider whether to limit might negatively affect the marketing of the offering. option grants as the IPO effective date approaches • The company should analyze its capitalization to because option grants close to an IPO may raise determine whether it will be appropriate after the “cheap stock” issues. See “What is ‘cheap stock’?” IPO. For example, because of the risk of “market • Reviewing securities law compliance. A company should overhang” (the concern that a large number of shares confirm that equity grants were made in compliance may flood the public market and depress the market with federal and state securities rules, including the price of the shares), most underwriters advise limits of Rule 701 under the Securities Act, to avoid companies to try to cause the conversion or exercise rescission or other compliance concerns. of outstanding convertible , warrants • Adopting plans. Public companies are usually and convertible debt into prior to the required by the exchanges to obtain shareholder IPO if the original documentation does not already approval for new compensation plans and material

82 6 Morrison & Foerster LLP Capital Markets amendments. In order to obtain favorable “incentive • “material correcting adjustments” identified by stock option” (“ISO”) treatment under U.S. federal the company’s accountants must be reflected in tax laws, the option plan must be approved by all periodic reports containing GAAP financial a company’s . An issuer will have statements; greater flexibility to adopt compensation plans • potential compensation disgorgement upon a prior to its IPO. An issuer should adopt the plans restatement of financial results attributable to it thinks it may need during its first few years as a misconduct; public company (including an equity incentive plan, employee stock purchase plans, and Code Section • auditor independence; 162(m) “grandfathered” bonus plans), and reserve • certifications by the company’s CEO and CFO of sufficient shares for future grants. each periodic report containing financial statements; • Adoption of policies and clawback arrangements. • adoption of a code of business conduct and ethics Particularly in light of the requirements of Dodd- for directors, officers and employees; Frank, a company should review or establish • protections for employees who come policies with respect to clawbacks of executive forward with information relating to violations of compensation, severance and post- federal securities laws; benefits (“golden parachutes”) upon the occurrence of certain events. • the creation of audit, nominating and compensation committees that comply with certain independence What is the organizational meeting? requirements; note that the independence requirements for compensation committees were The IPO process usually starts moving rapidly strengthened by Dodd-Frank; and beginning with an organizational meeting attended by representatives of the company, its accountants • shareholder approval of equity compensation plans. and counsel, the underwriters and their counsel. The meeting generally includes discussion of the timeline When does Sarbanes-Oxley apply to an issuer? for the offering, the general terms of the offering and the Certain provisions of Sarbanes-Oxley become responsibilities of the various parties. Also discussed applicable immediately upon the filing of the is the timing of the audited financial statements to be registration statement by a company, even before the included in the prospectus and any accounting matters registration statement is declared effective, and other or policies that may be of concern. The participants provisions of Sarbanes-Oxley apply to a company as will also discuss reasons for potential timing delays— soon as its registration statement becomes effective. for example, significant acquisitions or the need for Accordingly, the company must familiarize itself with financial statements relating to acquisitions or the need Sarbanes-Oxley requirements early in the offering to retain additional executive officers. process and take necessary steps to comply prior to The organizational meeting may also include filing the registration statement or prior to effectiveness. presentations by the company’s management, some However, the company will not have to comply with initial questions by the underwriters the requirements of Section 404 of Sarbanes-Oxley and their counsel and a general discussion of the scope regarding internal control over financial reporting and level of comfort that the accountants will be asked until the second fiscal year following its IPO (and to provide with respect to the financial information potentially after the fifth fiscal year for anE GC). included in the prospectus. What is the “due diligence” process? What do Sarbanes-Oxley and Dodd-Frank require? Underwriters have a defense to Securities Act liability The requirements of Sarbanes-Oxley, as augmented by if they exercise “due diligence,” which is the practice Dodd-Frank, include: of reviewing information about an issuer in an effort to mitigate liability and reputational risk. After the • a prohibition on most to officers and executive organizational meeting and during the quiet period, directors; the underwriters and their counsel will likely spend • limitations on the use of non-GAAP financial a substantial amount of time performing business, measures; financial and legal due diligence in connection with • disclosure of material off- the IPO. The process is usually started with a “due arrangements; diligence request” prepared by the underwriters

7 and their counsel. The company’s key management confidential information that, if used, could enable personnel will generally make a series of presentations them to make profitable in those securities. covering the company’s business and industry, market Even though this type of would opportunities, and financial matters. The underwriters violate the employee’s legal obligations, and not will use these presentations as an opportunity to necessarily the company’s obligations, insider trading ask questions and establish a basis for their “due violations are the type of publicity that all companies diligence” defense. The presentations will also aid the seek to avoid. Accordingly, it is an important part of company and the underwriters in determining how the offering process for a company to adopt an insider the prospectus will describe the company, its business, trading policy. A typical policy will bar trading in the strategies and objectives and risk factors, and provide company’s securities (and the securities of any other information for drafting the underwriting agreement. company with which the company does business) The company’s directors and officers will be during any period in which the individuals covered provided with a directors’ and officers’, or “D&O,” by the policy possess material non-public information questionnaire to complete. The purpose of the about the issuer, and most policies impose mandatory questionnaire is to identify any facts about those restrictions (“blackout periods”) during the period individuals, and the relationships that they have between the time that the company begins to compile with the company, its affiliates or business partners, its financial results for a quarter and one or two business that must be disclosed in the prospectus. The D&O days after the release of the financial information to the questionnaire usually tracks the specific E S C and public in the form of an earnings release. FINRA disclosure requirements. In some cases, holders of more than 5% of the company’s equity will also be What third-party consents are needed? asked to execute a D&O questionnaire. Prior to an IPO, a company may have entered into Typical areas of concern include: agreements that impose restrictions on its ability to • Business, including management presentations complete the IPO, including and discussions, customer and supplier calls or • Shareholder agreements that may require consents meetings, trips to company facilities, in-depth to share issuances or that require the company to review of financial positions and results and general register the shareholders’ shares as part of the IPO discussions with the company’s accountants; (“registration rights”); • Accounting, including , changes in accounting • or credit agreements that restrict share policies, critical accounting policies and tax issues, issuances or the use of proceeds from the offering; or cheap stock issues, and comfort • Operating agreements with significant business letters and the level of comfort to be provided; partners that contain broad “change of control” • Legal, including outstanding and even closed claims provisions that may be triggered by the IPO. and litigation, loan agreement restrictions, third A company, with the help of its counsel, should review party consents, FINRA issues, intellectual , all of its agreements to identify these provisions and labor, environmental, regulatory or other issues and negotiate for necessary consents or waivers with the legal opinions; and other parties involved so that they do not jeopardize • Management and corporate governance, including the timing of the IPO. Companies will want to avoid composition of the board, director independence, any last minute hold-up by a shareholder, creditor or senior management team changes, related party supplier or customer that could delay the offering or transactions and board actions relating to the IPO. require the issuer to pay a consent fee or make other concessions. What is “insider trading”? Federal securities laws impose significant restrictions, and may impose civil and criminal liability, on the company’s personnel who trade securities on the basis of material non-public information. While this is not a significant issue until a company completes its IPO, when the company’s securities begin to trade in the public market, there likely will be risk that the company’s officers, directors and employees will have

84 8 Morrison & Foerster LLP Capital Markets Pursuant to Dodd-Frank and the SEC’s implementing Reviewing Management Structure rules, exchanges must require that listed companies’ compensation committees, among other things, be composed entirely of independent directors. Are independent board members required? A company must comply with significant corporate Do board committees need charters? governance requirements imposed by federal Yes, under the rules of the exchanges, the audit, securities laws and regulations and the regulations compensation and nominating/corporate governance of the applicable exchanges, including with regard to committee charters must contain specific responsibilities the oversight responsibilities of the board of directors and provisions, including the committee’s purpose, and its committees. A critical matter is the composition member qualifications, appointment and removal, of the board itself. All exchanges require that, except board reporting and performance evaluations. If any of under certain limited circumstances, a majority of the responsibilities of these committees are delegated the directors be “independent,” as defined by both to another committee, the other committee must be federal securities laws and regulations and exchange comprised entirely of independent directors and must regulations. In addition, boards should include have its own charter. In addition, the NYSE and best individuals with appropriate financial expertise and practices require that the company make its charters industry experience, as well as an understanding available on or through its website, and disclose in of issues and public company its proxy statement (or on Form 10-K experience. In addition, the exchanges require that if it does not file a proxy statement) that the charters the independent directors have regularly scheduled are available on or through its website, including the executive sessions. address. A company should begin its search for suitable directors early in the IPO process even if it will not Does a company need to hire new senior management appoint the directors until after the IPO is completed. in connection with an IPO? The company can turn to its large investors as well as The need to hire new senior management is a its counsel and underwriters for references regarding company-specific determination. Some companies potential directors and also designate a committee of contemplating an IPO may feel the need to have the board to undertake the director search. chief executive officers who have public company experience but who may not necessarily have the What board committees are required? industry experience. In many ways, it may even be The exchanges all require listed companies to have more critical that the company have a chief financial an , consisting only of at least three officer with public company experience as the financial independent directors who meet certain standards. reporting requirements are extensive and unrelenting. At least one of the audit committee members must Often, underwriters will identify new or replacement be a “financial expert.” The passage of Sarbanes- officers that the underwriters believe will make the Oxley in 2002 resulted in a significant enhancement company more attractive to investors. Because finding of the independence and expertise requirements such officers is time-consuming and expensive, it is for audit committees. At the same time, the SEC best for the company to identify the management gap and the exchanges began to exert pressure to ensure as early in the process as possible. that compensation and nominating or corporate Well before its IPO, an issuer should begin to governance committees become more independent. approach like a public The NYSE also requires a compensation committee company. The IPO registration statement requires the and a nominating/corporate governance committee same enhanced executive compensation disclosures consisting only of independent directors. Nasdaq that public companies provide in their annual proxy also now requires, subject to certain phase-in rules, statements, including a discussion of compensation a compensation committee of independent directors philosophy, an analysis of how compensation but does not require a nominating committee. The programs implement that philosophy and a discussion functions of a nominating committee can be performed of the effects of risk-taking on compensation decisions. either by a committee consisting solely of independent An EGC will have reduced compensation disclosure directors or by a majority of the company’s requirements. See “What disclosures may an EGC omit independent directors operating in executive session. from its registration statement?”

9 under the Securities Act, the issuer must also file a Listing registration statement under the Exchange Act that acts as the continuing registration statement for the company after the IPO is completed. If the exchange What are the benefits of listing a class of securities on listing is in conjunction with the IPO, the Exchange an exchange? Act registration statement is a brief filing consisting primarily of cross-references to the Securities Act IPO Listing its stock on an exchange is one of the most registration statement. The exchange will review the important steps a company can take to achieve application and supporting documentation and once liquidity. Certain kinds of investors may only invest in the listing is approved, the shares will be admitted exchange-listed issuers. Liquidity and an active market for trading after the Exchange Act and, if applicable, should help establish a widely recognized value for Securities Act registration statements have been the company’s stock, which will help the company declared effective by the SEC and the shares have use its stock instead of cash for acquisitions and other been offered and sold if there is a concurrent IPO. A significant transactions. Listing on an exchange cannot company cannot state in its preliminary prospectus liquidity or investor interest and there are that its shares have been approved for listing, subject many companies that have liquid markets even though to official notice of issuance, unless it has actually they are traded in the over-the-counter (“OTC”) received such approval. As listing is often critical to markets such as OTCQX and OTCPink. However, the success of an IPO, it is best practice to get such particularly since the rise of the alternative trading approval before the preliminary prospectus has been markets, such as “dark pools,” it is usually beneficial printed. for a company to list on an exchange.

What are exchange requirements to list a stock? Underwriting Arrangements Exchange listing requirements may be generally described as “quantitative requirements” and “qualitative requirements.” Quantitative requirements What kinds of underwriting arrangements are are financial criteria for listing and include a minimum possible? number of shareholders of the company, a minimum , a minimum and In a typical IPO, the underwriters will have a “firm financial tests. Qualitative requirements are standards commitment” to buy the shares once they sign the relating to the company’s business and corporate underwriting agreement, meaning they will purchase governance, including the nature of the company’s all of the offered shares if the conditions specified in the business, the market for its products, its regulatory underwriting agreement are satisfied. However, other history, as well as the election and composition of the underwriting arrangements exist, including a “best- board of directors and audit committee, issuance of efforts” underwriting, in which the underwriters agree earning statements and the company’s shareholder to use their best efforts to sell the stock as the company’s approval requirements. Especially since the passage agents. If purchasers are not found, the stock will not of Sarbanes-Oxley and Dodd-Frank, there has been be sold. A best-efforts underwriting may provide that significant convergence of the exchanges’ corporate no shares will be sold unless purchasers can be found governance requirements, some of which are already for all of the offered shares but other arrangements discussed in these FAQs. provide that shares may be sold as long as a specified minimum is reached (sometimes known as a “min-max What is the listing process? best efforts offering”). The SEC imposes certain escrow and other requirements on a min-max best efforts To list its securities on an exchange, a company must offering. The nature of the underwriters’ commitment meet the quantitative and qualitative requirements will also affect the ability of the underwriters to engage and submit an application to the exchange. The in certain stabilizing transactions to support the stock NYSE and the NYSE American LLC require that the price following the IPO. company participate in a confidential pre-application eligibility review in order to determine whether the How much will the underwriters’ compensation be? company meets its listing criteria. Nasdaq offers a similar preliminary listing eligibility review. In order The underwriters will be paid a fixed percentage of for shares to be listed on the exchange, in addition the total dollar amount of securities sold, usually to filing a registration statement for the IPO itself about 7%. The percentage varies depending on a

86 10 Morrison & Foerster LLP Capital Markets number of factors, such as the size of the company, its whether the underwriters have a firm commitment profitability, its industry, etc., but cannot exceed 10%. or best efforts obligation and the underwriters’ See “What is FINRA and what are its requirements?”. compensation. While the underwriters will not receive their fee unless • Representations and warranties. The company makes the IPO is successful, when they are paid, their fees are statements about its business, and , substantial. the offered stock and the accuracy of the registration statement. What is an auction IPO? • Conditions to closing. Conditions usually include the In a traditional underwriting, the underwriters set continued effectiveness of the registration statement the initial offering price based on their understanding and the absence of material adverse changes. of non-binding indications of interest from potential Required deliverables. investors. In an auction, also sometimes called a • The company will need “,” potential investors put in bids for the to provide opinions of counsel and other shares at the they deem appropriate. The shares experts, certificates confirming the accuracy of are then sold at the highest price that results in all of the the representations and warranties, the initial offered shares being sold. Unlike a traditional auction accountants’ comfort letter delivered at the time where the price starts out low and rises, in a Dutch of pricing the offering and the bring-down letter auction, the price starts out high and decreases until all delivered at closing and other closing documents. shares are allotted to investors, and all investors pay • Division of expenses. The underwriting agreement that lowest price. The IPO in 2004 is the most will specify which expenses of the offering are paid famous example of a Dutch auction IPO. They are still by the company. rare occurrences. • Lock-ups. The underwriting agreement will prohibit the company as well as directors and executive What types of provisions are contained in the officers from selling equity, except for certain limited underwriting agreement? purposes, during a period of up to 180 days following An underwriting agreement is the agreement pursuant the IPO without the managing underwriter’s to which a company agrees to sell, and the underwriters consent. This “lock-up” will also often extend to all agree to buy, shares and then sell them to the public. or certainly the largest shareholders of the issuer. Until this agreement is signed, the underwriters do The exceptions from the lock-up provisions can be not have an enforceable obligation to acquire the highly negotiated. offered shares (in a firm commitment offering) or • Indemnification. The indemnification section to use their best efforts to place the shares (in a best is probably the most important part of the efforts offering). The underwriting agreement is underwriting agreement other than the payment executed after the offering price is agreed upon, which provisions. Arguably, the balance of the agreement is typically shortly after the Securities Act registration is a due diligence exercise designed to ensure statement is declared effective by the ES C. that the company provides sufficient information In addition to being a securities purchase agreement, to the underwriters to satisfy the underwriters’ an underwriting agreement may serve to protect the liability obligations under the Securities Act. In underwriters from liability under the Securities Act the indemnification section, the company (and in connection with an offering. Part of underwriters’ sometimes, the primary shareholder) agrees to due diligence is making sure that the representations indemnify and be responsible for the underwriters’ of the issuer in the underwriting agreement are true damages and expenses in the event of any litigation and accurate. In addition, the underwriters’ defenses or other proceedings regarding the accuracy of are bolstered by the receipt of opinions of counsel the registration statement and prospectus. The about specific matters relating to the company as well indemnification section will also provide that the as “comfort letters” from the company’s auditors and underwriters will be liable to the company for in some circumstances, receipt of similar letters from misstatements in the prospectus attributable to the other experts such as engineers and oil and gas experts. underwriters, which information is typically limited to the underwriters’ names and the stabilization The most important provisions of an underwriting and similar disclosures. Each underwriter has its agreement are: own form of indemnification provision and, in light • Description of the nature of the underwriters’ obligation. of the importance of this section, underwriters are The opening paragraphs describe the offering, usually reluctant to make changes to that provision.

11 It should be noted that the SEC has a long-standing A registration statement on Form 10 registers a that indemnification for Securities Act company’s stock pursuant to Section 12(b) or (g) of liabilities is unenforceable and against public policy. the Exchange Act, so that the company can become a reporting company under the Exchange Act. It requires What are lock-up agreements? many of the same disclosures as would be required in an IPO under the Securities Act that typically uses a To provide for an orderly market and to prevent registration statement Form S-1, including risk factors, existing shareholders who may have owned the financial information and statements and descriptions shares long enough to have freely tradable shares from of the company’s business and its management. dumping their shares into the market immediately after the IPO (and indicating a lack of trust in the Technology and the Internet have made self- future of the company), underwriters will require underwriting a more feasible prospect for even small the company as well as directors, executive officers companies. Through the Internet, companies can reach and large shareholders (and sometimes all pre-IPO a wider audience of investors without an underwriter. shareholders) to agree not to sell their shares of common Some companies have even conducted auction IPOs, stock, except under certain limited circumstances, in which the company solicits bids through a website. for a period of up to 180 days following the IPO, Three considerations for companies considering effectively “locking up” such shares. Exceptions to going public without an underwriter are: the lock-up include issuances of shares in acquisitions Locating investors: and in compensation-based grants. Shareholders may • If the offering is of a significant be permitted to exercise existing options (but not to size, it may be difficult for a company to find enough sell the shares), transfer shares to family investors for its shares. trusts, and sometimes to make specified private sales, • Independent scrutiny: In addition to the discipline provided that the acquiror also agrees to be bound by of responding to underwriters’ comments based on the lock-up restrictions. Lock-up exceptions can be their diligence, underwriters may have a better and highly negotiated. broader understanding of the company’s industry and markets and will have access to more investors, What is FINRA and what are its requirements? particularly institutional investors. FINRA is the largest non-governmental regulator for • Research coverage: An IPO without underwriters all securities firms doing business in theU nited States. may not have any or sufficient research coverage It was created in July 2007 through the after the offering, often resulting in an inactive, and of the National Association of Securities Dealers and therefore, illiquid, post-offering market. the member regulation, enforcement, and arbitration functions of the NYSE. FINRA determines whether the terms of the “underwriting compensation” and Financial Information arrangements relating to “public offerings” are “unfair and unreasonable.” Underwriters’ counsel will submit the underwriting What financial information is required to be included agreement, the registration statement, and other in the registration statement? offering documents for review Nto FI RA. FINRA The SEC requires the following information in the reviews the terms of the offering and the underwriting prospectus of an issuer: arrangements to determine whether they are “fair and • Audited balance sheets as of the end of the issuer’s reasonable.” FINRA will focus on the compensation to last two fiscal years; be paid to the underwriters, which could also include certain items of value received in the six months before • Audited statements of operations, statements of the IPO. An IPO cannot proceed until the underwriting cash flows, statements of comprehensive income arrangement terms have been approved by FINRA. and statements of changes in shareholders’ equity of the company’s last three fiscal years, or two years Can a company “go public” without an underwriter? in the case of an EGC; There are two ways a company can go public without • Depending on the length of time from the end an underwriter: (i) through a Form 10 filing and (ii) by of the last fiscal year and the date of filing, an self-underwriting. unaudited balance sheet for the most recent fiscal

88 12 Morrison & Foerster LLP Capital Markets interim period and statements of operations, may omit from its filed registration statements annual statements of cash flows and statements of changes and interim financial information that “relates to a in shareholders’ equity for the interim period and historical period that the issuer reasonably believes for the corresponding period of the prior fiscal year; will not be required to be included…at the time of the and contemplated offering.” Interim financial information • Selected historical financial data for the last five that will be included in a longer historical period fiscal years (or since the company’s incorporation, if relates to that period. Accordingly, interim financial the company has not been in existence for five fiscal information that will be included in a historical period years) and for the period since the end of the last that the issuer reasonably believes will be required full fiscal year and the corresponding period of the to be included at the time of the contemplated prior fiscal year; while the JOBS Act was unclear, offering may not be omitted from its filed registration the General Applicability FAQs clarify that an EGC statements. However, under Staff policy, anE merging may limit the selected historical financial data in Growth Company may omit from its draft registration its IPO prospectus to the same number of years as statements interim financial information that it the audited financial statements presented in the reasonably believes it will not be required to present registration statement. separately at the time of the contemplated offering.” These statements must be prepared in accordance The updated SEC Staff guidance includes a helpful with U.S. GAAP, and they will be the source of example as well: information for “Management’s Discussion and For example, consider a calendar year-end Analysis of Financial Condition and Results of Emerging Growth Company that submits a draft Operations” (“MD&A”). registration statement in November 2017 and In addition, a prospectus may contain audited and reasonably believes it will commence its offering in unaudited financial statements relating to acquisition April 2018 when annual financial information for of assets and companies as well as pro forma financial 2017 will be required. This issuer may omit from its information indicating what the issuer’s financial draft registration statements its 2015 annual financial statements would look like following the acquisition. information and interim financial information related to 2016 and 2017. Assuming that this issuer were to first publicly file in April 2018 when its Can an EGC omit any other financial information in annual information for 2017 is required, it would its confidential submissions? not need to separately prepare or present interim The FAST Act also amended the financial information information for 2016 and 2017. If this issuer were requirement for EGCs. As a result of the FAST Act to file publicly in January 2018, it may omit its 2015 amendments, an EGC may omit historical financial annual financial information, but it must include information for certain periods otherwise required its 2016 and 2017 interim financial information in by Regulation S-X at the time of filing or confidential that January filing because that interim information submission, if the EGC reasonably believes the relates to historical periods that will be included at information will not be required to be included at the the time of the public offering. time of the contemplated offering. By way of example, this change would allow an EGC to omit 2013 financial Can a non-EGC issuer that avails itself of the statements in a December 2015 filing if it does not confidential submission process omit any financial intend to consummate the offering until its year-end information? 2015 audited financial statements are available (at which point 2014 and 2015 financial statements will be An issuer that is not an EGC that is relying on the included in the registration statement). In December confidential submission process may exclude certain 2015 and subsequently superseded in August 2017, the financial information that the issuer believes will not SEC Staff provided guidance on this change, clarifying be required at the time that the registration statement that the accommodation applies to all historical is publicly filed (as opposed to, in the case of EGCs, financial information required to be presented discussed above, at the time of the offering). Also, pursuant to Regulation S-X, including, for example, as discussed above, an issuer cannot omit from its financial statements for an acquired company. confidential submission interim financial statements for a period that will be included within required As noted above, in August 2017, the SEC Staff financial statements covering a longer interim or provided updated guidance on this topic. In this annual period at the time of its offering, even though guidance, the SEC Staff notes that, “Under Section the shorter period will not be required to be presented 71003 of the FAST Act, an Emerging Growth Company

13 separately at that time. In the SEC Staff guidance What is “cheap stock”? issued in August 2017, the Staff provided an example Many offerings involve grants of options to officers, set forth below directors and employees before the IPO process …[C]onsider a calendar year-end issuer that is begins. The impact of any option grant on the not an Emerging Growth Company that submits a company’s financial statements in the prospectus draft registration statement in November 2017 and and in subsequent SEC filings should be discussed reasonably believes it will first publicly file in April with the company’s accountants, underwriters and 2018 when annual financial information for 2017 counsel before any action is taken as these grants will be required. This issuer may omit from its draft raise accounting issues that can result in less attractive registration statements its 2014 annual financial financial results. In addition, under IRS regulations, information and interim financial information stock options that are not priced at their fair market related to 2016 and 2017 because this information value as of the date of the grant may subject the would not be required at the time of its first public option holder to an excise tax on this component of filing in April 2018. compensation. “Cheap stock” describes options granted to What are auditors’ consents and why are they employees of a pre-IPO company during the 18-24 necessary? months prior to the IPO where the exercise price is The SEC requires that auditors consent in writing to deemed (in hindsight) to be considerably lower than the inclusion of their audit reports in the prospectus. the fair market value of the shares at grant date. If the Under the Securities Act, auditors have liability as SEC determines (during the comment process) that experts. Further, a positive audit report is viewed by the company has issued cheap stock, the company the market as critical to an IPO. Therefore, in order to must incur a compensation expense that will have a ensure that the auditors have reviewed the prospectus negative impact on earnings. The earnings impact may that includes their audit report and to protect the result in a significant one-time charge at the time of auditors from companies falsely including audit the IPO as well as going-forward expenses incurred reports in the auditors’ names, the SEC requires the over the option vesting period. In addition, absent company to include an executed auditor’s consent as certain limitations on exercisability, an option granted an exhibit to its filed registration statement. with an exercise price that is less than 100% of the fair market value of the underlying stock on the grant date Does the SEC comment on the financial statements? will subject the option holder to an additional 20% tax pursuant to Code Section 409A. The SEC will review and comment on the financial statements and the MD&A. The SEC’s areas of The dilemma that a private company faces is that it particular concern are: is unable to predict with any certainty the eventual IPO price. A good-faith pre-IPO fair market value analysis • revenue recognition; can different conclusions when compared to a • business combinations; fair market value analysis conducted by the SEC in • segment reporting; hindsight based on a known IPO price range. There is some industry confusion as to the acceptable method • financial instruments; for calculating the fair market value of non-publicly • impairments of all kinds; traded shares and how much deviation from this value • deferred tax valuation allowances; and is permitted by the SEC. A company will often address this “cheap stock” concern by retaining an independent • compliance with debt covenants, fair value and loan appraiser to value its stock options. However, it now losses. appears that most companies are using one of the safe- Companies and their auditors should review their harbor methods for valuing shares prescribed in the accounting policies and potential areas of concern Section 409A regulations. before filing the registration statement. TheE S C encourages discussions with its accounting Staff of What is a “comfort letter”? accounting concerns early in the preparation process, During the waiting period, underwriters’ counsel and thus avoiding potential problems once the registration the company’s independent auditor will negotiate the statement is filed and publicly available. auditor’s “comfort letter.” In the “comfort letter,” the auditor affirms (1) its independence from the issuer, and (2) the compliance of the financial statements

90 14 Morrison & Foerster LLP Capital Markets with applicable accounting requirements and SEC Offering Reform,” which included adding a number regulations. The auditor will also note period-to-period of communication safe harbors from enforcement of changes in certain financial items. These statements Section 5. follow prescribed forms and are usually not the subject of significant negotiation. The underwriters will also What is the quiet period? usually require that the auditor undertake certain Section 5(c) of the Securities Act prohibits offers or “agreed-upon” procedures in which the auditor sales of a security before a registration statement compares financial information in the prospectus has been filed. The pre-filing period begins when a (outside of the financial statements) to the issuer’s company and the underwriters agree to proceed with accounting records to confirm its accuracy. These a public offering. procedures can be the subject of significant negotiation as certain information for which the underwriters seek From the first all-hands organizational meeting comparison may not be in the issuer’s accounting forward, all statements concerning the company records. These are called “comfort letters” as they should be reviewed by the company’s counsel offer cold comfort because of the number of caveats to ensure compliance with applicable rules. and exceptions taken by the auditors, including use of Communications by an issuer more than 30 days negative assurance language (for example, “nothing prior to filing a registration statement are permitted has come to our attention that the relevant information as long as they do not reference the . is not true”). There may be more than one comfort letter Statements made within 30 days of filing a registration if the financial statements included in the registration statement that could be considered an attempt to pre- statement are audited by more than one auditor, and sell the public offering may be considered an illegal the allocation of agreed-upon procedures between prospectus, creating a “gun-jumping” violation. This the different auditors may also require negotiation. might result in the SEC delaying the public offering Agreed-upon procedures may also uncover errors in or requiring prospectus disclosures of these potential the prospectus. Therefore, it is best practice to finalize securities law violations. See “What is ‘gun jumping’?” the agreed-upon procedures prior to printing the Press interviews, participation in investment banker- preliminary prospectus for any road show. sponsored conferences and new advertising campaigns are generally discouraged during this period. In general, at least four to six weeks will pass between Pre-IPO Disclosures the distribution of a first draft of the registration statement and its filing with or confidential submission to the SEC. To a large extent, the length of the pre- Why are there limitations on public statements by a filing period will be determined by the amount of time company in proximity to its IPO? required to obtain the required financial statements to be included in the registration statement. Section 5(c) of the Securities Act prohibits offers of a security before a registration statement is filed. Section What are “testing-the-waters” communications by or 5(b)(1) prohibits written offers other than by means of on behalf of an EGC? a prospectus that meets the requirements of Section 10 of the Securities Act, such as a preliminary prospectus. The JOBS Act provides an EGC, or any other person, The bans are designed to prohibit inappropriate such as its underwriter, that it authorizes to act on marketing, conditioning or “hyping,” of the security its behalf, with the flexibility to engage in oral or before all investors have access to publicly available written communications with QIBs and institutional information about the company so that they can make accredited investors in order to gauge their interest in informed investment decisions. Generally, a company a proposed offering, whether prior to (irrespective of contemplating an IPO does not have much publicly the 30-day safe harbor) or following the first filing of available corporate information and none of that any registration statement, subject to the requirement information has been subject to regulatory review. that no security may be sold unless accompanied Until 2005, the Section 5 bans were quite prohibitive, or preceded by a Section 10(a) prospectus. An EGC created significant uncertainty about the effects of may utilize the testing-the-waters provision with ordinary business communications and did not address respect to any registered offerings that it conducts the explosion of new communication technologies while qualifying for EGC status. There are no form since the 1930s. In 2005, in order to modernize the or content restrictions on these communications, and offering process, the SEC adopted the “Securities there is no requirement to file written communications

15 with the SEC. In their comment letters on registration What is “gun jumping”? statements, the SEC Staff typically requests to see “Gun jumping” refers to written or oral offers made any written test-the-waters materials, which can before the filing of the registration statement and written also provide it with guidance about information that offers made after the filing of the registration statement should be included in the prospectus. other than by means of a Section 10 prospectus, a free writing prospectus or a communication falling within What is the waiting period? a safe harbor from the gun-jumping provisions. While The SEC targets 30 calendar days from the first gun-jumping can be a serious concern, the 2005 safe registration statement filing or confidential submission harbors created by Securities Offering Reform have date to respond with comments. It is not unusual for provided considerable guidance to companies about the first E S C comment letter to contain a significant this issue. Further, the ability of EGCs to test-the-waters number of comments that the issuer must respond prior to filing the registration statement, together to both in a letter and by amending the registration with the elimination of the ban on general solicitation statement. After the SEC has provided its initial set in connection with certain private placements also of comments, it is much easier to determine when the effected by the JOBS Act (see “How does the JOBS Act registration process is likely to be completed and the change the IPO process?”), have significantly reduced offering can be made. In most cases, the underwriters concerns about gun jumping. do not begin the formal offering process and distribute There are several safe harbors from the gun jumping a preliminary prospectus until the SEC has reviewed at provisions applicable to IPOs, including: least the first filing and all material changes suggested Rule 134 – Communications Not Deemed a Prospectus. by the SEC Staff have been addressed. • Rule 134 provides a safe harbor for certain limited Marketing generally begins during the waiting information about an offering such as the name period although an EGC can make test-the-waters and address of the issuer, the title and amount of communications even before filing the registration the securities being offered, a brief indication of the statement. Section 5(b)(1) of the Securities Act requires issuer’s business and the names of the underwriters. that written offers must include the information Rule 135 – Notice of Proposed Registered Offerings. required by Section 10. The only written sales materials • Rule that may be distributed during this period are the 135 provides a safe harbor for even more limited preliminary prospectus and additional materials notices of proposed offerings that do not include the known as “free writing prospectuses,” which must names of the underwriters. satisfy specified ES C requirements. See “What is a free • Rule 163A – Exemption from Section 5(c) of the Act for writing prospectus?” While Section 5(a) of the Securities Certain Communications Made by or on Behalf of Issuers Act prohibits binding commitments during the period More than 30 days Before a Registration Statement before the registration statement becomes effective, is Filed. Rule 163A provides a safe harbor for all the underwriters will receive indications of interest issuers, provided that the communication is made from potential purchasers that should allow the more than 30 days before the filing of a registration underwriters to determine the final price and number statement and does not reference the securities of shares to be offered. Once SEC comments are offering that is or will be the subject of a registration resolved, or it is clear that there are no material open statement. issues, the issuer and underwriters will undertake • Rule 169 – Exemption from Sections 2(a)(10) and 5(c) of a two- to three-week “road show,” during which the Act for Certain Communications of Regularly Released company management will meet with prospective Factual Business Information. Rule 169 provides a safe investors. Once SEC comments are cleared and the harbor for communications by all issuers containing underwriters have assembled indications of interest for regularly released factual information. the offered securities, the company and its counsel will request that the SEC declare the registration statement The consequence of gun jumping is that investors “effective” at a certain date and time, usually after would have the right to rescind the transaction for the the close of business of the U.S. securities markets on return of their original investment. In addition, the SEC the date scheduled for pricing the offering. For more may demand a delay of the offering and additional information, see “Marketing the IPO.” disclosure regarding potential liability as a result of the violation.

92 16 Morrison & Foerster LLP Capital Markets What is the effect on marketing of an issuer’s ability to submit its IPO registration statement confidentially? Filing Requirements As discussed below (see “Can an issuer submit its draft IPO registration statement for confidential review by the SEC?”), an EGC may submit its draft registration What must be filed with the SEC? statement to the SEC on a confidential basis and have The company must file a registration statement with it reviewed without public scrutiny. However, the EGC the SEC. The registration statement will usually be must publicly file the registration statement and any on Form S-1 (or Form F-1, if it is a foreign private revisions thereto at least 15 days before it begins a “road issuer). Real estate companies, including REITs, will show” (see “What are road shows and what materials are file on Form S–11, which requires specific real estate- permitted in a road show?”). The JOBS Act required that related disclosures, and BDCs file on Form N-2 an EGC publicly file 21 days prior to commencement (which is also a form under the of its roadshow; however, the FAST Act amended this Act of 1940), which requires detailed information requirement and reduced the 21-day period to a 15- about their investment strategies and policies and day period. Certain foreign issuers may also submit a . The registration statement consists of draft registration statement confidentially before filing two parts. Part I is the prospectus, which contains publicly, although they do not have the obligation to information about the company’s business and file at least 15 days before a road show unless they are financial condition, including the company’s audited filing asE GCs.3 Further, the JOBS Act does not amend financial statements. Part II includes information that Section 5(b)(1) of the Securities Act, which requires is not required to be included in the prospectus that is that written offers must include the information delivered to investors, such as information about the required by Section 10. Therefore, in order to make offering expenses and fees, indemnification of officers written offers, anE GC or a foreign private issuer must and directors and a description of recent sales of the first file (not just submit) its registration statement company’s unregistered securities. Part II also contains with the SEC and have a preliminary prospectus the company’s legal undertakings and the exhibits to available, irrespective of the expected commencement the registration statement. of the road show. In June 2017, the SEC’s Division of Separately from the Form S-1, the company typically Finance announced a new policy to make must file a registration statement on Form 8-A to the confidential submission process for registration register its common stock under the Exchange Act. statements more broadly available. Since July 10, 2017, The Form 8-A is required because the company will be all companies, including foreign private issuers and subject to the Exchange Act’s reporting requirements Canadian issuers that rely on the Multijurisdictional after the IPO. The Form 8-A is a simple, typically one- Disclosure System, may submit draft IPO registration page registration statement and is filed via theE DGAR statements for confidential review. Foreign private system. issuers may elect to benefit from this new guidance, the procedures available to EGCs (if they so qualify) or the What is included in a prospectus? Division of Corporation Finance staff guidance issued on May 30, 2012 for certain foreign private issuers. As A prospectus describes the offering terms, the is the case for EGC IPO issuers, any issuer that avails anticipated use of proceeds, the company, its industry, itself of the confidential submission process for its IPO business, management and , and its results must publicly file its registration statement at least 15 of operations and financial condition. Although it is days before the date on which the issuer conducts a principally a disclosure document, the prospectus is road show. A foreign private issuer that relies on the also crucial to the selling process. accommodations available to EGCs or on this new SEC regulations require certain disclosures in a policy will have to comply with the requirement to prospectus. The principal sections of the prospectus file publicly at least 15 days prior to commencement are identified below (“smaller reporting companies” of its roadshow, which would not apply under the (as defined by the SEC), EGCs and foreign private Staff’s 2012 guidance. The SEC did not extend any of issuers have less burdensome disclosure obligations, the other JOBS Act benefits (i.e., the ability to test the particularly with respect to executive compensation): waters or reduced disclosure requirements) to non- • Summary. The summary is a overview of EGC IPO issuers. the more important aspects of the offering and 3 See “Frequently Asked Questions about Foreign Private the company. The summary will cover the type of Issuers” at http://www.mofo.com/files/Uploads/ Images/ 100521FAQForeignPrivate.pdf. security offered, a brief description of the company,

17 the amount of securities offered, the trading market reduced compensation disclosure requirements. See for the securities and the use of the proceeds. “What disclosures may an EGC omit from its registration Generally, the summary section should not exceed statement?” three pages. • Related Party Transactions. This section must include • Financial Statements. The prospectus will include any material business transaction between the audited financial statements of the company, issuer and its executive officers, directors, significant including balance sheets for each of the last two shareholders and other key personnel. completed fiscal years and income statements for • Security Ownership. This section includes a tabular each of the last three (two for an EGC) completed presentation of the company’s officers’ and fiscal years. The prospectus must also include directors’ beneficial share ownership as well as the unaudited financial statements for any interim beneficial ownership of each holder of more than 5% periods subsequent to the last completed fiscal year. of the company’s outstanding stock. • MD&A. The MD&A section describes the company’s • Plan of Distribution. The plan of distribution section liquidity, capital resources and results of operation. describes the underwriting arrangements, including It also includes a discussion of known trends and the underwriters’ plans for distributing the shares in uncertainties that may have a material impact on the offering. the company’s operating performance, liquidity or capital resources. The SEC has identified three • Counsel and Experts. These two sections identify principal objectives of the MD&A section: (i) to counsel to the company and the underwriters and provide a narrative explanation of the company’s the accountants who have audited the company’s financial statements enabling investors to view the financial statements.E “ xperts” will also identify company through management’s eyes; (ii) to enhance anyone else who has “expertized” any information the overall financial disclosure and provide context in the prospectus. within which the company’s financial information A good prospectus sets forth the “investment should be analyzed; and (iii) to provide information proposition.” As a disclosure document, the prospectus about the quality of, and potential variability of, the functions as an “insurance policy” of sorts in that company’s earnings and cash flow, so that investors it is intended to limit the issuer’s and underwriters’ can assess the company’s future performance. potential liability to IPO purchasers. If the prospectus • Risk Factors. The risk factors section usually includes contains all SEC-required information, includes robust three types of : risks pertaining to the offering; risk factors that explain the risks that the company risks pertaining to the issuer; and risks pertaining faces, and has no material misstatements or omissions, to the issuer’s industry. The SEC requires that the investors will not be able to recover their losses in a risk factors section include only risks specific to the lawsuit if the price of the stock drops following the company. IPO. A prospectus should not include “puffery” or overly optimistic or unsupported statements about • Business. The business section describes the the company’s future performance. Rather, it should company’s business, including its products and contain a balanced discussion of the company’s services, key suppliers, customers, marketing business, along with a detailed discussion of risks arrangements and intellectual property. and operating and financial trends that may affect its • Management. Officers and directors must be results of operations and prospects. identified in the management section and brief SEC rules set forth a substantial number of specific biographical descriptions must be included. disclosures required to be made in a prospectus. In • Executive Compensation. The company must disclose addition, federal securities laws, particularly Rule the executive compensation of its five highest paid 10b-5 under the Exchange Act, require that documents executive officers, which must include the CEO and used to sell a security contain all of the information CFO. Most of this disclosure is presented in tabular material to an investment decision and do not omit format. The executive compensation section must any information necessary to avoid misleading also include directors’ compensation and employee potential investors. Federal securities laws do not benefit plans. TheE S C requires a compensation define materiality; the basic standard for determining disclosure and analysis (“CD&A”) in which the whether information is material is whether a reasonable company discloses the company’s executive and investor would consider the particular information board compensation matters. An EGC will have important in making an investment decision. That

94 18 Morrison & Foerster LLP Capital Markets simple statement is often difficult to apply in practice. such standards to the same extent that a non-EGC An issuer should be prepared for the time-consuming is required to comply with such standards; and drafting process, during which the issuer, investment (3) continue to comply with such standards to the bankers, and their respective counsel work together to same extent that a non-EGC is required to comply craft the prospectus disclosure. with such standards for as long as the company remains an EGC. What disclosures may an EGC omit from its • EGC Status. The SEC Staff has explained in the registration statement? General Applicability FAQs that an EGC must The JOBS Act created an “on-ramp” of scaled identify itself as an EGC on the cover page of its disclosure requirements for EGCs. Generally, an prospectus. In addition, SEC Staff comments on EGC has flexibility to choose the scaled disclosures EGC registration statements have requested the with which it will comply, except with respect to the following disclosures: (i) a description of how and timing of compliance with new or revised accounting when a company may lose EGC status; (ii) a brief standards. description of the various exemptions available to an EGC, such as exemptions from Sarbanes- • Financial Statements and MD&A. An EGC is required Oxley Section 404(b) and the Say-on-Pay/Say-on- to present only two years of audited financial Golden Parachute provisions; and (iii) the EGC’s statements in its registration election for extended transition to new or revised statement. An EGC may also limit its MD&A to cover accounting standards. The SEC Staff requests that only those audited periods presented in the audited if the EGC has elected to opt out of the extended financial statements. The SEC will also not object if transition period for new or revised accounting an EGC presenting two years of audited financial standards, then it must include a statement that statements limits the selected financial data included the election is irrevocable. If the EGC has elected to in its initial public offering registration statement use the extended transition period, then risk factor to only two years. As noted earlier, the FAST Act disclosure must explain that this election allows amended the financial information requirement an EGC to delay the adoption of new or revised for EGC submissions and filings. An EGC should accounting standards that have different effective consider, together with its advisors, whether it dates for public and private companies until those makes strategic sense to include additional years of standards apply to private companies. The SEC financial information. Staff requests that the EGC state in the risk factors • Executive Compensation. An EGC may comply that, as a result of this election, the EGC’s financial with the executive compensation disclosures statements may not be comparable to issuers that applicable to a “smaller reporting company,” comply with public issuer effective dates. A similar which means that an EGC need provide only a statement is also requested in the EGC’s critical Summary Compensation Table (with three rather accounting policy disclosures in MD&A. than five named executive officers and limited to two fiscal years of information), an Outstanding What is included in the registration statement? Equity Awards Table, and a Director Compensation Table, along with some narrative disclosures to A registration statement contains the prospectus, augment those tables. EGCs are not required to which is the primary selling document, as well as provide a Compensation Discussion and Analysis, other required information, written undertakings of or disclosures about payments upon termination of the issuer and the signatures of the issuer and at least employment or change in control. a majority of the issuer’s directors. It also contains exhibits, including basic corporate documents and • Compliance with New or Revised Accounting Standards. material . U.S. companies generally file a An EGC may elect an extended transition to Form S-1 registration statement. Most non-Canadian compliance with new or revised accounting foreign private issuers use a Form F-1 registration standards. However, if an EGC chooses to comply statement, although other forms may be available. with such standards to the same extent that a non- There are special forms available to certain Canadian EGC is required to comply with such standards, the companies. EGC must (1) make such choice at the time it is first required to file a registration statement, periodic report, or other report under the Exchange Act and notify the SEC of such choice; (2) comply with all

19 How is the registration statement filed and what is of any draft registration statement that is materially EDGAR? deficient.4 A registration statement is filed electronically with the Certain foreign private issuers also may submit their SEC through its Electronic Data Gathering, Analysis registration statements confidentially for nonpublic and Retrieval (EDGAR) system. Before the company review.5 can file via the EDGAR system, it must create an As discussed above, since July 10, 2017, all account with the SEC by obtaining a Central Index companies, including foreign private issuers and Key (“CIK”) number and associated security codes. Canadian issuers that rely on the Multijurisdictional The CIK number is a unique number assigned to Disclosure System, may submit draft IPO registration individuals and companies who file reports with the statements for confidential review. Foreign private SEC. Once the company files the registration statement issuers may elect to benefit from this new guidance, via the EDGAR system, it becomes publicly available. the procedures available to EGCs (if they so qualify) or the Division of Corporation Finance staff guidance Can an issuer submit its draft IPO registration issued on May 30, 2012. As is the case for EGC IPO statement for confidential review by the SEC? issuers, any issuer that avails itself of the confidential The JOBS Act permits an EGC to submit its initial submission process for its IPO must publicly file its public offering registration statement confidentially registration statement at least 15 days before the date for nonpublic review by the SEC Staff, provided that on which the issuer conducts a road show. A foreign the initial confidential submission and all amendments private issuer that relies on the accommodations are publicly filed with the ES C no later than 15 days available to EGCs or on this new policy will have to prior to the issuer’s commencement of a “road show” comply with the requirement to file publicly at least 15 (as defined in Securities Act Rule 433(h)(4)). The ES C days prior to commencement of its roadshow, which Staff will also require EGCs to submit via the EDGAR would not apply under the Staff’s 2012 guidance. The system all of the responses to Staff comment letters SEC did not extend any of the other JOBS Act benefits on the confidential draft registration statements at the (i.e., the ability to test the waters or reduced disclosure time the registration statement is first filed. TheE S C requirements) to non-EGC IPO issuers. In connection Staff also asks that the draft registration statement with announcing this policy, the SEC Staff provided be accompanied by a transmittal letter confirming additional guidance regarding the process. Although the issuer’s status as an EGC. The Staff expects that the process for submission of draft registration any registration statement submitted for confidential statements through the EDGAR system will be the review will be substantially complete at the time of same for submissions made in reliance on the new initial submission, including a signed audit report procedures, the SEC Staff noted that issuers may seek and the required exhibits (however, the registration confidential treatment when submitting responses to statement itself is not required to be signed or to SEC Staff comments on draft registration statements. include the consent of auditors and other experts). An issuer should consider requesting confidential The SEC Staff has noted that it will defer review of any treatment under Rule 83 for its draft registration draft registration statement that is materially deficient. statements and comment letters. “road show” (as defined in Securities Act Rule 433(h) (4)). The SEC Staff will also require EGCs to submit Can any other information or agreement be kept via the EDGAR system all of the responses to Staff confidential? comment letters on the confidential draft registration statements at the time the registration statement is first In addition to a registration statement, a company is filed. The ES C Staff also asks that the draft registration required to file certain exhibits with the registration statement be accompanied by a transmittal letter statement, including its certificate of incorporation, confirming the issuer’s status as an EGC. The Staff bylaws, material agreements (including the expects that any registration statement submitted for 4 See Frequently Asked Questions; Confidential Submission confidential review will be substantially complete Process for Emerging Growth Companies, issued by the at the time of initial submission, including a signed SEC Staff on April 10, 2012, revised December 21, 2015. 5 See “Frequently Asked Questions about Foreign Private audit report and the required exhibits (however, the Issuers” at http://www.mofo.com/files/Uploads/ registration statement itself is not required to be signed Images/ 100521FAQForeignPrivate.pdf for a discussion of or to include the consent of auditors and other experts). the circumstances under which a foreign private issuer that The SEC Staff has indicated that it will defer review is not an EGC may submit its draft registration statement confidentially.

96 20 Morrison & Foerster LLP Capital Markets underwriting agreement) and consents of experts. The review process is time-consuming. While there Since information filed via theE DGAR system with the was a time when the review process could be completed SEC will be publicly available, if the company wants in roughly two months, now, given the length of many to keep any information confidential, it must request prospectuses and the complexity of the disclosure, it confidential treatment of the information from the can take three to five months. The review depends SEC and file redacted versions of the exhibits with the on the complexity of the company’s business and the SEC. Requests for confidential treatment may involve nature of the issues raised in the review process. Initial trade secrets or commercial or financial information comments on Form S-1 are provided in about 30 days— that could harm the company competitively if depending on the SEC’s workload and the complexity disclosed to the public. However, the SEC will not of the filing, the receipt of first-round comments may grant confidential treatment requests if it believes take longer. The SEC’s initial comment letter typically the information is necessary to protect investors. As includes about 15 to 30 comments, with a majority of a result, requests should be as narrow as possible. the comments generally addressing accounting issues. The confidential treatment request process can be The company and counsel will prepare a complete and lengthy and initial requests should be submitted with often lengthy response. In some instances, the company or as soon as possible after the initial filing of the may not agree with the SEC Staff’s comments, and registration statement as the SEC will not declare the may choose to schedule calls to discuss the matter with registration statement for the IPO effective if there the SEC Staff. The company will file (or confidentially is an outstanding confidential treatment request. submit) an amendment revising the prospectus, and the information is necessary to protect investors. As provide the response letter along with any additional a result, requests should be as narrow as possible. information. The SEC Staff generally tries to address The confidential treatment request process can be response letters and amendments within 10 days, but lengthy and initial requests should be submitted with timing varies considerably. This timing is the same or as soon as possible after the initial filing of the whether the registration statement is filed publicly or registration statement as the SEC will not declare the submitted confidentially. registration statement for the IPO effective if there is an The SEC makes comment letters and responses from outstanding confidential treatment request. prior reviews available on its website, so it is possible to determine the most typical comments raised during What is the SEC review process? the IPO process and, if appropriate, to anticipate The SEC’s review of the registration statement is an them in the first filing. Overall, the SEC Staff looks integral part of the IPO process. Once a registration for a balanced, clear presentation of the information statement is filed, a team of SEC Staff members is required in the registration statement. Some of the assigned to review the filing. The team consists of most frequent comments raised by the SEC Staff on accountants and lawyers, including examiners and disclosure, other than on the financial statements, supervisors. The SEC’s objective is to assess the focus on whether the risk factors are specific to a company’s compliance with its registration and company and devoid of mitigating language, whether disclosure rules. The SEC review process should not the MD&A addresses known trends and events that be viewed as a “black box” where filings go in and affect the company’s financial statements, operations comments come out—rather, as with much of the IPO and liquidity, and whether the description of the process, the comment process is a collaborative effort. company’s market position is supportable by third party data. The SEC will even review artwork based on The SEC’s principal focus during the review process the theory that “a picture is worth a thousand words.” is on disclosure; although the nature of some comments shade into substantive review. In addition to assessing What is the difference between registration under the compliance with applicable requirements, the SEC Securities Act and registration under the Exchange considers the disclosures through the eyes of an Act? investor in order to determine the type of information that would be considered material to an investor. The It has been said that if the Exchange Act had been SEC’s review is not limited to just the registration passed first, the Securities Act would never have statement. The SEC Staff will closely review websites, been enacted. Both acts seek to protect investors databases, and magazine and newspaper articles, in “public” companies and make sure that public looking in particular for information that they think investors have the material information they need to should be in the prospectus or that contradicts make an informed investment in public companies. information included in the prospectus. The Securities Act generally addresses offerings of

21 particular kinds of securities and requires disclosure offering will be priced following the completion of the for a particular offering or, once a company is public, road show and the effective date of the registration perhaps a number of offerings. The Exchange Act statement. addresses whether a company should be seen as “public” because of its intention to list its securities Can an issuer hold an electronic road show? on an exchange or because of the size of its ownership Yes. Securities Offering Reform allows greater use base and the amount of its assets, and requires periodic of the Internet to distribute electronic road shows. A and ongoing public disclosure about the company. preliminary prospectus must be made available to Companies may become subject to the Exchange Act investors before or at the same time when the investors without a “public” offering. access the electronic road show.

What is a free writing prospectus? Marketing the IPO In the 2005 Securities Offering Reform, theE S C adopted the concept of a “free writing prospectus.” Rule 405 defines a free writing prospectus as any Can an issuer make offers before filing a registration written communication that constitutes an offer statement? to sell or a solicitation of an offer to buy securities No. Once a company decides to go public, it is “in relating to a registered offering that is used after the registration” and the quiet period begins. See “What registration statement is filed (there is more latitude for is the quiet period?”. However, communications made certain issuers that are already public) that is made by by the company more than 30 days before the filing means other than an actual prospectus or preliminary of the registration statement will not be deemed to prospectus meeting SEC requirements and certain be attempts to condition the market if they do not other written communications. While free writing reference the offering. Similarly, test-the-waters prospectuses are often used in debt transactions to communications by or on behalf of EGCs will not be describe the specific terms of the debt securities, they treated as an illegal conditioning of the market. are less often used in IPOs. However, they do have a very useful IPO function. Prior to 2005, if there were a Can an issuer make offers during the SEC review material change in the offering, the deal team—issuer, process? underwriters and counsel—would debate whether the Yes. During the SEC review process, an issuer can make change was so material that oral advice of the change offers to the public through distribution of a preliminary was insufficient and a revised prospectus needed to prospectus, free writing prospectuses and live oral be prepared, filed and circulated to investors (called presentations. Thus, an EGC cannot make offers to the a “recirculation”). Since 2005, the deal team has the public until it files the registration statement publicly. ability to provide a simple updating document to Generally, a preliminary prospectus, while available on potential investors no later than the time when the the EDGAR system, will not be distributed to investors investors have to make their investment decision (and until after the initial filing has been revised to address file it within the time required by ES C rules). The free any significant issues raised in the ES C’s comments. writing prospectus does not have a required format and will reflect transaction needs. Not all information What are road shows and what materials are permitted released by an issuer needs to be in the form of a free in a road show? writing prospectus, and the deal team may need to determine the value of filing specific information. “Road shows” or “dog and pony shows” are presentations where the company’s representatives Can an IPO issuer use free writing prospectuses? (usually the CEO, CFO and possibly an investor relations professional) and the underwriters meet Yes. A company may use free writing prospectuses in with potential significant investors to market the addition to a preliminary prospectus as long as the offering. For an IPO, the road show will begin after preliminary prospectus precedes or accompanies the the preliminary prospectus has been printed and free writing prospectus. In addition, certain free writing distributed. Depending on the size of the offering and prospectuses must be filed with the ES C and contain the company’s business, the road show may include a required legend. Underwriters may also use free meetings in outside the United States. The writing prospectuses, and the underwriting agreement road show typically takes two to three weeks. The for an IPO will contain mutual restrictions on the use

98 22 Morrison & Foerster LLP Capital Markets of issuer free writing prospectuses and underwriter more of the post-offering shares will be required to free writing prospectuses. BDCs and other investment file a short-form Schedule 13G within 45 days after companies may not use free writing prospectuses. the end of the calendar year, since the holder will not However, they may file similar information as sales have “acquired” securities triggering the long-form material or a term sheet pursuant to Rule 497 under Schedule 13D; however, any subsequent transactions the Securities Act. in the securities may require an amendment using Schedule 13D. What is a “family and friends” or “directed share” program? Pricing In connection with an IPO, an issuer may want the option to “direct” shares to directors, officers, employees and their relatives, or specific other designated people, such as vendors or strategic partners. Directed share What happens after the SEC has completed its review? (or “family and friends”) programs (“DSPs”) set aside Once a registration statement has been declared stock for this purpose, usually 5-10% of the total shares effective and an offering has been priced, the offered in the IPO. Participants pay the initial public issuer and the managing underwriters execute the offering price. Shares not sold pursuant to the DSP, underwriting agreement and the auditor delivers the usually within the first 24 hours after pricing, are then executed comfort letter. This occurs after pricing and sold by the underwriters in the IPO. Generally, directed before the opening of trading on the following day. The shares are freely tradable securities and are not subject company then files a final prospectus with theE S C that to the underwriter’s lock-up agreement, although the contains the final offering information. On the third or shares may be locked up for some shorter period. Each fourth business day following the pricing transaction underwriter has its own program format. There are, (T+2 or T+3), the closing occurs, the shares are issued, however, guidelines that must be followed. The DSP and the issuer receives the proceeds. The closing is not a separate offering by the company but is part of completes the offering process. Then, for the next 25 the plan of distribution of the IPO shares and must be days, aftermarket sales of shares by dealers must be sold pursuant to the IPO prospectus. accompanied by a final prospectus or a notice with respect to its availability. If during this period there Does an issuer need to disclose ownership by is a material change that would make the prospectus shareholders and/or management? misleading, the company must file an amended In addition to information about the issuer itself, prospectus. federal securities laws are concerned with trading by “affiliates” of the issuer and public disclosure of How is an offering priced? affiliate ownership of the issuer’s securities. TheE S C In most IPOs, after the road show, representatives of has a simple definition of affiliate that is often hard to a company and the underwriters will meet to price understand and apply to specific situations. An affiliate the offering. The initial public offering price will is any entity or person that, directly or indirectly, be determined based on the demand for the stock, controls or is controlled by or under common control current market conditions and the price range stated with the specified entity. While there is much written in the preliminary prospectus. This is referred to as about affiliates, Congress in Section 16 of theE xchange the process. If the number of shares Act has determined that directors, officers and holders will be significantly increased or decreased or the of 10% or more of the issuer’s equity securities are offering will not be priced within the range, afree persons likely to be affiliates. Therefore, under the writing prospectus is often issued at this point to make Exchange Act, directors, officers and 10% shareholders sure that investors have the necessary information must report their holdings of a company’s securities as before deciding to purchase the shares. Additional well as their purchases and sales. The initial statement information will also be determined at this time, of ownership is on Form 3, which must be filed with the including the underwriters’ fees and commissions SEC on or prior to the effective date of the registration and the members of the underwriting syndicate. The statement. Subsequent changes in ownership are company will issue a press release to announce the IPO filed on Form 4, or for certain transactions, on Form price before the opens the following day. 5, all of which are available on the EDGAR system. In addition, under Section 13 of the Exchange Act and its rules, certain existing holders who will own 5% or

23 What is a “syndicated offering”? made in an amount not greater than the underwriters’ In a syndicated offering, at the time of pricing, the option to purchase additional shares of common managing underwriter(s) will invite additional stock from the company in the IPO. The underwriters underwriters to participate in the offering. Each may close out any covered short position by either member of the underwriting syndicate will agree to exercising their option to purchase additional shares or underwrite, that is, purchase, a portion of the shares to purchasing shares in the . In determining be sold and will enter the existing general agreement the source of shares to close out the covered short among underwriters that governs their relationship. position, the underwriters consider, among other things, the price of shares available for purchase in the open market compared to the price at which they may What is a “green shoe” or “over-allotment option”? purchase shares through the over-allotment option. Most “firm commitment” equity public offerings Naked short sales are any sales in excess of the include an “over-allotment option” or “green shoe” over-allotment option. The underwriters must close (the latter name references a case about these kinds out any naked short position by purchasing shares in of options). This option enables the underwriters to the open market. A naked short position is more likely purchase additional shares (usually 15% of the “firm” to be created if the underwriters are concerned that shares purchased by the underwriters) from the there may be downward pressure on the price of the company if there is substantial demand for the offered shares in the open market prior to the completion of shares. The option is typically exercisable for 30 days the offering. after the pricing of the IPO and the underwriters may purchase the additional shares at the same price per Stabilizing transactions consist of various bids for share as those sold in the IPO. or purchases of the company’s common stock made by the underwriters in the open market prior to the What happens at a closing? completion of the offering. The closing of the offering usually takes place two or The underwriters may also impose a penalty bid. three business days (T+2 or T+3) after the pricing of the This occurs when a particular underwriter repays to IPO, typically T+3 because offerings are usually priced the other underwriters a portion of the underwriting after the close of the market at 4 p.m. Eastern time. discount received by it because the sole book-running Immediately prior to the closing, the underwriters will manager has repurchased shares of the common also hold a bring-down diligence call with the company stock sold by or for the account of that underwriter in to confirm that no material changes in the company’s stabilizing or short covering transactions. business or finances have occurred since the date Purchases to cover a short position and stabilizing of pricing and that the statements in the prospectus transactions may have the effect of preventing or remain accurate. At the closing, the company will slowing a decline in the market price of the common deliver the documents required by the underwriting stock. In addition, these purchases, along with the agreement, including a bring-down comfort letter, imposition of the penalty bid, may stabilize, maintain certificates of officers and one or more opinions of or otherwise affect the market price of the common counsel. Upon satisfaction of the closing conditions, stock. As a result, the price of the common stock may the underwriters will wire transfer the net proceeds be higher than the price that might otherwise exist in of the offerings to the company and upon receipt, the the open market. These transactions may be effected on company will instruct its transfer agent to release the the relevant exchange, in the over-the-counter market shares to the underwriters. A final prospectus must or otherwise. accompany or precede the delivery of the securities after their sale. Liability What actions may underwriters take after pricing? After pricing and during the offering itself, the underwriters may purchase and sell shares of common What liability can a company face in an IPO? stock in the open market. These transactions may Civil and criminal liability may arise under the include short sales, purchases to cover positions Securities Act from material misstatements or created by short sales and stabilizing transactions. omissions in a registration statement when it becomes Short sales involve the sale by the underwriters effective or in a preliminary prospectus upon which a of a greater number of shares than they are required for sale of shares of a company’s stock is based. to purchase in the IPO. Covered short sales are sales Liability can also arise from the failure to comply

100 24 Morrison & Foerster LLP Capital Markets with registration requirements or to supply or make or omitted to state a material fact necessary to make available a final prospectus to investors. Purchasers of a statement, in light of the circumstances under a company’s stock in a registered public offering have which it was made, not misleading. a right of action under Section 11 of the Securities Act Every person who controls (through share for an untrue statement of material fact or an omission ownership, agreement or otherwise) any other person to state a material fact in a registration statement. that is liable under Section 11 or 12 of the Securities Act Section 11 imposes liability on the issuer, each person is jointly and severally liable with that other person, who signs the registration statement, each director, unless the controlling person had no knowledge of, or the company’s accountants (and certain other experts) reasonable grounds to believe in, the existence of the and the underwriters. Purchasers also have a right of facts that resulted in the alleged liability. action under Section 12(a)(2) for false or misleading statements that are material in a prospectus and in oral Is directors’ and officers’ insurance needed? statements. The SEC may bring actions under Section Yes. Anyone who signs the company’s registration 17 of the Securities Act and Section 10(b) and Rule 10b- statement and anyone who is or was a director of 5 under the Exchange Act. the company or who consented to be named as a Under the Securities Act, the company is absolutely director of the company at the time the registration liable for material misstatements or omissions in the statement was filed may be sued by any purchaser of registration statement, regardless of good faith or the company’s stock. These officers and directors have the exercise of due diligence. Directors and officers several potential defenses to liability, including a due of the company, however, may have certain due diligence defense. No person will serve as a director or diligence defenses, as do underwriters, the company’s officer without indemnification from the company and accountants and other experts and controlling persons. appropriate directors’ and officers’ insurance, and a company usually represents that it has such insurance Who may also be liable under the Securities Act? in the underwriting agreement.

If a company’s registration statement contains an What is the SEC’s position on indemnification for untrue statement of a material fact or omits to state Securities Act liabilities? a material fact required to be stated in it (or that is necessary to make the statements not misleading), any Since its early history, the SEC has consistently purchaser of the company’s stock can sue the issuer stated that indemnification of directors, officers and and the following persons: controlling persons for Securities Act liabilities is against public policy and is therefore unenforceable. • anyone who signed the registration statement (the Every registration statement is required to set forth the registration statement is signed by the company’s SEC’s position. Nonetheless, companies have always chief executive, principal financial and accounting provided such indemnification and courts have upheld officers, and at least a majority of the company’s such contract rights. directors); • anyone who was a director of the issuer (or anyone

who consented to be named as a director) at the time ______the registration statement was filed; ©2018 Morrison & Foerster LLP • every accountant, engineer, appraiser or other expert who consented to be named as having prepared or certified the accuracy of any part of the registration statement, or any report or valuation used in the registration statement (but liability is limited to that information); and • every underwriter. A purchaser of a security can also sue any person who: • offered or sold the company’s stock to that purchaser in violation of Section 5 of the Securities Act; and • offered or sold the company’s stock to that purchaser by means of a prospectus or oral communication that included an untrue statement of a material fact

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