Initial public offerings have been making headlines in the past few weeks after Lyft’s stock slumped following a busy first day of trading, and have yet to rebound to the initial offering price, revealing some of the risks of taking a private company public. Now, the online inspiration board darling Pinterest is looking to raise as much as $1.28 billion in its own IPO, according to Bloomberg, far below its valuation of $12 billion back in 2017.
Before companies get listed on a stock exchange, their leadership first has to file a prospectus with the securities commission, which lets potential investors know about detailed information they need to make an informed investment decision, followed by an application for a public listing.
“In that prospectus, they outline a lot of things – what the proceeds of the IPO will be used for, the risk factors, and the competitive environment of the business, so they outline their entire business plan and executive comp based upon that premise, [and] they go out and try to raise money based upon that business plan,” said Jennifer Sharkey (pictured), Gallagher area executive vice president of insurance and risk management.
In the US, the Jumpstart Our Business Start-ups (JOBS) Act that was signed into law by President Barack Obama in 2012 made it easier for emerging growth companies to go public because it allowed them to file with the SEC confidentially, and test the waters to see if investors would be interested in the company based upon this early draft of the prospectus.
“It enables a company to poll their S-1 and not go public if there’s not a lot of interest in the company without giving away all of their confidential information,” explained Sharkey. “The risk remains the same from a shareholder perspective and from a D&O perspective because once you [make] that S-1 public, then it goes out into the open marketplace and anybody can still invest in those companies based upon representations you’re making in that S-1.”
Meanwhile, the D&O claims trends that Sharkey sees arising from IPOs include disclosure cases and fiduciary responsibility cases.
“You said that you were going to do this and you didn’t within the first year of going public. You said that you’re going to use the proceeds of that IPO for R&D, manufacturing, [or] building a plant, and you changed what you decided to do with those proceeds of the company, so it’s really breaching your fiduciary responsibility,” said Sharkey.
One issue right now that’s leading to more IPO litigation, another key risk, is related to the Cyan decision, whereby the Supreme Court decided that under the Securities Litigation Uniform Standards Act, class actions under the Securities Act of 1933 can be brought in state court, and are not removable to federal court, which opened the flood gates for “actions asserting ’33 Act claims against issuers, officers, directors, underwriters, and others involved in the securities offering process,” according to the Harvard Law School Forum on Corporate Governance and Financial Regulation.
As a result, before leaders take their companies public, they have a lot to think about beyond their initial offering price.
“What they need to consider is making sure they’re managing expectations because the marketplace has become challenging, [and] making sure that they’re working with a broker who has a good understanding of IPO placements,” said Sharkey. “There are very limited insurers who will write primary on IPOs. It depends also [on] trying to define yourself [from] other IPOs that have been going out, and what you’re going to do differently.”
Brokers, on the other hand, need to know the market through and through because it’s not easy to put placements together.
“There’s very limited capacity and sometimes, it takes 15 to 20 insurers to put together a tower. The self-insured component of putting together IPO placements now is different, and so looking at alternatives and different product designs [is important],” said Sharkey, “and then just making sure that because the odds of being sued are higher, that you’re aligned with an advocate that can really help you through some of those ‘33 Act cases.”