Paths to going public and insurance for directors and officers

Private companies can benefit by going public, such as by providing liquidity for long-term investors and employees, increase access to public markets, and bring additional attention to a company.

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Private companies can benefit in many ways when they go public. Among other advantages, this transition can provide liquidity for employees and long-time investors, increase access to public markets, provide a marketing boost, and bring additional attention to a company. It is no wonder, therefore, that despite the challenges imposed by the COVID-19 pandemic, companies are continuing to go public at substantial rates.

Unlike the initial public offerings (IPOs) of yesteryear, there is no longer just one primary pathway to becoming a public company. Today, companies can go public through a “traditional” IPO, a direct listing, a hybrid approach, or through a special purpose acquisition company (SPAC). While each avenue affords companies the benefits of access to public markets, there is a whole host of new risks to the company, its board, and other executives that must be addressed.

Going public opens a company up to laws governing publicly traded entities, including enforcement proceedings by federal agencies and shareholder class actions. In today’s heightened litigation environment, in particular, newly public companies must be as vigilant as possible with regard to disclosures and corporate governance.

The benefits to going public still outweigh the risks, but only if an appropriate risk transfer mechanism is in place in the form of a directors and officers liability (D&O) insurance program. A properly structured D&O program is integral to protecting not just a newly public company’s balance sheet, but most significantly, the personal assets of the organization’s leadership as its risk profile materially changes.

How a direct listing compares to a traditional IPO

The primary difference between a direct listing and a traditional IPO is that a company engaging in a direct listing is not creating new shares to be underwritten and sold to institutional investors and the public. Instead, in a direct listing, only existing shares of the company are sold.

While the Securities and Exchange Commission (SEC) has approved the New York Stock Exchange’s (NYSE) rules to allow companies engaging in a direct listing to also raise primary capital concurrently and Nasdaq has proposed a similar rule, no company has actually conducted a direct listing with a primary raise to date. As a result, this approach is untested; separate SEC no-action relief may be required for such a listing. Direct listings also differ from traditional IPOs in that there are no underwriters (and no underwriters’ commissions). Instead, investment banks are designated to serve as financial advisors in the transaction, which is a more limited role than underwriters in a traditional IPO.

A direct listing does not entail a roadshow, which is typical of traditional IPOs. Instead, in a direct listing, the company can conduct an investor day, which provides similar information to investors as they would receive in a roadshow, and may hold an earnings call after the registration statement is effective but before the listing in order to provide investors with earnings guidance, which will inform analyst models.

Direct listings and traditional IPOs both require a registration statement to be filed with the SEC. In a traditional IPO, the issuer is registering shares to be sold in the IPO; in a direct listing, certain shares that are held by pre-listing investors are registered for resale.

The legal and financial disclosure requirements are similar, and registration statements are subject to SEC review in both scenarios. In a direct listing, however, the registration statement will need to be kept effective for a period of time after the listing (usually 90 days), which requires continual updates for material events that may occur during the resale period.

Like a traditional IPO, there are publicity restrictions when a company is “in registration.” Companies in a direct listing or in a traditional IPO should be mindful of “gun jumping” — for example, soliciting investors using information that is not publicly available or approved of by the SEC.

In both a traditional IPO and a direct listing, the ultimate goal is for the company to become a publicly traded company, with all the privileges and obligations that come with it. As a result, it is prudent for companies considering one of these paths to begin thinking about their insurance needs.

Objectives of a public listing

Companies going public typically balance different objectives in determining the best path. These include:

  • The ability/need to raise primary capital. Traditionally, an IPO has been, at its core, a financing event. But some companies may not need to raise any primary capital, in which case a direct listing may make more sense. Still, no company has actually conducted a direct listing with a primary raise yet.
  • Achieving “fair” value. Direct listings have attracted a lot of attention from the venture capital community because of their supposed ability to solve the problem of “leaving money on the table.” In an IPO, there is often an after-market “pop” in the stock price, leading some to argue that the company could have raised more money by pricing the shares higher (which would also increase returns for selling stockholders). This pop is often the result of inefficient price discovery and limited visibility into the demand curve. In a direct listing, if there is robust supply and demand at the open of the listing, it should be reflected in the stock price, resulting in less of a pop. While that may be a good outcome for pre-listing investors, companies should also be aware of the optics for employees and other stakeholders of not having an after-market pop, which some may consider a sign of a successful IPO/listing.
  • Placing shares with long-term investors. A traditional IPO allows companies to curate their stockholder base by placing IPO shares with certain long-term investors. A direct listing, by contrast, is based purely on supply and demand — meaning there is little visibility into supply and demand and no ability to place shares with any particular investor. That means there is more risk of stock price volatility in the event of a significant mismatch between supply and demand.
  • Liquidity for pre-public investors and employees. Historically, underwriters in traditional IPOs have imposed a 180-day lockup on shares held by pre-IPO stockholders, which includes long-time investors, founders, and employees. This lockup is meant to allow for an orderly distribution of shares into the public market after the IPO. With some exceptions, there is generally no lockup involved in a direct listing, which allows pre-listing stockholders to sell immediately upon listing if so desired. As a result, there is now more pressure on underwriters in traditional IPOs to shorten or otherwise provide for early releases from lockup. We are thus seeing more bespoke lockups that may include triggers for early releases that could potentially apply to different groups of stockholders.
  • After-market stabilization. In a traditional IPO, underwriters provide after-market stock price support and typically have a 15% “green shoe” overallotment option, which allows them to purchase additional shares from the company at the IPO price. In a direct listing, financial advisors are not allowed to engage in stabilization activities.

Converging paths

Whether a company chooses the direct listing or the traditional IPO route, it will be listed on an exchange and become a public company. This means that the company must be adequately prepared to function as a public company, ensuring that it has the functions and processes in place to make certain that it can report financials and other disclosures to the SEC and its investors in a timely manner. A company must also adopt governance policies and programs to meet SEC and listing requirements.

D&O insurance considerations

The actions taken by companies before, during, and following either an IPO or a direct listing can attract heightened scrutiny from regulators, plaintiffs’ attorneys, investors, and the broader public. The first step for a private company embarking on the journey toward a public listing is to ensure that it has a D&O insurance policy in place that is sufficiently broad and that has appropriate limits of liability.

Importantly, companies going the route of a traditional IPO should take the steps necessary to address their insurance needs before engaging in roadshows or filing their preliminary prospectus documentation. Investors rely heavily on representations made during roadshows and often file lawsuits against companies accusing them of making misstatements as part of these meetings. Companies should confirm that their D&O policies provide coverage for roadshow activities and for claims that may arise if an IPO fails, as some insurers will seek to exclude these risks.

For companies that choose a direct listing and therefore do not conduct roadshows, there is still a heightened risk from regulators and investors that comes with going public. These companies should secure insurance to shield the personal assets of directors and officers from potential claims and to back up their organizations’ balance sheets where they indemnify individuals in any resulting litigation.

During the IPO or direct listing process, companies should work with insurance advisors to organize formal meetings and presentations with D&O insurers regarding the programs that must be built for them when they become public. The moment an IPO is completed or trading on an exchange otherwise begins, insurance that companies have secured as private organizations will cease to apply to go-forward risks.

Instead, a publicly traded organization requires a different policy form and higher limits to address its expanded risk profile. Companies must determine the appropriate limits based on their specific industry, operations, and expected market capitalization, among other factors. This program must be fully quoted and confirmed in place before trading begins.

To ensure the broadest terms at the most competitive pricing, it is crucial that companies work with insurance advisors with specific expertise in this area. Experienced advisors can advocate on their behalf, help generate interest from the underwriting community, and assuage concerns about particular risk factors.

Following the completion of an IPO or a direct listing and into the future as a public company, it is imperative that a company closely monitors its D&O insurance program to ensure that all risks are captured. This will require vigilance from company management because changes in risk profile, growth, acquisitions, new product offerings, and other factors can alter the company’s insurance needs.

Companies should seek to increase their policy limits as their market capitalization grows. Investor losses due to negative stock price movement resulting from missing earnings or other events will grow over time, contributing to larger potential damages in securities litigation. Companies should work with insurance advisors to strengthen their policies wherever possible and to prepare for renewals where material changes in companies’ risk could impact the scope, price, and insurer participation of their D&O programs.

Finally, companies of all sizes that are looking to become public should consider addressing insurance needs beyond a D&O policy. Based on their operations and the nature of their risk, companies should consider other forms of coverage, including fiduciary liability, cyber, employment practices liability, fidelity/crime, and other policies as appropriate.

Paths to going public and insurance for directors and officers

Learn more about D&O insurance considerations for directors and officers when going public.

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