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Q: What should I do to prepare for an IPO?
A: Here are some suggestions:
- Clean up your capital structure. Make sure your stock records are complete and contain canceled stock certificates. Avoid contracts that promise pre-emptive rights to purchase stock, or be sure to offer the opportunity to participate in subsequent rounds. Properly document all option grants and clean up any outstanding grants to terminated employees.
- Issue shares in compliance with securities laws. You will be required in your IPO to demonstrate that each pre-IPO issuance of shares or other securities complied with the federal securities laws. If securities have been sold in violation of those laws, it may be necessary to offer to buy them back before the IPO can proceed. You should consult with a qualified securities lawyer in making these determinations.
- Obtain shareholder approvals. Have option plans and golden parachute arrangements approved by the shareholders while you are still a private company.
- Clean up Insider Transactions. Document all loans and other compensatory arrangements, and prepare to disclose these transactions. Avoid or carefully document any transactions between the company and officers, directors or shareholders.
- Avoid issuing "cheap stock." Document carefully the fair market value of the company every time you issue stock options during at least the two years before your IPO. Don't grant below-market options or options with exercise prices inconsistent with venture financing valuations occurring at about the same time as the grants.
- Establish a corporate publicity policy. If you want to continue to publicize your products and services during your IPO, the SEC will look to see what your ordinary course approach to corporate publicity was in the years leading up to your IPO.
- Identify some independent directors. After your IPO, you will need at least two independent directors on your board to comply with Nasdaq listing requirements. In addition, the board's audit committee must have at least two independent directors and the compensation committee should be composed entirely of independent directors (two or more).
- Investigate D & O Insurance. If your company does not now have directors and officers
liability insurance, obtain some quotes for a policy. If you want to have this insurance in
force by the time the IPO is completed, you should start several months in advance to allow
sufficient time to evaluate the alternatives and put the policy in place.
Q: What are the steps for an IPO and how long will it take?
A: The typical IPO goes through the following steps:
- An "all hands" meeting of the underwriter and its counsel, company management and lawyers and accountants for the company to plan the IPO process and assign responsibilities.
- A period of drafting and due diligence meetings. In extraordinary circumstances this process could take as little as a month, but the usual time is two to three months. The process could take even longer if the company has unusual accounting or legal issues. At some point late in this process, the registration statement will be sent to a financial printer to prepare for filing.
- Filing of the registration statement with the SEC.
- The underwriter may decide to produce a preliminary prospectus at this point and begin the sales process, but frequently the decision will be made to wait for SEC comments before printing.
- The SEC issues written comments on the registration statement. The SEC staff tries to do this within 30 days after filing, but sometimes the comment period lasts longer if the staff is backlogged.
- An amendment is prepared and filed which addresses the SEC comments. If the preliminary prospectus was not produced at the initial filing, it may be produced now.
- The road show and other selling efforts begin.
- The SEC may issue additional comment letters on the amendment, and there may be further rounds of amendments until the SEC clears the registration statement to become effective.
- The offering is priced by the underwriters in consultation with the company. At this time, the underwriting agreement will be signed and, in most cases, the final amendment to the registration statement will be filed and the registration statement will be declared effective by the SEC (although this could happen before pricing).
- Three days after pricing the offering closes and the company receives the net proceeds.
The overall time between beginning preparation of the registration statement and the closing may easily exceed six months, and rarely will be less than three months.
Q: What is an S-1, and how is it different from an SB-1 or SB-2?
A: In order to sell stock to the public, the federal securities laws require you to file a registration statement with the SEC. The registration form typically used in an IPO by a company with no prior filing experience is Form S-1. However, your company could qualify to use Form SB-1 (for offerings up to $10 million in a year) or Form SB-2 (for larger offerings) if it qualifies as a "small business issuer," by having revenues of less than $25 million and an aggregate market value of outstanding common equity held by non-affiliates of less than $25 million and by meeting certain other requirements. Forms SB-1 and SB-2 generally require less extensive disclosure than Form S-1, including fewer years of audited financial statements (and more lenient accounting presentation standards).
Q: What are the financial statement requirements for an IPO?
A: Form S-1 requires three years of audited statements (or such shorter period that the company has been in business) plus interim financial statements for each quarter since the end of the prior fiscal year. These statements must be presented in compliance with special SEC rules for financial statements (Regulation S-X). In addition, you will need to provide audited financial statements for recent or impending acquisitions which meet specified standards of significance. Forms SB-1 and SB-2 require only two years of audited income statements (or such shorter period that the company has been in business) and an audited balance sheet plus interim financial statements for each quarter since the end of the prior fiscal year. These statements need not comply for the most part with Regulation S-X. Although audited financial statements must also be provided for recent or impending acquisitions on these forms, the number of years to be provided may be less with certain large acquisitions.
Q: What is the difference between a "primary" offering and a "secondary" offering?
A: A "primary" offering is an offering of securities by the company. A "secondary" offering is an offering of securities by a shareholder. Often an IPO will include both a primary offering by the company and a much smaller secondary offering by major shareholders who want to liquidate some of their holdings.
Q: What is the difference between a "firm commitment" offering and a "best efforts" offering?
A: In a "firm commitment" offering, the underwriter agrees to buy all of the securities offered, whether or not it has ultimate purchasers for them. Note that this commitment is typically entered into only after several weeks of sales efforts and immediately prior to the pricing of the offering. In a "best efforts" offering, the underwriter agrees only to act as an agent of the company and sell as many shares as it can. Virtually all IPOs are firm commitment offerings, although a best efforts offering may be an option for a company that cannot interest an underwriter in a firm commitment offering.
Q: What is an underwriting syndicate?
A: Often, an underwriter in an firm commitment offering will not distribute the entire offering itself. Instead, it will enter into agreements with other underwriters to share the commitment and buy some of the stock. This group of underwriters, which is usually listed in the Underwriting section of the final prospectus, is known as the "syndicate."
Q: Do I need an underwriter in order to do an IPO?
A: The securities laws do not require you to use an underwriter to sell your IPO. In fact, several companies have attempted "direct public offerings" through the Internet and otherwise with varying degrees of success. This is especially popular with very small offerings for which the normal costs of an underwritten IPO would be prohibitive. Some considerations are:
- You will save the 7% underwriting discount on the sale of your shares.
- You still need to file a registration statement and prepare a prospectus, and you will not have the benefit of the underwriter's securities sales experience. You will also need to find buyers for your shares without the benefit of the underwriter's sales network or institutional investor contacts.
- The offering will take significant amounts of management time-maybe as much time as you spend running the business-and could distract management from its focus on the business. In addition, the overall offering will probably take longer than an underwritten offering because there are less people trying to sell your shares.
- If you use the Internet, there are additional SEC and state securities rules with which you must comply.
- It may be harder to establish a liquid market for your shares after the IPO is done if there
is no underwriter to sponsor it and serve as a market maker. Thus, you may need to find
dealers who will agree to make a market and provide research.
Q: What is a "green shoe"?
A: A "green shoe," also known as an over-allotment option, is a right given to an
underwriter to purchase up to 15% more of a company's stock than was planned to be
offered. The purpose for this option is to allow the underwriter to satisfy higher
than expected demand for the stock. The term comes from The Green Shoe Company (now
the Stride Rite Corporation), where the device was first used.
Q: What is "due diligence"?
A: Prior to an underwritten offering, the underwriter and its counsel will investigate the financial, business and legal affairs of the company. This process generally includes an extensive review of documents as well as interviews of company executives.
Q: What is a "lock-up"?
A: An underwriter attempting to distribute stock in an offering typically does not want the company or officers, directors and substantial shareholders of the company to sell stock immediately after the offering because such sales would tend to drive down the stock price and make it harder to maintain an orderly market. Therefore, the underwriter will generally insist that the company (in the underwriting agreement) and the company's officers, directors and substantial shareholders (in separate agreements) agree not to sell any stock for a period of time. The lock-up period for an IPO is typically 180 days, but it may vary from a few months to over a year, depending on what the company and the underwriter negotiate.
Q: What is a "red herring"?
A: A "red herring" is the preliminary prospectus with which the underwriter will sell the stock. The name comes from the legends at the top and down the left side of the cover, which are required to be printed in red ink.
Q: What are the expenses associated with an IPO?
A: For the typical $50 million to $75 million IPO, count on underwriters' commissions of 7% of the gross proceeds of the offering (i.e., $3.5 million to $5.25 million) plus an additional $1.5 million in SEC filing fees, NASD filing fees, Nasdaq listing fees, printing and engraving fees, transfer agent fees, blue sky fees and legal and accounting fees.
Q: What kind of publicity can I have during my IPO?
A: The SEC strictly regulates the types of publicity a company can have during the IPO process. Any publicity outside these limits (e.g., newspaper stories, etc.) may be regarded as illegal market preparation or "gun jumping" and could cause the SEC to delay effectiveness of the offering for a significant period of time.
Q: What is a "road show"?
A: A company involved in a public offering will usually make a series of short sales presentations on the company to institutional investors in major financial centers over a period of several weeks. In these meetings, senior management will discuss the company's financial outlook, business plans, management and products. Although road show presentations are traditionally made in face to face meetings, video and Internet road shows are now occurring more often.
Q: What is a "comfort letter"?
A: In connection with an offering, the underwriting agreement usually requires a "comfort letter" from the company's independent auditor which states that the auditor has checked the financial information in the prospectus and found it to agree with the company's financial records. The comfort letter also states that no material changes have occurred since the date the prospectus was prepared. A comfort letter is sometimes referred to as a "cold comfort letter" because the auditors will only go so far as to say that they don't disagree with any statements made in the prospectus.
Q: What is a CUSIP number?
A: CUSIP is a trademark of the Committee on Uniform Security Identification Procedures of the American Bankers Association. A CUSIP number is a unique identification number assigned to each issue of securities. A CUSIP number consists of a six-character number identifying the issuer of the security and a three-character number identifying the particular security. A CUSIP number is obtained from the CUSIP Service Bureau, associated with Standard & Poor's Corporation. During the process of your IPO, your counsel will need to apply for a CUSIP number for the common stock you are selling to the public.
Q: Why do I need to register under the Securities Exchange Act if I have already registered my IPO under the Securities Act?
A: You are required to register a class of equity securities under the Securities Exchange Act any time it is held by a sufficiently large number of persons. This registration is what subjects you to the proxy rules, the reporting rules, the short-swing trading rules and other aspects of being a public company. This registration is fairly simple when it is done in connection with your IPO, and the SEC will typically make it effective at the same time as your IPO registration statement is effective.
Q: What are "blue sky" laws?
A: In addition to the federal securities laws, each state has a securities or "blue sky" law which may be applicable to an IPO if sales are to be made in the state. If you qualify for quotation on the Nasdaq National Market or a securities exchange, then your IPO is exempt from the registration requirements of state securities laws. If you will instead be quoted on the Nasdaq SmallCap Market, the OTC Bulletin Board or the Pink Sheets, you will need to apply to register your IPO by coordination in each state in which it will be offered, and the offering will be subject to a merit review in the states, which may result in additional comments from the states.
Q: What are the requirements to be quoted on the Nasdaq National Market?
A: You must meet one of three listing standards in order to be quoted on the Nasdaq National Market:
Listing Standard 1
- Net tangible assets of at least $6 million;
- Pretax income in the latest fiscal year (or 2 of the last 3 fiscal years) of at least $1 million;
- At least 1.1 million shares with a market value of at least $8 million which are not held directly or indirectly by officers, directors or 10% or greater shareholders;
- A minimum bid price of at least $5;
- At least three market makers;
- At least 400 holders of at least 100 shares; and
- Compliance with certain corporate governance rules.
Listing Standard 2
- Net tangible assets of at least $18 million;
- An operating history of at least 2 years;
- At least 1.1 million shares with a market value of at least $18 million which are not held directly or indirectly by officers, directors or 10% or greater shareholders;
- A minimum bid price of at least $5;
- At least three market makers;
- At least 400 holders of at least 100 shares; and
- Compliance with certain corporate governance rules.
Listing Standard 3
- Either a market capitalization of at least $75 million, total assets of at least $75 million or total revenue of at least $75 million;
- At least 1.1 million shares with a market value of at least $20 million which are not held directly or indirectly by officers, directors or 10% or greater shareholders;
- A minimum bid price of at least $5;
- At least four market makers;
- At least 400 holders of at least 100 shares; and
- Compliance with certain corporate governance rules.
Q: What are the requirements to be quoted on the Nasdaq SmallCap Market?
A: In order to be quoted on the Nasdaq SmallCap Market, a company must have:
- Either net tangible assets of at least $4 million, a market capitalization of at least $50 million or net income in the latest fiscal year (or two of the last three fiscal years) of at least $750,000;
- At least one million shares with a market value of at least $5 million which are not held directly or indirectly by officers, directors or 10% or greater shareholders;
- A minimum bid price of at least $4;
- At least three market makers;
- At least 300 holders of at least 100 shares;
- Either an operating history of at least one year or market capitalization of at least $50 million; and
- Compliance with certain corporate governance rules.
Q: What is the Over-the-Counter Bulletin Board?
A: The OTC Bulletin Board is a regulated quotation service that displays real-time quotes, last-sale prices, and volume information in over-the-counter equity securities which are not eligible for quotation on a securities exchange or on the Nasdaq National Market or SmallCap Market. Although the Bulletin Board is operated by
Nasdaq, companies traded on the Bulletin Board do not have any agreement with
Nasdaq, and application for quotation on the Bulletin Board is made by the market makers who trade the stock. There are no listing standards for inclusion on the Bulletin Board, except that companies must file Exchange Act reports with the SEC.
Q: What are "pink sheets"?
A: Small companies in the over-the-counter market which are not traded on the OTC Bulletin Board are typically traded through the "pink sheets," paper quotations printed weekly on pink paper and distributed to broker/dealers. An electronic version of the pink sheets is updated once a day and disseminated over market data vendor terminals. The pink sheets are published by Pink Sheets, LLC, formerly known as the National Quotation Bureau.
Q: What is a market maker?
A: A market maker is a dealer who attempts to maintain trading in a stock by entering bid and asked prices on the stock. A market maker is required to stand ready to buy and sell shares of the company's stock in order to meet market demand.
Q: What is a "tombstone" ad?
A: An underwriter who has completed an IPO will usually place an advertisement in select newspapers, known as a "tombstone." This ad, which is designed to publicize the offering but not to make an offer of the securities, is typically a stark, black and white "official notice" listing of the name of the company, the amount of the offering and a listing of the members of the underwriting syndicate.
Q: Who is CEDE & CO. and why does it own so much of my company's stock after an IPO?
A: CEDE & CO. is the nominee for The Depository Trust Company (also known as
DTC). Most of the stock of a public company is held by DTC. Brokerage firms and institutional investors are "participants" in
DTC, and their accounts at DTC reflect how much of the total stock in your company held by DTC is allocated to each participant. Customers of brokerage firms in turn have accounts with their brokers that show how much of that broker's position at DTC is owned by that customer. The primary reason stock is held in "street name" this way is to facilitate trading without the need for delivery of physical certificates.
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