Friday, February 17, 2017

SEC advisory committee ponders why companies are staying private

By Anne Sherry, J.D.

“Because they can,” quipped panelists at an SEC advisory committee session examining why companies are staying private longer. A higher accredited investor limit and unprecedented amounts of private capital were cited as key reasons that companies are able to delay their IPOs. But some members of the Advisory Committee on Small and Emerging Companies reported that they had not experienced the “gusher of small capital” the panelists described.

JOBS Act flexibility. Glen Giovannetti (Ernst & Young) attributed companies’ staying private to technological and regulatory factors. The digital transformation means companies’ business models require less capital, he said. Decimalization, tick size, reduced availability of analyst coverage, and related effects on trading profitability reduce intermediaries’ incentive to take small companies public. Giovannetti also cited the JOBS Act, which allows companies to delay registering with the SEC until they amass 2000 accredited investors. Google and Facebook went public once they reached the previous 500-investor limit, he noted.

James A. Hutchinson (Goodwin Procter LLP) also credited the JOBS Act and the FAST Act’s safe harbor for secondary sales with allowing companies more flexibility. Additionally, he emphasized the high costs of being a public company. Beyond the costs directly attributable to the IPO, recurring costs include salary increases, board expansion, advisory fees, and new investments of technology. Regulatory compliance is also “real money,” he said. It costs millions to go public and millions to stay public, so that decision needs to make economic sense.

The emotional side. Yanev Suissa (SineWave Ventures) added that there are subjective, even emotional reasons, that companies don’t go public. Entrepreneurs believe in their company and want to grow it long-term, he said; they don’t want to hear that their passion isn’t working because an investor doesn’t understand it. He observed, however, that many tech companies, including Uber and AirBnB, are probably feeling the pressure to go public this year. Speaking as a venture capitalist, Suissa said that VCs who have a bad experience “wear their scars forever.” If they leap back in and get burned again, it kills the opportunity set.

Where is all this capital? There was a lively discussion around the so-called gusher of small capital. Many committee members seemed to doubt that there was such a phenomenon. The panelists maintained that there are unprecedented levels of capital at the moment, but conceded that the funds may not be making their way to all companies. Giovannetti focused specifically on biotech as an industry that isn’t seeing the influx of capital. Very few investors are going to write a check and wait around for five years to see if the drug comes out, he said. The financing model doesn’t fit the business model. Suissa had a more pragmatic explanation. “There are a lot of companies that shouldn’t be companies out there,” he said. “A lot of companies that shouldn’t get funding.” But he also recognized that the problem is one of information and matchmaking. Companies like Kickstarter and Angel List provide opportunities for capital-raising beyond the VC set.

Board diversity proposal. The committee also discussed its draft recommendation that the SEC require board diversity disclosure. Currently, Item 407(c)(2)(vi) of Regulation S-K requires companies to disclose whether, and if so how, a nominating committee considers diversity. The committee found that this rule failed to generate useful information and proposed a new requirement that companies further disclose the extent to which their boards are diverse. The draft recommended that:
The Commission amend Item 407(c)(2) of Regulation S -K to require issuers to describe, in addition to their policy with respect to diversity, if any, the extent to which their boards are diverse. While, generally, the definition of diversity should be up to each issuer, issuers should include disclosure regarding race, gender, and ethnicity of each member/nominee as self - identified by the individual. While disclosure should be the default, issuers should have the option to opt -out. 
The committee discussed whether to retain or strike the last sentence. Several members argued that the sentence would allow companies to withhold information the committee had already determined was relevant to investors. The issuer’s ability to define diversity however it chooses provides enough flexibility without making disclosure optional, one posited. Another committee member reported that she had spoken with women-owned businesses who opt out of diversity disclosure in other contexts because they feel it will hurt their business.

Sara Hanks, who co-chairs the committee, remarked that the recommendation does not have to be perfect or anticipate all issues. The rule-writers will craft an appropriate regulation. The committee voted to strike the last sentence from the draft recommendation.