A new study is lifting the lid on the slowing market for initial public offerings.
Law firm Proskauer Rose LLP, in their third annual survey of the IPO market, found some stark changes in the way companies approached public offerings in 2015, a year when many public debuts underwhelmed. By year-end, stocks that debuted in 2015 traded below their offering price on average, and a slew of companies simply decided to wait before braving the dicey public market.
The law firm dug in to some of the more esoteric parts of IPO prospectuses and studied the correspondence between companies and the Securities and Exchange Commission prior to the offerings.
The changes they found include a decline in how much investors and employees sell in IPOs, a rise in multiple-class share structures and a longer wait to go public after companies submit their first filing with the Securities and Exchange Commission.
Proskauer’s analysis and database now includes 309 U.S. listings that priced between 2013 and 2015, including 90 in 2015. Here are some of the key takeaways from this year’s report and the starkest changes between 2015 and the preceding years:
1. The SEC is speeding up
The SEC is asking many fewer questions of companies en route to a public debut. The Proskauer study found that the number of comments the SEC made when companies filed their registration documents dropped dramatically in the past two years.
The average number of so-called first round comments dropped to 30 in 2015 from 38 in 2014 and 42 in 2013.
Robin Feiner, a partner in Proskauer’s global capital markets group, said that comments have not only decreased but the comments they do make tend to be more targeted. “The whole process generally seems to be more streamlined and more efficient,” she said. In fact, partners at Proskauer say, the SEC has become much more user-friendly over the past decade.
2. The market slowed down the runway in 2015
Still, that didn’t speed up the IPO timing for companies that debuted last year. The average time from the first submission or SEC filing to pricing an offering increased to 149 days in 2015 from 124 days in 2014.
The longer wait time was likely due to companies waiting out volatile stock markets. Issuers were exercising more caution last year, Philippa Bond, a partner in Proskauer’s global capital markets group, speculated. “There wasn’t always a market opening when companies wanted to launch,” she said.
3. Investors and employees are selling fewer shares
Fewer insiders and investors sold shares when companies debuted in 2015. Only 19% of IPOs had a so-called secondary component, i.e. stock sales where the proceeds do not benefit the company. In 2014, 26% of stock sales had a secondary component, and in 2013, 28% of IPOs did.
Moreover, when there was a secondary component in a deal, managers were much less likely to participate. In 2015, only 36% of managers participated in such sales, down from 40% in 2014 and 52% in 2013.
Ms. Bond called that trend “symptomatic of the market volatility” and said that it’s likely a result of push back from investors who might “not be as willing to invest in deals where the proceeds were not going to the company.”
4. The stigma against insiders buying in an IPO has been lifted
Not only were fewer insiders and early investors selling shares last year, more were buying. The survey found that 41% of IPOs had insiders purchasing in the offering, up from 27% in 2014 and 21% in 2013.
“This three year increase suggests a heightened need for insiders to help support deals in a weaker market,” the report said.
Ms. Bond said that insider IPO buying is now built into the structure of a deal rather than something that’s done if a deal appears to be in trouble. Companies want to show potential investors that there’s insider support for a transaction.
Historically, a high percentage of insider buying meant underwriters were struggling to find willing buyers among traditional IPO investors.
5. Investors don’t balk at multiple-class structures
A greater proportion of companies seeking to tap the public markets are using multiple classes of stock. Dual-class or multiple-class structures are often used to give chief executives, founders, or other individuals outsize control of the company with special voting rights. In 2015, the percentage of issuers with multiple-class structures jumped to 24% from 15% in 2014.
Corporate watchdogs typically say that these types of structures should raise red flags for investors. But investors have become increasingly non-plussed by them, even in a slowing IPO environment. The study said that IPOs with multiple class structures also priced in or above their initial range more often than IPOs with a single class of stock.
Facebook and Google’s parent company, Alphabet, are often cited as positive examples of how these structure give a visionary founder room to execute strategy over the longer-term with relative freedom. Recent history is also littered with troubled companies employing these structures. Among them: online-gaming company Zynga founder Mark Pincus owns a minority of the company’s shares but a majority of its voting power. Mr. Pincus has been in and out of the CEO seat at Zynga, recently handing the reins to another new CEO. Its stock now trades more than 75% below its December 2011 IPO price.
While Proskauer says that these types of deals have popped up in every sector, they are most commonly used in tech, media, telecom and financial services companies.
6. Material weaknesses also don’t matter much
Investors don’t seem to care much whether companies raised yellow flags during their pre-IPO reviews by auditors. Companies where auditors found a “material weakness” in the numbers–or in other words, some potential problem with their financial reporting that could result in an important omission or misstatement –actually did better by at least one metric. The study found that 77% of the companies that revealed a material weakness priced in or above their range, compared to 67% of all IPOs.
In addition, the study found that more issuers have been outlining material weaknesses in their internal controls in SEC filings. Roughly one-third of IPOs in 2014 and 2015 disclosed one, compared to 17% in 2013.
7. Investors will settle for fewer years of audited financial statements
Proskauer took a look at usage of provisions of the 2012 Jumpstart Our Business Startups Act, or JOBS Act. These provisions apply only to companies with less than $1 billion in revenue in the prior year, which are known as “emerging growth companies.”
Those emerging growth companies are increasingly taking advantage of is the option to submit two years of audited years of financials, rather than three. In 2015, 69% of eligible companies offered up just two years of audited financials. That’s up from 58% in 2014 and 39% in 2013.