IPO Boot Camp

Presented by

John Meade, Davis Polk Shane Tintle, Davis Polk Richard Truesdell, Davis Polk

December 9, 2016

IPO READINESS: STRUCTURE, GOVERNANCE AND EXECUTION

Corporate Domicile

Review suitability of corporate domicile

Domicile considerations Corporate financing flexibility Shareholder approval requirements for the issuance of equity securities

Pre-emptive rights

Ability to waive pre-emptive rights

Requirements?

For how much?

For how long?

Availability of blank check preferred stock

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Corporate Domicile (continued)

Anti-takeover protection (see Annex A for more details) Takeover code

Staggered board

No-action by written consent

Ability to limit special meetings

Removal of directors

Blank check preferred stock

Residency requirements for directors

Stock transfer tax

Availability of tax treaty

Say on pay

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Corporate Structure

“C” corp Single versus dual class stock

“Up-C” Tax receivable agreement

Single versus dual class stock

MLPs, REITs and Yieldcos

ADRs versus Shares No longer necessary in many jurisdictions

Generally only used To limit stock transfer tax in applicable jurisdictions

To facilitate settlement if issuer is dually listed

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Dual Class Stock

Dual classes of stock are not uncommon – in our 2016 IPO survey of each of the 50 largest controlled and non-controlled IPOs 20% of non-controlled companies had two or more classes of stock

24% of controlled companies had two or more classes of stock

Multiple classes of common stock Permit founders, parents, etc. to maintain control even if they are diluted below 50%

economic ownership

May permit a tax free spin-off even if the parent is diluted below 80% economic ownership

Key terms High vote/low vote ratio

Sunset provisions

Conversion on transfer

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Anti-Takeover ProvisionsMarket practice

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While anti-takeover defenses at public companies continue to be under pressure from ISS and activist shareholders, still typical to include in IPOs

2016 DPW IPO Corporate Governance survey:

Non-Controlled Controlled

Blank check preferred stock 100% 100%

Classified board 90% 76%*

Removal of a director only for cause permitted 90% 78%

Shareholders prohibited from calling a special meeting 86% 80%*

Shareholder action by written consent permitted 10% 80%*

Supermajority shareholder vote required to amend bylaws 90% 78%*

Shareholder rights plan at time of IPO 0% 0%

Advance notice for shareholder action 100% 98%

* Includes many that “spring” once no longer controlled company

Exclusive Forum Provisions

Exclusive forum provisions are an increasingly popular construct that limits shareholders ability to bring breach of fiduciary duty and similar claims except in the specified jurisdiction Delaware has affirmed the enforceability of provisions that specify Delaware courts

for companies domiciled in Delaware

More than 90% of the companies in our 2016 IPO survey had an exclusive forum provision

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Relationship with Pre-IPO StockholdersOverview

Reconstitution of the board

Management services agreement Maintain vs terminate with or without termination fee Valuation impact

Amending/granting of registration rights

Termination/amendment/execution of shareholders agreement

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Relationship with Pre-IPO StockholdersMaintaining control post IPO

Shareholders agreement

Board/committee member designation rights and/or board observer rights, if any

Transfer restrictions, if any including ROFO or ROFR

Special voting requirements, if any

Preemptive rights, if any

Contractual veto rights

Other covenants – e.g., delivery of financial information and other reports

What are the sunset provisions for such rights?

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Relationship with Pre-IPO StockholdersMaintaining control post IPO

Board/committee rights may include:

Right to certain number of board seats (to be reduced upon sell down of ownership stake in company)

Right to nominate a certain number of directors for election by the annual meeting (to be reduced upon sell down of ownership stake in company)

Right to board observer seats

Right to board committee seats, subject to independence requirements

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Relationship with Pre-IPO StockholdersMaintaining control post IPO

Contractual veto rights may include:

Merger, consolidation, reorganization, etc. Liquidation, bankruptcy, etc. Authorization or issuance of any shares of [senior] capital stock or any options, warrants or other

rights to acquire [senior] capital stock or any security convertible into or exchangeable for any [senior] capital stock (subject to specified exceptions, such as limited issuances to employees and M&A transactions). Declaration or payment of dividends on [junior classes of] capital stock. Redemption, repurchase or other acquisition of capital stock. Approval or modification of the annual operating budget, or any expenditure that would exceed

[$___] [__%] of [line item] [total budget].

Acquisitions and dispositions of any assets or business (whether by purchase or sale of assets, purchase or sale of stock, merger or otherwise) with a value of more than $ .

Debt or capital expenditures exceeding the budget or specified thresholds.

Investments or guarantees exceeding the budget or specified thresholds.

Transactions with shareholders, officers, directors or other affiliates

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(Cnt’d..)

Relationship with Pre-IPO StockholdersMaintaining control post IPO

Contractual veto rights may include (cont’d):

Change strategic direction or scope of company’s business.

Employee stock options and other management equity compensation arrangements.

Hiring or termination of key employees; employment agreements with annual compensation over $ .

Amendment of certificate of incorporation or bylaws (including by merger, consolidation, combination reclassification or otherwise).

Change size of board.

Adopt a “poison pill”

Permit sale of shares by management.

Public offering of [equity] securities.

Appointment of public accountants.

This is not an exclusive list of all possible voting provisions. The facts of each situation should be considered carefully.

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Corporate Governance - Board Composition

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Basic Rule

Majority of Board must be “independent” One year transition period until full compliance is required

Exceptions

Controlled Company Defined as ‘person’ or ‘group’ has more than 50% of vote

Special situations High vote stock

“Group” definition and implications

The average level of director independence at controlled companies was 41% versus 73% at non-controlled companies

Foreign Private Issuers Must disclose non-compliance in annual reports

Corporate Governance - Board Composition (cont’d)

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Definition of Independence – Two Tests

“Subjective test” NYSE: No director qualifies as "independent" unless the board of directors

affirmatively determines that the director has no material relationship with the listed company

NASDAQ: An independent director is a person other than an executive officer or employee of the Company or any other individual having a relationship which, in the opinion of the Company's board of directors, would interfere with the exercise of independent judgment in carrying out the responsibilities of a director

Corporate Governance - Board Composition (cont’d)

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Definition of Independence – Two Tests (cont’d)

“Categorical test” of specific fact patterns Director or immediate family member is, or has been within the last three years, an executive officer, of the

listed company. (Interim CEO is not disqualifying)

Director or immediate family member (except non-EO family member) received more than $120,000 in compensation from company in any twelve month period in last 3 years, other than director fees and pensions.

Director is affiliated with internal or external auditor, or immediate family member is partner of firm or employee working on audit company's audit or did so in last 3 years.

The director or an immediate family member is an executive officer of another company where any of the listed company's present executive officers was on compensation committee (3 year lookback).

The director is a current employee, or an immediate family member is a current executive officer, of a company that has made payments to, or received payments from, the listed company for property or services in an amount which, in any of the last three fiscal years, exceeds the greater of $1 million ($500Kfor NASDAQ), or 2% of such other company's consolidated gross revenues. Charitable contributions exempt under NYSE Rules, but disclosure is required.

NOTE: references to the "listed company" or "company" include any parent or subsidiary in a consolidated group with the listed company.

Corporate Governance – Audit Committee

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Audit Committee

Rule 10A3: must have 3 independent directors Exchange independence AND

Additional independence No affiliation with company: large shareholdings

Any payments from company other than director fees

All must be financially literate

Must disclose if none are financial experts [so effectively must have one]

One at listing, one within 90 days and fully within one year

36% of controlled companies had fully independent audit committees at the IPO versus 88% of non-controlled companies

Exceptions

FPI can have fewer than 3

FPI only needs to satisfy additional independence rules

Corporate Governance – Compensation Committee

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Compensation Committee

Must have fully independent comp committee One at listing, majority within 90 days and fully independent within one year

Special independence rules Exchange independence

Additional independence rules: the board must consider all factors material to that director's ability to be independent from management, including: (A) the source of compensation of such director; and

(B) whether such director is affiliated with the listed company

Exceptions

Controlled company

FPI

However, Section 16 and IRS rules both encourage an independent committee

NOTE: Ownership of even a significant amount of stock is not, by itself, a bar to an independence finding unlike with audit committee independence.

Corporate Governance – Nominating Committee

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Nominating Committee

Independent directors NYSE requires committee

NASDAQ permits informal actions

One year transition period

Exceptions

Controlled company

FPIs

Corporate Governance – Loans to Directors and Executive Officers and Audit Pre-Approval Rules

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Loans to Directors and Executive Officers

Prohibited to provide or arrange for loans

Grandfathering is for loans outstanding in 2002 – not ones made before IPO

Can solve through forgiveness or refinancing

Lots of unintended consequences

Audit Pre-Approval Rules

Any engagement of auditor for audit or non-audit services must be pre-approved by audit committee

Can approve specified services in advance

Corporate Governance – Whistleblower Hotline

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Whistleblower Hotline

Must set up ability for people to anonymously report accounting issues to audit committee Can go through GC

Experience is that most complaints are HR-related

Corporate Governance – Internal Audit Function

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Internal Audit Function

Required by NYSE, with one year transition period

NASDAQ proposed a similar rule but withdrew its proposal

FPIs exempt

Corporate Governance – Code of Conduct

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Code of Conduct

SEC requires disclosure of whether issuer has one applicable to senior management governing specified issues [effectively required]

Exchanges require more fulsome one applicable to all FPIs exempt but routinely comply

Corporate Governance – Disclosure Controls and SOX 404

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Disclosure Controls

Must be in place at listing

Internal Controls/SOX 404

Must have internal controls over financial reporting at listing; SOX 404 in effect year following listing

Exception: EGC for up to 5 years

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Executive Compensation

Must Disclose Compensation of NEO’s in the Prospectus for Domestic Issuers

Named Executive Officers (NEOs) STEP 1: Identify executive officers – Rule 405 Executive officer = Issuer’s president, any VP in charge of a principal business unit, division or function (such as sales,

administration or finance), any other officer who performs a policy making function or any other person who performs similar policy making functions

Executive officers of subsidiaries may be deemed executive officers of the IPOing company

STEP 2: Identify named executive officers (NEOs) NEOs - Item 402(a)(3)

All individuals serving as the issuer’s CEO, regardless of compensation level;

All individuals serving as the issuer’s CFO, regardless of compensation level;

Issuer’s three most highly compensated executive officers other than the CEO and CFO who were serving as executive officers at the end of the last completed fiscal year; and

Up to two additional individuals for whom disclosure would have been provided pursuant to the above but for the fact that the individual was not serving as an executive officer of the issuer at the end of the last completed fiscal year

Any CEO or CFO serving during the last completed fiscal year is a NEO

Highly compensated NEOs are determined on the basis of compensation paid or accrued during the last completed fiscal year

EXAMPLE: Any Form S-1 filed in 2017 will include highly compensated executive officers based on their 2016 compensation

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Executive Compensation – CD&A and Other Disclosures

CD&A and Other Disclosures

Compensation discussion & analysis (CD&A)

Summary compensation table

Related tables and narrative Grants of plan-based awards

Outstanding equity awards at fiscal year-end

Option exercises and stock vested

Pension benefits

Non-qualified deferred compensation

Potential payments upon a termination of employment or a change in control

Director compensation

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Executive Compensation – Emerging Growth Companies

Reduced Disclosure for Emerging Growth Companies (EGCs)

No need for a CD&A

Only requires Compensation of three (rather than five) executive officers, consisting of the CEO

and two other most highly compensated executive officers (i.e., not automatically the CFO)

Summary Compensation Table and related narrative disclosure

Outstanding Equity Awards at Fiscal Year-End table

Director Compensation table

Additional narrative disclosure (e.g., material terms of retirement plans, termination payments and change in control arrangements)

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Executive Compensation – Employment Agreements

Employment Agreements

Should executive officers enter into new, or amend existing, employment agreements, offer letters or “change in control” agreements? Private company executives often do not have employment agreements, and

existing agreements may not be appropriate Executive concern re: a termination of employment or a possible “change in control”

transaction

Opportunity to provide for covenants

Underwriters’ / company’s concern of flight risk

Counsel should review existing arrangements to ensure that they are consistent with the company’s goals as a public company

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Executive Compensation - Historical Compensation Plans

Historical Equity and Performance-Based Compensation Plans

Review plans to determine impact of IPO and potential employee terminations / change in control

Treatment of historical outstanding equity awards Will vesting be accelerated?

Will awards be rolled over into awards under new equity plan?

Treatment of historical performance-based awards Will bonus plans continue with the same metrics or will new plans be developed?

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Executive Compensation – Post-IPO Compensation Plans

Post-IPO Equity and Performance-Based Compensation Plans (Prospective)

Considerations How many shares should we reserve?

Can awards be granted in connection with the IPO?

Should directors receive equity awards?

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Executive Compensation – Section 162(m)

Section 162(m) – Applies to Both Equity and Cash General rule: Under Section 162(m) of the Internal Revenue Code, compensation paid

to NEOs (other than the CFO) in excess of $1 million is not deductible by the issuer

Exception: Qualifying performance-based compensation granted by an independent committee

Transition for IPOing issuers: Recognizing that the shareholders of an IPOing issuer are aware of the issuer’s compensation arrangements when they decide to invest, Congress has permitted a transition period before full compliance with Section 162(m) Condition: Equity compensation and other performance-based compensation plans must be

disclosed in the Form S-1

Duration: Section 162(m) generally does not apply until the first meeting of shareholders at which directors are to be elected that occurs after the close of the third calendar year following the calendar year in which the IPO occurs EXAMPLE: IPO in 2017 → generally, transition relief until shareholder meeting in 2021

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Executive Compensation - Pre-IPO Equity Awards

Pre-IPO Equity Awards - Compliance Check Federal securities laws Exemptions available to private companies under ’33 Act

Rule 701

Sales must be pursuant to a written “compensatory benefit plan” (or a written contract that relates to compensation)

Applies to employees, directors and consultants who provide bona fide services to the issuer

Regulation D

Rule 506: Offering to accredited investors (i.e., directors and executive officers and certain sophisticated investors) and up to 35 non-accredited investors (disclosure required for non-accredited investors)

Regulation S (available for certain offshore offerings)

Because of the JOBS Act, ’34 Act registration is not likely to be required

State securities laws (aka “Blue Sky” laws)

“Cheap stock”

Documentation – Key Documents

Key Documents are:

S-1 or F-1 registration statement, which is the prospectus

Analyst presentation

Testing-the-waters deck

Roadshow deck

Various legal documents, including Underwriting Agreement, Comfort Letter and Legal opinions

Documentation is basis for legal liability and marketing – they must be accurate, and require lots of company attention

Important to pick an IPO czar to coordinate company preparation and review, who has knowledge of company and ability to get others to cooperate

Management should review document and be comfortable with it

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Documentation – Registration Statement

S-1 or F-1 Registration Statement Key sections will include: Prospectus Summary (or the “box”) – an overview of the company and its strengths and

strategies – underwriter should be asked to draft this –

Risk Factors

Management’s discussion and analysis of financial condition and results of operations

Business

Description of capital stock

Executive compensation disclosure

Related party transactions

Description of board, structure and governance

Financial statements

Exhibits, including material contracts – note confidentiality issues

Most material contracts have provisions requiring consent to describe in F-1 and file with SEC

It is possible to request confidential treatment of certain terms

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Documentation - Analyst Presentation

Analyst Presentation

Overview of company

Includes model/financial projections

Becomes basis for roadshow (minus projections)

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Documentation - Testing the Waters/Roadshow

Testing the Waters/Roadshow Documentation

Subject to liability like a prospectus Should conform to prospectus

Reviewed by lawyers

TTW materials must be provided to the SEC

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Documentation - Other Documents

Underwriting Agreement

Agreed before launch, but executed at pricing, when underwriter commits to buy stock

Include indemnity of the underwriters by the company

Comfort Letter

Agreed before launch, but executed at pricing

Auditors confirm the numbers are audited or reviewed, and that all numbers in the F-1 are derived from financial records – the so-called ‘circle-up’ or ‘tick and tie’

Opinions

Agreed before launch, but executed at closing

Both counsel opine on validity of offering, and deliver a “10b-5” statement that document is materially accurate

Because of this letter, counsel is actively involved in due diligence, not just legal but also business and accounting

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Obtaining Consents

Approval of shareholders for structural changes

Class votes such as “Qualifying IPO” triggers in preferred

Termination/amendment of shareholders agreement

Approval of lenders

Change of control provisions in leases and contracts

Confidentiality restrictions in material agreements that need to be filed and disclosed

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• For EGCs that have submitted confidentially, public filing must be made at least 15 days before roadshow

• Decision to launch • Print red herrings

Phase 4Pricing and Aftermarket Management

• Prepare and rehearse testing-the-waters and roadshow presentation

• Target key investors

• Receive and respond to various rounds of SEC comments

• Underwriters prepare internal Selling Memoranda

Phase 2Submit or File/SEC Review

10-11 weeks

IPO Offering Timeline4–5 Months

1 week

Pricing day• S-1/F-1 declared effective• Pricing and allocation• Deliver comfort letter• Sign underwriting

agreement• Press release

Aftermarket activities• Stabilization• Initiation of research

coverage• Investor relations activities

Ongoing Post-Offering

• Research teach-ins to salesforce

• Management salesforce presentations

• Roadshow

2–3 Weeks(After Decision to Launch)

Phase 3Marketing

Phase 1Preparation and Analysis

5–7 Weeks

Determine structure and size of IPO

Organizational meeting/management due diligence presentations to bookrunners

Prepare audited financials

Board meeting to approve filing S-1/F-1

Draft registration statement

Valuation• Prepare financial model• Preliminary valuation

advice

File S-1/F-1 and issue press release

Other due diligence• Financial• Customer/Partner• Accounting • Legal

Bookrunner research diligence

Four business days post pricing

• Print final prospectus• Closing

Execution Timetable

• Conduct testing-the-waters meetings

Annex A – Anti-Takeover Provisions

Defense Description Provision Location

Classified or “Staggered” Board

Directors are divided into separate classes Usually three classes, with directors in each class serving three-year terms and only one class elected annually Makes it more difficult for raiders or dissidents to use proxy contest to take control of target immediately Under Delaware law, if you have a classified board, your directors can be removed only for cause

Charter

Shareholder Rights Plans/ Poison Pills

Gives shareholders (other than “triggering stockholder”) right to purchase common or preferred stock at substantial discount, if triggering stockholder buys enough stock to cross pill’s “trigger” (usually 10-20%)

Threatens substantial economic and voting dilution to potential acquirer unless target’s Board takes affirmative action to “disable” the rights

Adopted solely by Board (approval of rights agreement); implemented/amended solely by Board

Rights Agreement

Board Vacancies and Size

Provisions giving Board the sole authority to fix its size and fill vacancies Provide Board control over its size and constitution Typically Board size is subject to minimum and maximum numbers; Board has ability to select size within these

constraints Having Board determine its size prevents raiders/dissidents from “packing” Board by increasing its size and filling

newly created vacancies

Charter and/or Bylaws

Limits on Shareholders’ Ability to Act by Written Consent or to Call a Special Meeting

Charter or bylaw provisions that restrict shareholders from (i) taking action by written consent and/or (ii) calling a special meeting: Critical defensive provisions that give Board control of voting mechanism Restrict “window of vulnerability” to proxy contest conducted in connection with annual meeting

Charter

Removal of Directors

Provisions that permit removal of directors only for cause prevent raiders/dissidents from causing removal of director for any reason other than fraud, criminal acts, etc.

These provisions are necessary complement to classified board provision In Delaware, a classified board provision in Company’s charter automatically provides for removal only for cause,

even if charter is silent on removal issue.

Charter

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Annex A – Anti-Takeover Provisions (continued)

Defense Description Provision Location

Blank Check Preferred Stock

“Blank check preferred stock” describes provisions that gives Board broad discretion to establish voting, dividend, conversion and other rights for preferred stock: Provides Board with flexibility to meet changing financial conditions in setting preferred stock terms Also grants Board authority to issue preferred stock necessary to implement certain defenses, including

a poison pill/stockholder rights plan

Charter

Limited Ability to Amend Charter or Bylaws

Limitations on rights of shareholders to amend corporation’s governing documents typically take form of provisions requiring a “supermajority vote” of shareholders to amend charter and/or bylaws:In Delaware, stockholder vote is required to amend charter and shareholders cannot be denied absolutely the right to amend bylawsProxy contests seeking to amend bylaws can be restricted more effectively by using supermajority stockholder vote requirements for such action

Charter

Supermajority Stockholder Vote to Approve Merger

Supermajority provisions establish stockholder vote requirements that are higher than minimum levels set by state law to approve merger/other business combination: These provisions typically require approval of holders of two-thirds or more of outstanding shares for

actions that would otherwise require majority approval (e.g., Delaware statute requires only a majority vote)

Supermajority vote requirements may be found in tandem with fair price provisions Because the Board must approve any merger before it is submitted to shareholders, this provision is

“defensive” only if there has been a loss of Board control In fact, supermajority approval could make a “friendly” deal more difficult ― the higher the vote

threshold require, the greater the likelihood that a block of stock may have veto rights over corporate action (especially since approval criteria is based on outstanding shares)

Charter

Cumulative Voting Cumulative voting permits shareholders to apportion the total number of votes they can cast in an election of directors in any fashion they desire, including casting all of the votes for one director

With cumulative voting, the total number of votes to be cast would equal the number of directors to be elected at meeting multiplied by the number of shares eligible to vote

Cumulative voting enables holders of a minority stake to elect one or more directors if they can muster sufficient support: For example, owners of 11% of voting shares of a corporation with 10 open board seats are assured of

electing one director if they vote all their shares cumulatively for a single nominee

Charter and/or Bylaws

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Annex A – Anti-Takeover Provisions (continued)

Defense Description Provision Location

Advance Notice Provisions

All public companies should have Charter or Bylaw provision requiring shareholders to provide advance notice of business that they intend to present at a shareholders’ meeting:

Requirements may apply to Board nominations, resolutions to be offered from the floor, or both

Advance notice provisions prevent “last minute” matters from being proposed at meetings of shareholders, generally dissuading disruptive practices

Usually Bylaws

Expanded Constituency Provision

• Express authorization for Board to consider interests of non-shareholder constituencies (e.g., creditors, employees, community, etc.).

Charter

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