April 4, 2016

Pre-IPO Private Placements: The SEC Speaks on Unicorns

As noted in this MoFo blog by Anna Pinedo, SEC Chair White recently delivered this speech out at Stanford that addressed a broad range of issues affecting the technology sector, including how many private companies defer their IPOs, rely on exempt offerings to raise capital and rely on private secondary markets to create liquidity for shareholders.

Chair White also talked about unicorn financings (here’s a recent survey of unicorn financings). Here’s an excerpt from her speech:

A current feature of the pre-IPO financing market that puts these questions in sharp (and local) relief is one that has gathered considerable attention recently – unicorns. Of course, this audience knows that I am speaking not of the creatures of fantasy, but of private start-up firms with valuations that exceed $1 billion. By one count, there are nearly 150 unicorns worldwide, many based here in Silicon Valley. And, they do not appear to be an endangered species. One survey shows that there were 52 unicorn financings in the last three quarters of 2015 compared to 37 such financings over the 12 months that ended in March 2015.

Beyond the hype and the headlines, our collective challenge is to look past the eye-popping valuations and carefully examine the implications of this trend for investors, including employees of these companies, who are typically paid, in part, in stock and options. These are areas of concern for the SEC and, I hope, an important focus for entrepreneurs, their advisers, as well as investors.

At the SEC, the questions we are asking do not fundamentally differ from the questions we ask about all transactions. They include whether the information supplied to investors is accurate and complete – that is, whether it accurately reflects the performance and prospects of the company. Making sure that is so becomes more compelling when the transactions are smaller and the investors are more retail. And, for those involved in advising, investing and nurturing unicorns, there is an important related question – how do $1 billion valuations affect all of the relevant investors – both those investing in the unicorn round, and those that came before and after, whether in private or public transactions.

It is axiomatic that all private and public securities transactions, no matter the sophistication of the parties, must be free from fraud. Exchange Act Section 10(b) and Rule 10b-5 apply to all companies and we must be vigorous in ferreting out and punishing wrongdoers wherever they operate. In the unicorn context, there is a worry that the tail may wag the horn, so to speak, on valuation disclosures. The concern is whether the prestige associated with reaching a sky high valuation fast drives companies to try to appear more valuable than they actually are.

Nearly all venture valuations are highly subjective. But, one must wonder whether the publicity and pressure to achieve the unicorn benchmark is analogous to that felt by public companies to meet projections they make to the market with the attendant risk of financial reporting problems. And, yes that remains a problem. We continue to see instances of public companies and their senior executives manipulating their accounting to meet various expectations and projections.

CII Targets Newly-Public Companies on Governance

As noted in this press release, CII has adopted a new policy for IPOs to ensure they have sound governance frameworks, such as a “one share, one vote” structure, simple majority vote requirements, independent board leadership and annual elections for directors.

REITs: Corp Fin Issues Game Changing Rule 144 Guidance

Recently, as noted in this Bass Berry memo (& these other memos), Corp Fin issued Rule 144 interpretive guidance for the common situation involving the exchange of operating partnership (OP) units into shares of the parent REIT. The interpretive guidance provides that, under certain conditions, the holding period for REIT common stock acquired upon an exchange of units in the REIT’s OP commences upon the unit holder’s acquisition of the OP units, rather than at the time the REIT common stock is acquired. The Staff’s guidance provides long-awaited relief to REITs structured as umbrella partnerships or “UPREITs” that seek to issue OP units as part of their consideration for real estate acquisitions through their OPs.

Broc Romanek