Private equity portfolio companies are estimated to have represented nearly a quarter of all U.S.-issuer initial public offerings (IPOs) in 2015, with that proportion being even higher in prior years. The relationship between private equity firm and IPO issuer presents a core group of issues and a short list of recurring themes in the U.S. Securities and Exchange Commission (SEC) review and comment process. 1 For certain of these issues, the SEC staff has issued substantially identical comments to multiple private equity-backed issuers, suggesting that they have developed models for reviewing private equity-backed IPOs. In advance of an initial IPO registration statement filing, and when structuring pre- and post-IPO relationships, private equity firms and their counsel should consider these trending comments and likely areas of SEC scrutiny to avoid potential IPO disclosure difficulties and to guide the drafting of IPO registration statement disclosure.
Related-Party Transaction Disclosure
Among these recurring issues, related-party transactions were a key area of focus in SEC review. SEC staff comments frequently included a request to disclose all related-party transactions. In fact, our analysis identified one such comment which was provided word-for-word to multiple private equity-backed issuers:
|Please disclose in this subsection, or under a separate heading in your prospectus summary, any payments, including dividend payments, compensation, or the value of any equity that [the private equity firm] or its affiliates, and your directors or executive officers received or will receive in connection with the offering.
Related-party disclosure drew particular focus in cases where a significant number of contemporaneous transactions—such as repayment of indebtedness, termination of consulting arrangements with the private equity firm and restructuring of the issuer or the private equity fund’s ownership—were disclosed. Where these types of transactions occur at or shortly prior to the IPO, the SEC staff often commented on compliance with use of proceeds disclosure requirements as well:
| We note that an affiliate of [the private equity firm] holds a portion of the outstanding term loan facility; to the extent [that the private equity firm] or its affiliates will receive a portion of the proceeds of the offering that are used to discharge indebtedness, please disclose that fact here.
Often, contemporaneous transactions will trigger a requirement to present pro forma financial data. For issuers engaged in transactions with a private equity firm at the time of the IPO, the SEC staff frequently challenged pro forma financial statement disclosure, including requests for revised and expanded disclosure related to management and termination fees paid to private equity firms and repayment of indebtedness.
Disclosure of Post-IPO Control
Another area of focus in SEC comments was the private equity firm’s continuing control of the IPO issuer. SEC comments most frequently requested additional disclosure on the topic of control in the prospectus summary. These requests ranged from general disclosure of the private equity firm’s control, to descriptions of arrangements for post-IPO nomination of directors and executive officers.
|Please clarify that your principal shareholders will continue to be controlling shareholders after this offering and will have the right to designate a number of directors to your board pursuant to a shareholders’ agreement.
The SEC staff also frequently requested additional information and disclosure with respect to any arrangement or understanding with a director or executive officer pursuant to which he or she was or is to be selected as a director or executive officer post-IPO.
In addition to comments on the prospectus summary, the SEC staff frequently requested additional risk factor disclosure about the nature and extent of post-IPO control by the private equity firm, and the potential for conflicts of interest with public investors.
Beneficial Ownership Disclosure
The final key area of focus in the SEC comments we reviewed related to beneficial ownership disclosure. The IPO registration statement must include tabular disclosure of certain information relating to beneficial owners of more than five percent of the registrant’s voting securities. Beneficial owners are any persons who, directly or indirectly, through any contract, arrangement, understanding, relationship, or otherwise have or share voting power and/or investment power with respect to the securities.
Because the structures through which private equity funds own interests in portfolio companies can be complex and often include several affiliates, disclosure of ownership interests frequently includes disclaimers of beneficial ownership by affiliates of the private equity firm and fund. The SEC staff frequently challenged such disclaimers of beneficial ownership where the staff had formed an initial view that certain persons or entities controlled the portfolio company or the private equity firm or fund. These comments frequently requested that the portfolio company either provide its legal analysis supporting the disclaimers (which will ultimately become publicly available after completing the IPO) or remove them.
In addition, the SEC staff also frequently requested that private equity-backed issuers identify natural persons affiliated with the private equity firm or fund in the tabular ownership disclosure. These comments generally focused on whether such individuals participated in investment decisions by the private equity firm or fund, or otherwise could be deemed to have voting or dispositive control over securities held by the private equity fund.
| Please include the natural persons or persons who have voting and dispositive control of the shares included in Funds affiliated with [the private equity firm] listed in the table.
Indicative of their concerns relating to disclosure of both ownership and control, the SEC staff also frequently requested that IPO issuers provide structure charts in the prospectus summary or provide additional information to highlight the issuer’s ownership and governance. These included requests to provide detail with respect to conversion and exchange rights, ownership interests of pre-IPO owners as a group and ownership percentages generally. In several cases, this information had already been provided elsewhere in the draft disclosure, but the SEC staff specifically requested that it also be brought forward to the prospectus summary.
|Summary: Trending SEC IPO Comment Topics
- Transactions with related parties and the use of proceeds in contemporaneous transactions with the private equity firm, including related pro forma financial information.
- Disclosure of the private equity firm’s control post-IPO, including increased prominence of such disclosure in the prospectus summary, additional risk factors and more detailed organizational/structure charts.
- Beneficial ownership, including disclaimers of beneficial ownership by affiliates of the private equity firm or fund and identification of natural persons who have voting or investment discretion over securities held by the private equity fund.
A version of this article first appeared in Transaction Advisors and is available for download here.
1 The authors reviewed SEC comment letters in IPOs of private equity–backed issuers that closed from January 2015 through June 2016 with gross proceeds of at least $100 million. The comments analyzed are only those with respect to the private equity firm (and fund) and its relationship with the issuer, not the financial and business disclosure of the issuer itself.