It’s been a little more than two years since Congress passed the Jumpstart Our Business Startups Act, a law intended to make it easier for smaller companies to obtain access to capital.
Title 1 of the act created the so-called IPO on-ramp, consisting of provisions that make it simpler and less costly for emerging growth companies—defined as those with less than $1 billion of annual gross revenue—to go public. Unlike larger companies, an EGC can, for example, file a confidential draft registration statement with the Securities and Exchange Commission for review, “test the waters” with institutional investors to gauge interest in an IPO, provide two years of audited financial statements instead of three, and delay an independent audit of their internal controls (see “The IPO On-Ramp,” at the end of this article).
Today, nearly 9 out of 10 IPOs are by emerging growth companies, according to a study of year two of the JOBS Act by Latham & Watkins. The pharmaceutical industry accounted for the largest group of EGC IPO issuers, followed by technology, real estate, energy, and health care.
What effect has JOBS Act offerings had on the overall IPO market? Most market watchers say that broad economic factors are responsible for the surge in offerings over the past two years, according to Morrison & Foerster. But a new study by researchers from the State University of New York at Buffalo and Pennsylvania State University suggests that the IPO on-ramp is working as intended: “Controlling for market conditions, we estimate that the JOBS Act has led to 21 additional IPOs annually, a 25% increase over pre-JOBS levels.” (The study, “The JOBS Act and IPO Volume: Evidence That Disclosure Costs Affect the IPO Decision,” by Michael Dambra, Laura Field, and Matthew Gustafson, is available on the Social Science Research Network.)
Meanwhile, nearly everyone agrees that the JOBS Act has significantly affected the way IPOs are done. To find out just how the rubber hits the road in a JOBS Act offering, we asked the CFOs of five such companies—TrueCar, Zoës Kitchen, GlycoMimetics, ChannelAdvisor, and Malibu Boats—to discuss their experiences. Some of them had previously taken companies public, either as CFOs or bankers. All had strong opinions about the effectiveness of the IPO on-ramp. Here’s what they had to say.
Shifting Into Public Gear
Before he left Wall Street in 1999 to co-found TPG Ventures, Michael Guthrie had participated in many IPOs as an investment banker. Earlier this year he found himself on the other side of the process—as CFO of TrueCar, a car buying and selling platform, which went public in May, raising $70 million (see “Road Show,” June). Asked to compare taking a company public now with then, he says: “In 1999 it was a very receptive market, and the entire process of going public tended to move very quickly. The process today is harder than it was back then—but easier post–Sarbanes Oxley.”
There was nothing quick or easy about TrueCar’s preparation to go public. Although the company started the IPO process in earnest in October 2013, “we were not in a position to file our registration statement until the middle of February,” says Guthrie. “The underwriters take it very seriously, and put you through a rigorous process.” The legal review was “thorough and exhaustive,” while on the accounting side, “PwC had people at our company for months, going through the books and records to make sure everything was tied down.” How sure? The night before filing the S-1, “we found a $70 discrepancy on an expense report,” says Guthrie. “We literally had to take care of it that night before we filed our document.”
TrueCar filed its Form S-1 confidentially, in February, two and a half months before the IPO. “It was great to be able to get that document in place and start the SEC review without exposing our filing to the market or competitors or anyone else,” says Guthrie. “It gave us a lot of confidence to move forward and get a huge amount of work done. That was probably the biggest benefit for us of doing a JOBS Act filing.”
The company didn’t use the testing-the-waters provision, though. “We talked a lot about it, but ultimately our underwriters didn’t think it was necessary,” says Guthrie. We took their advice.” Nor did it limit its audited financial statements to two years. “Because of the timing of the offering and our desire to have a little more financial information in the prospectus—we thought it was important for investors to understand some of the transitions we had gone through—we put in a full three years of audited financial statements,” says Guthrie.
TrueCar will also take advantage of the five-year exemption from complying with Sarbanes-Oxley’s Section 404(b) auditor attestation requirements for internal controls, although “we were well on our way to launching SOX compliance before we filed,” says Guthrie. Now, the company will phase in compliance over time.
In Guthrie’s opinion, the IPO on-ramp isn’t about lower standards, but rather about making it simpler for growth companies to get through the going-public process. “I think the way Wall Street works with companies [to go public] is healthier and more thorough than ever before,” he says. “Investors are better protected and better informed than ever.”
An Appetite for Shares
Founded in 1995, Zoës Kitchen is a fast-casual restaurant chain featuring “a distinct menu of Mediterranean-inspired dishes, served with warm Southern hospitality,” says CFO Jason Morgan. The Plano, Tex.-based company has more than 120 restaurants across 15 states, largely in the Southeast. Investors showed plenty of appetite for the company’s $87 million offering in April, driving the stock price up 65% on the first day of trading and 129% through the end of June, according to Renaissance Capital.
The IPO enabled Zoës to repay its bank debt, with its growth-restricting covenants, leaving the company with about $40 million in cash. “That, combined with our cash flow from operations, will fuel our growth for the next several years,” says Morgan, who joined the company in 2008.
Rapid growth (the chain has added more than 100 restaurants under its current owners) was a big reason why Morgan appreciated the confidential S-1 filing. Confidentiality “allowed for only a limited number of our team to be involved in the IPO process,” the CFO explains. “It kept the rest of the company focused on their roles and on growing the company,” he says, noting that Zoës was “right in the middle of adding 28 to 30 stores in 2014.”
As the success of the offering demonstrated, Zoës didn’t need to test the waters to determine market interest. “The banks and Zoës had the first conversations with potential investors after the S-1 was publicly filed,” says Morgan. The company also filed three years of audited financials instead of the permitted two and included selected audited data going back five years instead of two. It also opted not to use the ability to adopt new or revised accounting standards using the same phase-in periods as private companies.
While the company is taking advantage of the SOX 404(b) compliance exemption, “we’re not going to use the full time allotted,” says Morgan. Prior to the IPO, the company had already begun marshaling the internal and external resources needed to begin the necessary planning and documentation for SOX compliance, he explains. “Our goal is to be fully compliant the first full fiscal year post-IPO, which would be 2015.”
There’s a bit of irony in Morgan’s presence at Zoës, given his background. His résumé includes stints at casino operator Harrah’s Entertainment and hotel operator Gaylord Entertainment, “and I liked to joke that we didn’t care if we made money in the restaurants,” says Morgan. “They were there as an extra benefit for the guests.”
But it was in part his corporate-finance experience at those two big public companies that made him a desirable candidate for a company planning to go public, along with his subsequent stints at two small, entrepreneurial ventures, where he built finance teams from scratch—“a lot of rolling up your sleeves, getting things done.” All in all, says Morgan, the combination of big- and small-company experience “really prepared me well for the IPO and for the future, as we continue to expand.” Indeed, he adds, “I knew a lot of the people on the road show from my Gaylord days.”
In April 2013, GlycoMimetics reached a turning point in its development. The clinical-stage biotech company’s lead product—a compound for treating sickle cell disease, dubbed Rivipansel, or GMI-1070—had performed well in Phase II clinical trials, significantly reducing the length of hospitalizations and the amount of pain medication patients needed. Pharmaceutical giant Pfizer, which owns the worldwide licensing rights to Rivipansel, was ready to take the compound to Phase III trials, the last step before a drug can be marketed to the public.
In turn, GlycoMimetics was ready to go public. Until then the company, which was founded in 2003, had relied on funding from venture capital investors, along with milestone payments from Pfizer for the development of Rivipansel.
“Between April and June, the biotech IPO market was heating up,” recalls Brian Hahn, GlycoMimetics’ CFO. “As soon as Pfizer committed to moving the program forward, we started drafting the S-1.” The company filed the form confidentially with the SEC in late August and started meeting with investors. The testing-the-waters provision of the JOBS Act is especially beneficial to biotech companies, says Hahn, giving them time to educate investors on their complicated stories and complex technologies.
“Between testing the waters and the road show we met with close to 90 different investors,” says Hahn. The meetings enabled GlycoMimetics to get a feel for investor interest and what the potential valuation of the company could be. “We were able to give investors a lot of time to dig in and get comfortable with the science,” he says. The response was encouraging, and GlycoMimetics flipped its S-1 from private to public in early October. Then it was a matter of waiting the required 21 days before the company could launch its road show.
That’s when the bottom dropped out of the biotech market. Until October the market had been up more than 50% for the year, says Hahn, “but between October 1 and the road show the market dropped 25% to 30%.” The first week of the road show went well, he says, but in the second week, “volatility shot up, and the market went south on us, three days before we were supposed to price.”
Although investors liked its story, they told the company that they didn’t want to take on any more risk until the first of the New Year, says Hahn. As a result, GlycoMimetics postponed the IPO. “We were nervous at first,” he says. “We weren’t sure whether it was us or the overall market.”
It was the market: following GlycoMimetics’ decision, seven other biotech IPOs were postponed. In December, the company made numerous phone calls to potential anchor investors, says Hahn, and GlycoMimetics finally launched its IPO during the first week of January—the first offering on NASDAQ in 2014. “We upsized the offering,” says Hahn. “Bankers exercised the shoe, and it was very successful.” The IPO priced at $8, and GlycoMimetics raised $64 million. The stock ran up to $17 before biotech stocks tanked again, and currently trades near $8.
The ability to test the waters with investors was crucial to the success of GlycoMimetics’ IPO, says Hahn. Another important advantage was the ability to defer compliance with SOX 404(b).
“We’ve got good internal controls—we put in a SOX-like framework—but I don’t have to grow my staff as much on the corporate compliance side,” says Hahn. At this stage in a biotech company’s lifecycle, investors like to see money put in R&D, not G&A, he says. Currently, the company’s total payroll is $4 million, and “our cash burn is going to increase $1.5 million a year just to be a public company,” says Hahn, citing the added burdens and reporting requirements involved.
In April, Hahn testified before a House of Representatives subcommittee on behalf of the Biotechnology Industry Organization, noting that nearly 80 biotech companies had taken advantage of the JOBS Act to go public, with many more on file with the SEC. “Because these R&D-focused innovators do not fund the billion-dollar biotech research process through product revenue, they depend almost entirely on external investors for innovation capital,” he said. The IPO on-ramp, he said, “has led to a sea change in how growing biotechs approach the public market.”
A New Channel for Investors
Unlike biotech firms, ChannelAdvisor has a story that most investors can grasp immediately. The Morrisville, N.C., company provides a software-as-a-service platform for retailers and manufacturers to ensure that their products and associated data are listed uniformly on different websites, such as Amazon, eBay, and Google. “We’re like a universal remote control,” says CFO John Baule. “Companies put their information in our platform, and we connect it to all the different channels.”
Given the explosive growth of e-commerce and the number of SaaS- and cloud-based companies going public, ChannelAdvisor didn’t have to test the waters before going public, says Baule, other than consulting with its bankers. “We have about 2,500 customers in a pretty nice cross-section of the economy,” he notes. The company also receives plenty of online exposure through its CEO, Scot Wingo, whose blog is widely followed by analysts. “We’re viewed as having real thought leadership in this space,” says Baule.
Not surprisingly, ChannelAdvisor had a rousing IPO, listing on the New York Stock Exchange. The company’s stock (ticker symbol: ECOM) priced at $14 per share in May 2013 and rose nearly 40% in the first day of trading. ChannelAdvisor raised $81 million from the offering, and its stock nearly reached $49 before settling to the mid-$20s this summer.
Baule, who came to the company via an executive search firm in November 2012, says the ability to file a confidential S-1 was a big benefit. “There’s probably a five-to-six-month lead time, depending on the industry, between the initial filing of the S-1 and the time you go public,” he says. “If you have a public S-1 for a long time, you get the worst of both worlds”—disclosing key information to competitors on one hand, and incurring “a kind of stigma” if the company has to alter the S-1 significantly or cancel the offering. “It’s a huge advantage to get the SEC’s blessing on all the big items before you hit the tape, so to speak,” says Baule.
Baule says a confidential S-1 filing might have altered the course of events when he previously led a company through an IPO—at K12, a technology-based education firm, in 2007. “We filed our first S-1 on July 3,” he recalls. “We were out there, and we had to go forward.” K12 debuted on the New York Stock Exchange in December 2007, when the economy was slipping into the Great Recession. “Maybe if we hadn’t been out publicly, we would have considered delaying,” says Boule. “But in retrospect maybe [going forward] wasn’t a bad thing.” K12’s stock opened at $18 per share and currently trades in the mid-$20s.
Likewise, testing the waters might have helped K12 as well, says Baule. “We didn’t have any comparables,” he explains. “We weren’t sure there was a public market for us.”
ChannelAdvisor also elected to delay compliance with SOX 404(b). “The delay in implementing Sarbanes-Oxley is a real advantage,” says Baule. Complying with 404(b) “is incredibly expensive,” he says, noting the extra staff work involved. “If your auditor has to sign a report saying they’ve audited your controls, you’ve just added $200,000 to your bill.”
Tested on the Water
Like ChannelAdvisor, Malibu Boats didn’t test the waters before its $115 million IPO in January, according to CFO Wayne Wilson. It didn’t really have to—the company’s products were already well known for their performance on the water. Since 2010, the Loudon, Tenn.-based company has been the top manufacturer of performance sport boats and premium water-ski and wakeboard boats in terms of U.S. market share, generating fiscal 2013 net sales of $167 million.
“Our business has really good growth prospects,” says Wilson, who joined the company in 2009. “We went through an incredible downturn in our space”—unit sales in the category dropped more than 50% between 2006 and 2013, thanks to the recession—“but we emerged on the other side even stronger. We invested extensively during the downturn, including the introduction of Axis, our more affordable brand. We were able to strengthen our position with our distribution, and within the market as a whole.”
But like most emerging growth companies going public, Malibu did file a confidential S-1. “To be able to get that far in the process without allowing competitors to see that information was meaningful,” says Wilson. “Especially when you take into account your other constituencies—customers, dealer relationships, suppliers, and so on.” The SEC’s review was straightforward, Wilson says, involving “a handful of comment letters.” Filing confidentially “gave us a decent amount of time to deal with those issues and probably saved us a couple of months of public knowledge and exposure.”
Malibu did post three years of audited financial statements instead of the required two, but like other EGCs the company will phase in compliance with SOX 404(b) over time. “It’s nice to be able to focus more on managing the business and not have to immediately turn all your energies to [404(b)],” says Wilson.
The IPO was Wilson’s second; he was an investment banker in the first one. “I gained a lot of appreciation for being on the CFO side of the fence,” he says with a chuckle.
The IPO On-Ramp
Emerging growth companies (EGCs) can take advantage of some or all of the following provisions of Title 1 of the JOBS Act.
• Testing the Waters – Before or after filing a registration statement, EGCs may meet with qualified institutional buyers and other institutional accredited investors to gauge their interest in a contemplated offering.
• Confidential SEC Review – EGCs may initiate the SEC registration process confidentially.
• Scaled Financial Disclosure – EGCs may go public using two years, rather than three years, of audited financial statements and as few as two years, rather than five years, of selected financial data.
• Internal Controls Audit – EGCs are exempt from the internal controls audit required by Section 404(b) of the Sarbanes-Oxley Act.
• Executive Compensation Disclosure – EGCs may use streamlined executive compensation disclosure and are exempt from shareholder advisory votes on executive compensation.
• Extended Phase-In for New GAAP – EGCs may use private-company phase-in periods for new accounting standards.
• PCAOB Rules – EGCs are exempt from any Public Company Accounting Oversight Board rules that, if adopted, would mandate auditor rotation or auditor discussion and analysis.
Source: Latham & Watkins