IPO and VC Questions and Answers

QUESTION: What is a "double trigger"?

ANSWER: A double trigger describes a situation in which not one, but two, stock option accelerators must kick in before a company is obligated to speed up an employee's vesting schedule. For example, a change in the company's ownership control (one common vesting accelerator), would have to be followed by a subsequent event such as the company's decision to terminate the employee without cause. A double trigger means that vesting won't occur until the second event takes place.

QUESTION: What is a secondary offering?

ANSWER: A secondary offering, also known as a "follow-on" offering or "secondary distribution," is any subsequent public offering of a company's shares made after its initial public offering (IPO). As with an IPO, a secondary offering is usually handled by an investment banking syndicate that purchases shares from the issuing company and then re-sells them to institutions and the public. 

Institutions find it easier to accumulate a large position in a company via a secondary offering than by purchasing the same number of shares in the open market. Also, since secondary offerings are akin to a coordinated series of block trades, they can greatly reduce volatility in the issuer's primary stock. 

QUESTION: What is a "limit order"?

ANSWER: A limit order is an order to buy a security, (or commodity) at a specific price or lower. A limit order can also be an order to sell a security or commodity at a specific price or higher. On a limit order, a broker will execute the trade only within the specified price restriction. 

For example, a customer places a limit order to buy Microsoft (MSFT) at $61, even if Microsoft stock reaches $61-1/16, the broker will not execute trade until it has fallen to $61 or less.

QUESTION: What is "spinning" and how does it relate to IPOs?

ANSWER: Spinning is a controversial practice in which an investment firm gives stock of a "hot" IPO to a potential client's top executives in the hope of getting future underwriting business from that company. 

QUESTION: In light of the turmoil in Nasdaq stocks, how low can a company's stock price go before it runs the risk of being de-listed

ANSWER: Any Nasdaq listed company whose minimum bid price has been consistently under $1 per share, for at least 30 consecutive days, will be issued a 90-day warning by a Nasdaq analyst who follows the company. The company must outline a plan for correcting the situation. If the company cannot rectify the situation in the next 90 days, then the exchange can move toward de-listing the company. A hearing will be arranged and the company can accept or refute the recommendations of the exchange.

In addition to maintaining a minimum bid price of $1 for its shares, Nasdaq-listed companies must maintain several other "continued listing standards":

At least $4 million in net tangible assets.
A public float of at least 750,000 shares (i.e. shares not held by insiders, directors or 10% beneficial owners.) 
A market valuation of at least $5 millionAt least 400 round-lot shareholders (minimum holding of 100 shares.) 
At least two market makers in its stock. 

QUESTION: What is a "pre-syndicate bid"?

ANSWER: A pre-syndicate bid can be entered in the Nasdaq System to stabilize the price of a Nasdaq security prior to the effective date of a registered secondary offering. This activity is permissible under SEC Rule 10b-7. 

QUESTION: What is a "direct public offering"?

ANSWER: A direct public offering (DPO) is the practice of selling shares of an IPO directly to the public without using an underwriter. The DPO strategy is often used by companies that have struggled to raise capital through conventional channels and/or companies conducting small offerings in which traditional underwriting fees would be prohibitive. DPOs tend to have a lower success rate than conventional IPOs, because there is less liquidity in the marketplace for their shares.

QUESTION: What is a private placement?

ANSWER: A private placement is an issue of stock, debt or other securities to raise money for a company. However, instead of selling he securities to the public, they are sold to high net worth individuals, institutions and other "accredited" investors. Unlike a public offering, a private placement does not have to be registered with the SEC if the securities are purchased for investment, rather than re-sale purposes.

QUESTION: What is a syndicate

ANSWER: A syndicate, also known as an underwriting group, is a team of underwriters who work together to purchase a new issue of securities for resale to the investment public. Since IPOs typically involve millions of shares, sometimes tens of millions, numerous underwriters are needed to get the newly issued shares into the public markets. The firm that heads the syndicate is referred to as the lead manager. On large deals, there are sometimes co-lead managers. 

QUESTION: When is an investment letter used? 

ANSWER: An investment letter, used in the private placement of new securities, is a letter of intent between the issuer and the buyer, verifying that the securities will be used for investment purposes and not for immediate resale. A properly executed investment letter exempts the issuer from having to register the securities with the SEC. 

QUESTION: What is stabilization?

ANSWER: Stabilization occurs when an IPO's lead underwriter intervenes into the market by placing "buy orders" at a specific price to prevent a new issue from falling below its public offering price. The practice of stabilization protects the issuer's stock and is therefore allowed by the SEC. 

QUESTION: What is an insider?

ANSWER: An insider, according to the Securities Exchange Act of 1934, is an officer or director of a public company -- or an individual (or entity) owning at least 10% of any class of a company's shares. The definition of an insider is intended to cover those who
theoretically have the greatest knowledge of the inner workings and future prospects of a publicly traded company, and therefore, have the most to gain. In terms of an IPO, there are a variety of restrictions on how much stock an insider can sell - and when they
can sell.

Once pegged as an "insider", the SEC becomes very interested in you, especially whenever you trade your own companies' shares. Form 3 must be filed with the SEC the first time you officially become an "insider." Form 4 must be filed each time you buy or sell your company's shares - within 10 days of the end of the month in which the trades occurred. And Form 5 must be filed at the end of the year by any person (or entity) that qualified as an insider at any point during the past year.

NOTE: Forms 3,4 and 5 are not required to be filed electronically with the SEC.

QUESTION: What is a collar?

ANSWER: A "collar," in terms of an IPO, is the lowest price that the issuer will accept for shares of a planned initial public offering. If underwriters are not confident that the minimum price can be achieved in the current market climate, then the issuer may opt to
delay, suspend or withdraw the offering until market conditions improve.

QUESTION: What is a "comfort letter"?

ANSWER: In securities underwriting agreements, a "comfort letter" from an independent auditor is required to ensure that disclosures made in a company's registration statement (and prospectus) are correct. The comfort letter also verifies that no material changes
have occurred since the company's registration and prospectus were initially prepared. This notice is sometimes called a "cold comfort letter" because auditors only go so far as to say that they're not in disagreement with any statements made in the prospectus and
registration document.

QUESTION: What is a "firm commitment offering"?

ANSWER: In a firm commitment offering, the underwriter commits to purchasing the entire new issue in the public offering. Thus, underwriter or investment banking group assumes the full underwriting risk, as opposed to a "best efforts" offering  in which the underwriter (or distributor) promises to sell as much of the new issue as they can -- but makes no guarantee that they'll purchase the entire offering from the issuer.

QUESTION: What is a "market maker?"

ANSWER: A "market maker" is a firm that stands ready to buy and sell a particular stock on a regular and continuous basis at a publicly quoted price. Strong market makers are important for an IPO since they must provide liquidity for investors to buy and sell the issue. Market-makers must be ready to buy and sell a minimum number of shares - typically 100 - of any stock in which they "make a market." Sometimes a large order from an investor may have to be filled by several market-makers at potentially different prices. You'll most often hear about market makers in the context of the Nasdaq or
other "over the counter" (OTC) markets. Market makers that stand ready to buy and sell stocks listed on an exchange, such as the New York Stock Exchange, are called "third market makers."

QUESTION: Are there ways around a lock-up?

ANSWER: Yes. Sometimes underwriters release a portion of the lock-up shares for sale before the lock-up period expires. In other cases, underwriters will allow employees to sell their shares -- together with outside investors who purchased stock when the company was private -- in a follow-on underwritten offering.

NOTE: A lock up period is a pre-specified period of time - typically the first 180 days after an IPO - when a company's executives, officers and other insiders are restricted from selling their shares. Underwriters impose lock-ups because they are concerned that if insiders sell shares soon after an IPO, the company's stock price will fall, undermining the initial public offering price and the post-IPO trading market.

QUESTION: Do venture capital funds fall under the general category of hedge funds since both are essentially unregulated pools of capital raised from sophisticated investors?

ANSWER: Venture capital funds fall under the category of "alternative assets." However, their actions are regulated by partnership terms. They don't have free rein over how to conduct their partnership nor can they sell shares short. Also, most venture capital funds are focused on private equity. Hedge funds, by contrast, are mostly public equity investors and can take both long and short positions.

QUESTION: Do technology companies use special vesting schedules?

ANSWER: Yes. Technology companies, particularly pre-IPO companies, often have shorter vesting schedules with more frequent vesting. 

For example, an Internet startup might grant stock options with a three-year graded vesting schedule, under which one-third of the stock options vest each of the first three years, upon the anniversary date of employment. Another popular scenario is one in which one-third of the stock options vest on the first one-year anniversary of employment, and the remaining two-thirds of the stock options vest on a monthly basis thereafter. The idea, either way, is that by the end of the third year of employment, the employee is 100% vested in the award. 

Some pre-IPO technology companies provide for pro-rata daily vesting of stock options after the first anniversary date. In other instances, companies will vest a portion of the stock options after as few as six months of service. Another trend is for options to be immediately exercisable at grant, but the shares received are subject to a company repurchase right (at the grant price) under a vesting-like schedule.

QUESTION: What is the bargain element?

ANSWER: The bargain element, or "option spread," is the difference between the option exercise price (i.e., what you pay to purchase your shares) and the market price of those shares at the time of exercise. 

QUESTION: Which are the most commonly filed SEC forms?

ANSWER: While there are 360 different SEC form types, the 25 most common account for 75% of all SEC documents filed each year, and the 10 most frequent account for over half. Here are the Top 10:

1.      10-Q (Quarterly Report) 11.6%
2.      8-K (Unscheduled Material Event) 10.4%
3.      SC 13G/A (Amended filing of beneficial owner) 5.0%
4.      497 (Investment Company Prospectus) 4.6%
5.      SC 13G (Filing of beneficial owner) 4.2%
6.      DEF 14A (Proxy) 3.7%
7.      N-30D (Fund manager's semi annual report) 3.3%
8.      Form 4 (Insider sales and purchases) 3.2%
9.      24F-2NT (Inv. company registration of securities) 3.2%
10.    10-QSB (Quarterly Report, small business issuer)  3.0%

Statistics compiled by Financial Insight Systems (FIS), an EDGAR Online company.

The above information is from EDGAR Online News and is featured as a service to the 
viewers of The CEO Refresher and to promote the services of EDGAR ONLINE.

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