The measure, passed by Congress in March, is designed to grease the IPO onramp for small companies. Three months after it was signed into law, signs of its impact, both expected and unexpected, are visible.
Among the expected is a spurt of confidential draft registrations the act permits young companies to submit. These private Securities and Exchange Commission filings allow startups to keep sensitive financial and strategic information out of the hands of competitors. They also let companies avoid public embarrassment should they decide to pull an S-1 in the face of lackluster stock demand.
Several of the unexpected I came across on a Goodwin Procter and J.H. Cohn conference call earlier this week. Here are a few:
- Special purpose acquisition companies. Among the companies filing confidential S-1s are a number of special purpose acquisition companies using the act as a way to go public and then, with the money they raise, acquire other companies with established products or services. The Wall Street Journal last month also reported on this trend, which runs counter to the act’s stated purpose of supporting growth companies.
- New legal boilerplate. The act has generated new S-1 boilerplate. Among the risk factors now showing up on registration statements is the claim that companies cannot predict whether investors will find their stock attractive due to the act’s reduced disclosure requirements. One reduced disclosure is the requirement for only two years of financial information.
- Testing the waters. Perhaps most surprising is the reaction to the act’s test the water provision, which permits private companies to solicit the feedback of investors prior to publicly filing an S-1. It hasn’t worked out according to plan. The effectiveness of the meetings so far are hard to judge, says Christopher Austin, a partner at Goodwin Procter.
In some instances, investors tell companies to come back when they are ready for formal roadshows. Schedules are busy and time is difficult to set aside. One company approached 12 investors, says Austin. Two said no to a meeting. Ten said maybe. And only two investors with potential interest in the shares ended up buying them when they became available.
The result is that some banks are becoming cautious about testing the waters. “I do think the practice is still evolving,” says Austin. Companies need to be careful about the “signal” they obtain, he says.
Austin adds that he advises companies not to leave written materials with investors, despite investor interest in them. Some startups have apparently begun to handover draft S-1s.
Clearly the act is in a shakeout stage. Rules are still being written, with the SEC already having missed one deadline. The commission now looks ready for an Aug. 22 vote on a rule to lift the ban on the private company general solicitations, with talk the advertising ban could be lifted, at least on an interim basis.
Reuters also reported this week that investor advocates worried about the bill’s scaling back of investor protections met in Washington with Treasury and SEC officials.
It will take time to know how the whole thing plays out.
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