The Jumpstart Our Business Startups (JOBS) Act throws a new wrinkle into the “dual track” strategy in which late-stage private companies pursue an IPO while simultaneously negotiating with an acquirer.
By enabling such companies to file a confidential S-1 with the Securities and Exchange Commission before they go public, the law will allow sellers to force acquirers to act urgently without requiring the seller to publicly disclose information like trade secrets and key customer names. That will give sellers some new advantages, says a recent note to clients from attorneys at law firm Davis Polk & Wardwell.
Companies take the dual track when they want to retain flexibility and put competitive pressure on buyers, and some studies have shown that dual-track firms are sold at 20% premiums to other companies. The JOBS Act may cause even more companies to pursue this strategy.
Up to now, all the IPO filings were public, and because they were, some companies didn’t want to do them, says Bill Kelly, a partner in the Menlo Park, California, office of Davis Polk. “Nonetheless, they wanted the optionality of a public offering or at least have it as a fallback position. Those companies [previously] had to choose between filing publicly [versus] not filing and not having a credible IPO alternative,” he says. “Now they can sort of have their cake and eat it, too.”
Says Michael Nall, founder of the Alliance of Merger & Acquisition Advisors: “The SEC has put much of [the JOBS Act] up for comment, and there’s going to be much more in the way of specifics to unfold, but this would create a better situation for the issuing company, because it wouldn’t have to tip its hand.”
A private filing with the SEC wouldn’t remove the leverage of the dual-track strategy. Such leverage derives from the ability to signal to potential buyers that a company is serious about going public at a higher valuation and that the acquirer may lose its chance to buy the company at an attractive price, says Kelly. (The filer would still be able to share the confidential S-1 with an individual potential buyer.)
The biggest problem a smaller company has in an M&A situation is trying to attract the attention of larger companies, Kelly says. “Big companies have corporate-development teams that are looking at a dozen [projects] at a time. How do you move your company to the top of the stack? The dual track has been a way of doing that.”
A confidential IPO filing with the SEC still enables a company to communicate its message, and, because the S-1 must eventually be released publicly 21 days before the start of its road show, a later public filing would signal that the IPO is imminent, says Kelly.
If the merger deal falls apart for a company that’s offering the IPO only as a way to drive up the price, a confidential IPO filing would allow the company to pull the IPO offering without the stigma associated with doing so, Kelly adds. “No one wants to be involved with a failed IPO or the perception of one,” he says.
The JOBS Act also gives pre-IPO companies more latitude to test the waters of the public market. The firm’s advisers can premarket an offering — even before the S-1 is filed with the SEC — to gauge how much interest investors have in a company’s shares. Companies wouldn’t be guilty of illegally soliciting orders for a stock before the IPO is approved by the SEC.
“Another way of getting comfort if you are the selling company is the banks go out and talk to the big institutional investors and try to get a more clear indication of what the valuation of an IPO would be,” says Kelly. “That would give the seller more information to decide whether selling is the right approach as opposed to an IPO.”
On the other hand, private companies may give up the ancillary benefits of a highly visible share offering if they file confidentially. “There are companies that will say the ability to publicly announce an IPO filing with a prominent underwriter is good for the company: it suggests the company is successful and the visibility helps with customers and employee recruitment,” Kelly says.
“Private companies keep a very tight circle, and inevitably there is a trade-off,” says Nall of the Alliance of Merger & Acquisition Advisors. As he sees it, the choice is between creating more competition by attracting outside buyers and releasing trade secrets and names of key customers in a publicly filed S-1. “There’s no doubt that the bigger the number of potential buyers, most often, the higher the price, because the company gets bid up,” says Nall.
But, says Kelly, “if a company has a competent banker, they should know who the potential acquirers are, and the company shouldn’t have to file something with the SEC in order to attract them.’
The SEC started accepting comments on the rulemaking related to the JOBS Act on April 11.