With the U.S. initial public offering market for technology deals all but dead in the water, many U.S. venture capitalists are taking a closer look at deals based in Europe. Valuations in the U.S. for quality, early-stage opportunities can still be relatively high. In addition, technology adoption rates in some foreign countries appear poised for rapid growth and many funds have been formed for the purpose of, or have allocated a portion to, pursuing international deals. Interest has also risen steadily during the past two years as venture-backed European companies have increasingly conducted cross-border IPOs or secondary listings in foreign markets, enhancing the potential liquidity for VCs as to their European portfolio companies.
Even though the overall IPO market in U.S. was down last year, IPOs in the U.S. by foreign issuers rose by 63% from 1999. In fact, there were more foreign IPOs in the last six months of 2000 (52) than in the first-half of the year (46), and foreign companies accounted for nearly a quarter of the total U.S. IPOs in 2000 and nearly half, or about $53 billion, of the money raised.
Many VCs hesitated on European deals in the past because they lacked a European presence or strong local contacts, they found the tax rates too high or were concerned about extended exit horizons. The downturn in the U.S. IPO market may be reason enough for some VCs to reconsider overseas opportunities.
Pros and Cons of Cross-Border IPOs
A listing in a foreign country generally makes the most sense when a company has or hopes to do substantial business in the jurisdiction. Multiple listings can enhance international sales and marketing strategies by increasing name recognition among potential customers and alliance partners. A foreign listing can also provide local acquisition currency in markets where targets are attractive. In addition, companies with employees in a foreign market can offer options or other stock-related incentives based on shares that trade locally.
Dual listings can also promote stock-price stability due to longer, staggered trading days and a wider shareholder pool. Some foreign companies list on Nasdaq to improve analyst coverage and list on a European market to attract shareholders more likely to hold shares longer.
On the downside, cross-border offerings or a mere listing can be expensive, especially when financial statements need to be reconciled to another jurisdiction’s requirements. Reconciliation can cause delays, making it more difficult to hit a narrow market window. Conflicts in securities laws among various jurisdictions and the need for multiple regulatory approvals can also make offering mechanics unwieldy and inefficient.
When a U.S. offering is considered, non-U.S. companies and their shareholders are concerned about a higher risk of shareholder litigation, a point often driven home when underwriters require a company to appoint and maintain a resident agent for service of process for a period of several years to facilitate a lawsuit against the company or selling shareholders in a U.S. court.
Finally, its worth noting that foreign issuers with securities registered under U.S. securities laws are subject to the U.S. Foreign Corrupt Practices Act, which requires companies to maintain accurate books and records and prohibits them from making bribes or engaging in other corrupt practices involving foreign officials. A recent case brought against IBM Corp. by the Securities & Exchange Commission involved misstatements regarding the characterization in SEC filings about illicit payments to directors of a state- owned bank.
Nonetheless, a U.S. offering is attractive to foreign issuers due to the large pools of available capital, deeper ranks of institutional investors focused on emerging companies and large numbers of analysts in all sectors. Regulatory developments in the U.S. are likely to further encourage cross-border transactions by promoting convergence of varying market practices.
Foreign IPOs in the U.S.
New SEC rules governing disclosure by non-U.S. companies became effective late last year. The new SEC rules are significant because they adopt international disclosure standards of the International Organization of Securities Commissions. The SEC said it adopted them to encourage other countries to follow suit.
Although the SEC expects the new rules to eventually lead to harmonization of disclosure standards, they actually modestly increase rather than relax non-financial statement disclosure requirements for non-U.S. companies and leave strict U.S. financial statements requirements intact. Many companies are not waiting for the adoption of international accounting standards and, bowing to market forces, complying with international standards voluntarily in a manner that minimizes any differences from U.S. generally accepted accounting principles (GAAP).
“Foreign Private Issuers” under U.S. Securities Law
If a company organized outside the U.S. does not meet the SEC’s definition of “foreign private issuer” it becomes fully subject to the more extensive disclosure requirements applicable to domestic U.S. public companies. As an accommodation by the SEC to foreign practices, foreign private issuers are subject to slightly less burdensome prospectus disclosure compared with a U.S. company in conducting a registered public offering under the Securities Act of 1933 and significantly less required disclosure compared with a U.S. company in periodic reporting under the Securities Exchange Act of 1934.
Under the new SEC rules, qualifying as a foreign private issuer may be somewhat harder for foreign companies with substantial U.S. operations and a large U.S. shareholder base. A company does not qualify if it fails both of two tests: the location test and the share ownership test. The location test which is failed if the majority of executive officers or directors are U.S. citizens or residents, or more than 50% of the company’s assets are located in the U.S. or if the company’s business is managed primarily in the U.S. The share ownership test is failed if 50% or more of outstanding voting securities of the issuer are owned by U.S. residents.
The new SEC rules replace a “held of record” method of ownership calculation with a beneficial ownership – directly or indirectly owned – determination made pursuant to intricate rules that include provisions for “looking through” record ownership and taking notice of publicly available information in applicable jurisdictions.
U.S. Public Offerings by Foreign Private Issuers
Registration and General Prospectus Disclosure. Foreign private issuers conducting an IPO in the U.S. must generally register the offering on Form F-1, which requires much the same disclosure as domestic Form S-1. However, foreign issuers are permitted to provide less information concerning individual executive compensation and transactions between the company and its directors and other management.
Foreign Issuer-specific Disclosure. Some of the information required under Form F-1 as modified by the new rules is specific to the foreign company, including:
* governmental regulations applicable to the company which restrict the import or export of capital or affect the remittance of dividends, interest or other payments to security holders;
* limitations on the right to hold or vote securities applicable to persons who are not citizens or residents of the company’s home country; taxes applicable to U.S. security holders under the laws of the foreign country in which the company is organized and any applicable tax treaty;
* exchange rates between U.S. dollars and the home country currency;
* a complete description of organizational documents, the nature and extent of any principal non-U.S. trading market for the company’s securities; and tax disclosure covering U.S. and home jurisdiction taxation.
U.S. GAAP Requirements. Financial statements of foreign private issuers must be in accordance with U.S. GAAP or another recognized comprehensive body of generally accepted accounting principles. If financial statements are not presented in U.S. GAAP, a detailed reconciliation to U.S. GAAP must be provided, including the material differences in accounting principles, the impact on balance sheets and income statements and explanations for variations. In an IPO, foreign companies are required to reconcile the last two fiscal years and subsequent interim periods. Because of the difficulty and expense of reconciliation, if a foreign company’s principal listing is in the U.S., it will usually present its financial statements in accordance with U.S. GAAP.
Financial Statement Staleness. Under the new SEC rules a registration statement generally must include audited financial statements no more than 15 months old (previously 18 months) and six month financial statements with U.S. GAAP information must be included if the audited financial statements are more than nine months old (10 months under the prior rules). The more stringent rules could have the effect of a “black-out” period in the second quarter of each fiscal year for companies that file their audited financial statements in the latter half of the six-months after their fiscal year end.
Confidential Review. Unlike domestic companies, foreign private issuers can and should submit their IPO registration statement to the SEC for a preliminary review on a confidential basis. In a dual listing, a foreign company may be required to do a confidential filing in order to comply with foreign listing rules requiring a “quiet” filing until a listing is approved. The confidential process allows the company an opportunity to resolve any difficult issues, such as those arising from the need to reconcile financial statements to U.S. GAAP, before publicly disclosing offering plans.
American Depositary Receipts. With the exception of Canadian and Israeli companies, most non-U.S. companies entering the U.S. capital markets offer American Depositary Shares represented by American Depositary Receipts (ADRs). The ADR represents an ownership interest and a specified number of securities that have been deposited with the depository by the holder of such securities. The benefits of ADRs include facilitation of share transfers and conversion of dividends paid in foreign currency. ADRs and deposited securities are considered separate securities, each subject to the registration requirements of the Securities Act unless an exemption is available. On SEC Form F-6, the registrant must provide in the prospectus a description of the ADRs being registered.
Nasdaq Listing Requirements. Most foreign private issuers with sufficient capitalization to reasonably consider a Nasdaq listing will meet the National Market requirements, which are the same for foreign and domestic companies. In addition to the quantitative requirements, domestic and foreign Nasdaq companies are subject to the qualitative corporate governance rules, including having a three-member independent and financially literate audit committee, annual meetings and a quorum at meetings of at least one-third of outstanding shares. Nasdaq usually grants exemptions from its rules when it can be shown that they would require a company to do anything contrary to generally accepted business practices at home.
Ongoing Disclosure for U.S. Listed Foreign Private Issuers
A foreign private issuer with securities registered under the Exchange Act is:
* required to file an annual report on Form 20-F with the SEC, within six months following the end of each fiscal year (the New York Stock Exchange or an underwriting may require it to be filed earlier);
* not required to file current reports on Form 8-K as is required of a U.S. company, but instead, is required to furnish to the SEC, under cover of Form 6-K, copies of all information that the company makes or is required to make public information under the laws of its home jurisdiction, files or is required to file under the rules of any stock exchange and which is made public by the exchange, or otherwise distributes or is required to distribute to its stockholders;
* not required to file quarterly reports on Form 10-Q, although it will need to furnish to the SEC quarterly earnings reports under cover of Form 6-K if it makes or is required to make such information public in its home jurisdiction or by an agreement with underwriters; and
* exempt from the proxy solicitation requirements and its insiders are not subject to the Section 16 six-month, short-swing trading restrictions and reporting obligations (Forms 3, 4 and 5) that are applicable to insiders of companies subject to full SEC disclosure.
Simultaneous Dual-listed Public Offerings
Concurrent public and private cross-border offerings occur more frequently than dual- or fully-registered public offerings because U.S. and European public offering laws are inconsistent regarding publicity restrictions, prospectus disclosure, timing issues, analyst research and underwriting practices. The SEC has taken steps in recent years to mitigate these differences, including modifying its publicity rules to accommodate foreign country practices, but the extraterritorial reach of its research and publicity rules in global offerings still hamper deals in several European jurisdictions, including the U.K., where similar regulation is less strict.
Although simultaneous dual-listed IPOs are problematic, more companies find its worth the trouble where the value and potential for realization of benefits such as increased price stability, a more diverse shareholder base and an international profile are clearly present.
David Cifrino and Mark Stein are partners, and Catherine Moss is English solicitor, of the international law firm McDermott, Will & Emery.
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