granted to underwriters. Venture capital and private equity shareholders view a secondary offering as their principal realisation event. An issuer must consider whether any of its shareholders have registration rights that could require the issuer to register shareholder shares for sale in the IPO.
Cheap stock “Cheap stock” describes options granted to employees of a pre-IPO company during the 18–24 months before the IPO where the exercise price is deemed (in hindsight) to be considerably lower than the fair market value of the shares at grant date. If the SEC determines (during the comment process) that the company has issued cheap stock, the company must incur a compensation expense that will have a negative impact on earnings. The earnings impact may result in a significant one-time charge at the time of the IPO as well as going-forward expenses incurred over the option vesting period. In addition, absent certain limitations on exercisability, an option granted with an exercise price that is less than 100% of the fair market value of the underlying stock on the grant date will subject the option holder to an additional 20% tax pursuant to section 409A of the Internal Revenue Code. The dilemma that a private company faces is that it is
unable to predict with certainty the eventual IPO price. A good-faith pre-IPO fair market value analysis can yield different conclusions when compared to a fair market value analysis conducted by the SEC in hindsight based on a known IPO price. There is some industry confusion as to the acceptable method for calculating the fair market value of non-publicly traded shares and how much deviation from this value is permitted by the SEC. Companies often address this cheap stock concern by retaining an independent appraiser to value their stock options. It now appears, however, that most companies are using one of the safe-harbour methods for valuing shares prescribed in the section 409A regulations.
Governance and board members Even with the accommodations available to an EGC, a company still must comply with significant corporate governance requirements imposed by the federal securities laws and regulations and the regulations of the applicable exchanges, including with regard to the oversight responsibilities of the board of directors and its committees. A critical matter is the composition of the board itself. All exchanges require that, except under limited circumstances, a majority of the directors be “independent” as defined by both the federal securities laws and regulations and exchange regulations. In addition, boards should include individuals with
26 JOBS Act Quick Start
appropriate financial expertise and industry experience, as well as an understanding of risk management issues and public company experience. A company should begin its search for suitable directors early in the IPO process even if it will not appoint the directors until after the IPO is completed. The company can turn to its large investors as well as its counsel and underwriters for references regarding potential directors. The Sarbanes-Oxley Act and the Dodd-Frank Act
require publicly traded companies to implement corporate governance policies and procedures that are intended to provide minimum structural safeguards to investors. Certain of these requirements are phased in after the IPO. Again, quite a number of these requirements will be applicable to an EGC and should be carefully considered. Key provisions include: • Prohibition of most loans to directors and executive officers (and equivalents thereof).
• The CEO and CFO of a public company must certify each SEC periodic report containing financial statements.
• Adoption of a code of business conduct and ethics for directors and senior executive officers.
• Required “real time” reporting of certain material events relating to the company’s financial condition or operations.
• Disclosure of whether the company has an “audit committee financial expert” serving on its audit committee.
• Disclosure of material off-balance sheet arrangements and contractual obligations.
• Audit committee approval of any services provided to the company by its audit firm, with certain exceptions for de minims services.
• Whistleblower protections for employees who come forward with information relating to federal securities law violations.
• Compensation disgorgement provisions applicable to the CEO and CFO upon a restatement of financial results attributable to misconduct.
• The exchanges’ listing requirements contain related substantive corporate governance requirements regarding independent directors; audit, nomination, and compensation committees; and other matters.
Selecting the underwriters A company will identify one or more lead underwriters that will be responsible for the IPO. A company chooses an underwriter based on its industry expertise, including the knowledge and following of its research analysts, the breadth of its distribution capacity, and its overall
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