INSIGHT: Indicating Interest to Buy IPO Shares—Strategic Planning Helps Avoid Long SEC Review

Upfront indications of interest to purchase shares in micro-cap initial public offerings are key to facilitating an IPO in today’s volatile markets. The disclosure of indications of interest can be a highly beneficial feature, but must be strategically planned to avoid extended SEC review that could delay or jeopardize the offering.

Indications of interest are conditional, non-binding pre-IPO expressions of interest from potential investors to participate in an IPO. Indications from an issuer’s directors, executive officers, large existing stockholders, or potential new anchor investors, provide a strong message to the market communicating increased deal execution certainty by pre-“selling” a portion of the IPO shares.

A commitment for a sizable order early in the book-building process gives underwriters a head start on raising capital. Disclosure of potential investments by sector specialists is highly persuasive in validating an offering. This is true, for example, with smaller early-stage issuers and companies in industries with a considerable degree of uncertainty, such as biotech.

Typically, if indicated investors are involved in an IPO, the IPO prospectus prominently includes a statement such as:
“Certain of our existing stockholders or persons associated with them have indicated an interest in purchasing from us an aggregate of up to and no more than $X.X million, or X00,000 shares of our common stock in this offering. All shares sold to these stockholders or persons associated with them will be at the initial public offering price and on the same terms as the other investors in this offering.”

The indicated investor may not “agree to purchase” shares in a forthcoming offering, but only “indicate an interest in purchasing” shares in the offering, prior to the effective date of the registration statement. During the “quiet period,” Section 5(c) of the Securities Act of 1933 prohibits all “offers,” either oral or written, prior to filing a registration statement.

‘Waiting Period’ and SEC Requests for Explanations

During the “waiting period” (between filing and registration statement effectiveness), written or oral offers can be made. However, any offer must be made exclusively through the “red herring” prospectus.

Due to these restrictions, the SEC periodically requests issuers to explain how they received the indications of interest, especially from new unaffiliated investors, and disclose written communications to see if indications of interest go too far and “accept” the investments.

Any pre-IPO meetings or oral communications with potential new investors—where an investor indicates an interest in purchasing shares—must be conducted in the context of “testing-the-waters” activities pursuant to Section 5(d) of the Securities Act.

Underwriters can seek non-binding indications of interest from prospective investors (including the share amounts and price ranges) as long as actual orders are not solicited and an investor is not asked to commit to purchase any particular securities.

The IPO prospectus frequently includes disclosure to rebuff suggestions that the issuer guaranteed allocations for the indicated investors, as follows: “Because indications of interest are not binding agreements or commitments to purchase, the underwriters may determine to sell less or no shares in this offering to any of these stockholders or persons associated with them, or any of these stockholders or persons associated with them may determine to purchase less or no shares in this offering.”

Comments About Investors

The SEC has issued comments requiring information pertaining to the indicated investors, including:

• The number of investors who indicated an interest in purchasing shares, and whether the investors are independent third parties or affiliated with the issuer
• The individual number of shares and/or dollar amount each investor indicated an interest in purchasing and whether investors are acting independently or in concert
• Whether any investor or “group” of investors has indicated an interest in purchasing over 5% of the offering or whether such purchase could result in an investor beneficially owning more than 5% of the issuer’s outstanding shares following the offering

Indications of interest disclosure is typically included on the IPO prospectus cover page. While Item 501(b) of Regulation S-K limits cover page disclosure, the SEC has generally not objected to such disclosure since it informs IPO investors of potential concentration of ownership and, if the indicated investors are affiliates, the non-affiliate public float through sales to public investors.

Additional disclosure of indications of interest is sometimes included in the Risk Factors, Principal Stockholders, Certain Relationships and Related Party Transactions, and Underwriting sections.

Risk factor disclosure would note that the available public float is reduced if the indicated investors are allocated all or a portion of the shares in which they have indicated an interest because they may be restricted from selling the shares by a lock-up agreement and/or by applicable securities laws.

Consequently, the trading market for the shares may not be as active relative to what it would be had these shares been purchased by public investors with no association with the issuer.

Investor, Underwriting Disclosures

If the indicated investors are directors, executive officers, large existing stockholders, or a new anchor investor acquiring more than 5% of the issuer’s outstanding shares, the Principal Stockholders beneficial ownership table should note their potential purchase. If the indicated investors are existing stockholders or even third parties (to the extent of their business relationship with the issuer), disclosure may be required under the Certain Relationships and Related Party Transactions section.

Underwriting section disclosure is included if the underwriters’ firm commitment is contingent upon the indicated investors ultimately purchasing all the shares they have indicated an interest in purchasing, or if the underwriters receive less cash or equity-based compensation from the purchase of shares in the offering by the indicated investors than from shares sold to the public.

Testing-the-waters communications, as expanded by new Securities Act Rule 163B, enables issuers, not just “emerging growth companies,” to gauge market interest by permitting solicitations of interest from institutional investors prior to filing their registration statement, if no sales are made or commitment to purchase is accepted. The SEC’s accommodation augments the possibility of issuers lining up influential indicated investors to enhance their chances of a successful IPO.

Allowing early stage engagement creates advantages for issuers and investors typically seen only in late-stage venture capital and “cross-over” or cornerstone investments that could sway issuers to conduct fully registered securities offerings rather than less-costly direct listings. The disclosure of indications of interest can be a highly beneficial feature, but must be strategically planned to avoid extended SEC review that could delay or jeopardize the offering.

A longer Practical Guidance examination of the process is available on Bloomberg Law.

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.

Author Information

Spencer G. Feldman is a partner in the New York City law firm Olshan Frome Wolosky LLP, where he specializes in securities and capital markets.