Private companies have never faced the same in-depth level of scrutiny from investors as public ones, but that’s changing. One of the most significant unintended consequences of the Jumpstart Our Business Startups (JOBS) Act is the expansion of the need for an in-depth external investor-communications process for privately held companies — particularly those on the cusp of going public.
The JOBS Act created a new category of equity issuer, the “emerging growth company” (EGC), to give some young companies an easier path to completing an initial public offering (IPO). The EGC designation is for companies with less than $1 billion in revenue and provides options for lighter regulation, such as exemption from Sarbanes-Oxley’s internal-controls attestation and a transition period to comply with certain executive-compensation disclosure rules.
Two-thirds of the U.S. exchange-traded IPOs taking place in 2012 used the EGC designation, including 31 companies that retroactively assumed EGC status (available for companies that filed prior to December 2011). Despite the easing of reporting rules, based on public-ownership filings investors do not appear to be discriminating against issuers that declare themselves EGCs — at least when it comes to willingness to invest in the IPO.
Price performance of EGC offerings during 2012 was superior to non-EGCs in both the short term (one day and one week subsequent to pricing) and the longer term (through the end of 2012), according to data from Ipreo and Factset. In addition, investor participation in the offerings based on ownership filings shows shareholder bases for EGCs nearly identical to those of non-EGCs. While many public pension plans such as CalPERS were among the most vocal critics of the potential for the JOBS Act to lower the bar on corporate governance, their participation in EGC deals appears robust.
New Information Flow
For EGCs, the JOBS Act legislation revolutionizes the communications around a potential new issuance transaction. Investment banks and issuers previously had to carefully limit the information and the audience for that information, similar to the way media companies manage their content to maximize revenue by controlling access to it through different channels; e.g., theater, premium cable, home video, and streaming. (Media companies call this managing the “windows.”)
Securities and Exchange Commission registration requirements ensured that in an IPO, the windows of access to information were fairly narrow in both the duration of the contact between issuers and investors and the magnitude of it. Without an effective registration statement (and the necessary legal and audit expenses to produce this statement), for example, both written and oral communications between potential issuers, bankers, and investors were generally prohibited, and discussions around the structure of a deal would only begin after the initial documents became available.
The “testing the waters” provisions available to companies that become EGCs, however, throw open the windows of access and give prospective issuers an opportunity to structure a more effective deal. Now, a firm’s advisers can premarket an offering, even before an SEC filing, to gauge investor interest in a firm’s equity. Communications between a prospective issuer and investors long before the IPO are now an acceptable practice. Beginning in mid-2012, testing the waters road shows for potential issuers hosted by major investment banks started to become commonplace. Major investors took part to not only gather information for a potential direct investment but also assist the investment-research process for other, existing public-company investments.
This new communication window offers significant benefits. To help gauge whether an offering is likely to succeed, issuers can begin the process of hearing feedback on the investment story from a broader audience Buy-side institutional investors get a deeper view of the presenting company and can also gain access to nonmaterial nonpublic information about the industry and sector, which can help build their “mosaic” of an overall thesis on the industry and sector.
What’s more, bankers receive feedback on how best to structure a deal and take indications of interest, as well as use this opportunity to provide access to unique information for their buy-side clients. In addition, they get to manage the “window” of distribution for this type of content: the exclusivity of this information and access makes it a more valuable asset for all participants.
However, as with media companies, content matters as much as distribution. Test the waters road shows place demands for disclosure on a private-company issuer: demands much greater than these companies faced previously at this point in their lifecycle. There are no legal requirements for fully audited financial statements, detailed line-item guidance, or any other in-depth operational details.
However, investors enter meetings with private companies with the expectation that they’ll receive disclosures on par with what they receive from publicly held companies. In order to formulate a full investment thesis, investors will look for much deeper details about both the history and the future of the company. For example, Wall Street analysts who base their valuation assumptions on a discounted cash-flow model won’t be able to generate an investment recommendation unless they receive all the necessary cash-flow inputs.
It will also be essential for the issuer to have a complete and cohesive “story” for investors. Since test the waters provisions allow authorized outside individuals (e.g., banks, institutional sales, corporate directors) to communicate more freely with investors, each will need a fully formed picture of the investment thesis. Although this disclosure does not have a truly public audience, investors will still expect it to be of public-disclosure quality.
The overarching impact of these JOBS Act rules is to increase the ability to supply information about the investment stories of private companies. This increased supply generates higher demand and greater expectations. Subsequent to the JOBS Act, investor relations will become an increasingly important responsibility of the senior management of privately held companies. It won’t be easy. CFOs of micro-to-small-cap public companies (the most relevant comparable to later-stage private firms) conduct an average of 30 to 60 meetings per year with institutional investors. Additional time is spent interacting with investors over the phone, as well as formulating disclosure policies and shaping the investment story.
Despite the new workload, in a post-JOBS Act world investor-relations responsibilities can be viewed as an opportunity to add value to the enterprise. Managing working capital, seeking new business opportunities, and financing the business are still the primary functions of a private company’s management team, but superior communication of the company’s vision and its opportunities also directly affect valuation.
Brian Matt, CFA, is a director in the analytical services group of Ipreo, a market-intelligence and investor-relations-services firm based in New York. He advises corporate issuers and provides analytics around the impact of corporate actions and changes to capital allocation.