Friday, August 28, 2015
Back in January, I joined Planet Fitness. The $10/month membership seemed too good to be true. Most gyms I had joined in the past had cost 3-5X that amount, and the equipment looked pretty similar. Also, the advertisement of No Commitment* Join Now & Save! (small font – *Commitments may vary per location) gave me pause.
Like a good lawyer, I read all the fine print in the membership contract, looking for a catch. There wasn’t really a catch – except for a small, one-time annual fee (~$30), if I did not cancel before October.
I signed up, enjoyed the gym, and canceled a few months later, as soon as the weather outside improved. (When I exercise, which is not as consistently as some of my co-bloggers, it is mostly just running, and I prefer to run outside if the weather is decent).
So, in total, I paid around $30 for three months of access to a single location of a decent gym.
This deal is still somewhat puzzling to me. If Planet Fitness’ business model makes sense, why aren’t more competitors coming close to the $10/month price point?
Here are some of my guesses (based on my brief experience at one location and pure speculation):
- Planet Fitness may have a lower cost structure than some gyms. While I thought the equipment was fine, most of the equipment seemed to be of the “no frills variety.” For example, none of the treadmills at my location had color screens and most of the machines appeared to be base models. I did, however, appreciate that Planet Fitness seemed to pay attention to what machines members use regularly – like treadmills, bikes, and ellipticals – and devoted most of their space to those machines.
- Planet Fitness may be taking a page from the behavioral economist’s playbook. Planet Fitness made signing up extremely easy and automatically deducted the fee from the member's checking account each month. Canceling was slightly more difficult. You had to physically come into the gym to sign cancellation paperwork, or you could snail mail your cancellation. You also had to give a bit of notice, prior to cancellation, to avoid getting charged for the following month. The slight difficulty canceling, coupled with the very low monthly fee might result in some folks forgetting about their membership for a while, simply taking a while to cancel, or purposefully avoid canceling, in hopes they would return to working out. I will say that I did not find canceling at Planet Fitness terribly difficult. However, when I was a member of LA Fitness a number of years ago, I remember their cancellation process, through certified “snail-mail” letter, being a pain.
- Planet Fitness may have been offering $10/month as a "teaser rate" to attract members, with plans to increase rates once members had developed habits of going to their gyms. My gym has already increased the “no commitment” membership to $15/month, while the $10/month membership now comes with a 1-year commitment.
- Judging from these complaints, many members may not understand the annual fee, the commitments (on some plans), and the cancellation requirements. Perhaps these parts of the contracts are helping off-set the low monthly price.
- Planet Fitness may have been trying to increase their membership numbers in advance of their IPO this summer.
This last bullet-point, regarding increasing membership numbers to help their IPO, is the one I find most interesting. If the valuation of certain tech-companies, like Instagram, can be based on, at least in part, “number of users,” I think it is reasonable to assume that “number of members” is an important metric for the valuation of gyms.
On August 5, The Wall Street Journal reported that Planet Fitness priced its IPO at $16/share and raised $216 million. Planet Fitness disappointed in early trading (See here and here), then rose to just under $20/share, and is now back around its IPO price. Given the prevalence of IPO under-pricing, I imagine early investors hoped for better. That said, I plan to follow Planet Fitness and see if their business model is one that works in the long-term. If they have continued success, I imagine other companies will attempt to imitate.
Update: Will Foster (Arkansas) passed along this interesting public radio podcast on gym memberships, which discusses Planet Fitness. Basically, it suggests that many gyms seek members who will not show up regularly (or at all). Maybe this is a key to Planet Fitness' business model; Planet Fitness advertises itself as a "no judgment" gym and even has a "lunk alarm" that it rings on weightlifters who grunt or drop weights. Members seeking "no judgment" may come to the gym much less frequently than serious weightlifters. In fact, at the Planet Fitness featured, 50% never even showed up once. That location has ~6000 members, but a capacity of ~300. Also, this podcast makes sense of why Planet Fitness has free candy, bagels, mixers, massage chairs, and pizza parties - again this attracts less serious gym members and it also gives some value to those who come to the gym only to socialize and eat. Listen to the whole thing.
Thursday, July 30, 2015
Last week I attended a panel discussion with angel investors and venture capitalists hosted by Refresh Miami. Almost two hundred entrepreneurs and tech professionals attended the summer startup series to learn the inside scoop on fundraising from panelists Ed Boland, Principal Scout Ventures; Stony Baptiste, Co-Founder & Principal, Urban.Us, Venture Fund; Brad Liff, Founder & CEO, Fitting Room Social, Private Equity Expert; and (the smartest person under 30 I have ever met) Herwig Konings, Co-Founder & CEO of Accredify, Crowd Funding Expert. Because I was typing so fast on my iPhone, I didn’t have time to attribute my notes to the speakers. Therefore, in no particular order, here are the nuggets I managed to glean from the panel.
1) In the seed stage, it’s more than an idea but less than a business. If it’s before true market validation you are in the seed round. At the early stage, there has been some form of validation, but the business is not yet sustainable. Everything else beyond that is the growth stage.
2) The friend and family round is typically the first $50-75,000. Angels come in the early stage and typically invest up to $500,000.
3) The seed rounds often overlap with angels and businesses can raise from $500,000 to $1,000,000. If you have a validated part of a business model but are not self funding then you are at Series A investment stage. You still need outside capital despite validation. The Series A round often nets between $3-5 million and then there are subsequent rounds for growth until the liquidity event which is either the IPO or acquisition.
4) Venture capitalists are investing their LPs' money and often the LP will co-invest with the VC. Their ultimate goal is for the company to get acquired or go public.
5) At the early stages some VCs will show a deal to other investors if it looks good. Later stage VCs will become more competitive and will keep the information and good deals to themselves.
6) It’s important to find a lead investor or lead angel to champion your idea.
7) Not all funding is helpful. Some panelists discussed the concepts of “fallen angels” or “devils,” which were once helpful but now are not providing value but still take up time and energy that could be better spent focusing on building the business. “False angels” are those who could never have been helpful in the first place.
8) You don’t want to be the first or the last check the angel is writing. You want to get references on the angel investor and see where they have invested and what their plan is for you.
9) There is smart money and dumb money. Smart money gives money and additional resources or value. Dumb money just gives money and nothing else. It’s passive and doesn’t jump into the business (note the panelists disagreed as to whether this was a good or bad thing). Another panelist noted the distinction between helpful and harmful money. Harmful people think they are helpful and give advice when they don’t have a lot to add but take up a lot of time. Sometimes helpful money just gives a check and then gets out of the way. It’s the people in between that can cause the problems.
10) VCs and angels invest in teams as well as ideas. They look for the right fit and a mix of veteran entrepreneurs, a team/product fit, a mix of technical and nontechnical people, professionals whose reputations and resumes can be verified. They want to know whether the people they are investing in have been in a competitive environment and have learned from success or failure.
11) Crowdfunding can be complicated because investors don’t meet the entrepreneurs. They see everything on the web so the reputation and the need for a good team is even more important.
12) Convertible notes are the “gold standard” according to one speaker and it’s the workhorse for funding. There was some discussion of safe notes, but most panelists didn't have a lot of experience with them and that was echoed this week by attorney David Salmon, who advises small businesses and holds his own monthly meetups. One panelist said that the sole purpose of safe notes was to avoid landmines that can blow up the company. Another panelist indicated that from an investor standpoint it’s like a blackhole because it’s so new and people don’t know what happens if something goes wrong.
13) The panelists indicated that businesses need to watch out for: the maturity date for their debt (how long is the runway); when can the investors call the note and possibly bankrupt the company; how will quirky covenants affect the next round of financing and where later investors will fall in line; and covenants that are easy to violate.
14) There was very little discussion of Regulation A+ but it did raise some interest and the possibility to raise even more funds from non-accredited investors. Only 3% of the eight million who can invest through crowdfunding actually do, so Reg A+ may help with that.
16) All of the panelists agreed that entities may start out as LLCs but they will have to convert to a C Corp to get any VC funding.
There was a lot more discussion but this post is already too long. Because I've never been an angel nor sought such funding, I don’t plan to provide any analysis on what I’ve typed above. My goal in attending this and the other monthly events like this was to learn from the questions that entrepreneurs ask and how the investors answer. Admittedly, most of my students won’t be dealing with these kind of issues, but I still introduce them to these concepts so they are at least familiar with the parlance if not all of the nuances.
July 30, 2015 in Business Associations, Corporate Finance, Corporate Governance, Corporations, Current Affairs, Entrepreneurship, Financial Markets, International Business, Law School, Legislation, LLCs, Securities Regulation, Teaching | Permalink | Comments (0)
Thursday, July 16, 2015
Love him or hate him, you can’t deny that President Obama has had an impact on this country. Tomorrow, I will be a panelist on the local public affairs show for the PBS affiliate to talk about the President’s accomplishments and/or failings. The producer asked the panelists to consider this article as a jumping off point. One of the panelists worked for the Obama campaign and another worked for Jeb Bush. Both are practicing lawyers. The other panelist is an educator and sustainability expert. And then there’s me.
I’ve been struggling all week with how to articulate my views because there’s a lot to discuss about this “lame duck” president. Full disclosure—I went to law school with Barack Obama. I was class of ’92 and he was class of ’91 but we weren’t close friends. I was too busy doing sit-ins outside of the dean’s house as a radical protester railing against the lack of women and minority faculty members. Barack Obama did his part for the movement to support departing Professor Derrick Bell by speaking (at minute 6:31) at one of the protests. I remember thinking then and during other times when Barack spoke publicly that he would run for higher office. At the time a black man being elected to the president of the Harvard Law Review actually made national news. I, like many students of all races, really respected that accomplishment particularly in light of the significant racial tensions on campus during our tenure.
During my stint in corporate America, I was responsible for our company’s political action committee. I still get more literature from Republican candidates than from any other due to my attendance at so many fundraisers. I met with members of Congress and the SEC on more than one occasion to discuss how a given piece of legislation could affect my company and our thousands of business customers. My background gives me what I hope will be a more balanced set of talking points than some of the other panelists. In addition to my thoughts about civil rights, gay marriage, gun control, immigration reform, Guantanamo, etc., I will be thinking of the following business-related points for tomorrow’s show:
1) Was the trade deal good or bad for American workers, businesses and/or those in the affected countries? A number of people have had concerns about human rights and IP issues that weren’t widely discussed in the popular press.
2) Dodd-Frank turns five next week. What did it accomplish? Did it go too far in some ways and not far enough in others? Lawmakers announced today that they are working on some fixes. Meanwhile, much of the bill hasn’t even been implemented yet. Will we face another financial crisis before the ink is dried on the final piece of implementing legislation? Should more people have gone to jail as a result of the last two financial crises?
3) Did the President waste his political capital by starting off with health care reform instead of focusing on jobs and infrastructure?
4) Did the President’s early rhetoric against the business community make it more difficult for him to get things done?
5) How will the changes in minimum wage for federal contractors and the proposed changes to the white collar exemptions under the FLSA affect job growth? Will relief in income inequality mean more consumers for the housing, auto and consumer goods markets? Or has too little been done?
6) Has the President done enough or too much as it relates to climate change? The business groups and environmentalists have very differing views on scope and constitutionality.
7) What will the lifting of sanctions on Cuba and Iran mean for business? Both countries were sworn mortal enemies and may now become trading partners unless Congress stands in the way.
8) Do we have the right people looking after the financial system? Is there too much regulatory capture? Has the President tried to change it or has he perpetuated the status quo?
9) What kind of Supreme Court nominee will he pick if he has the chance? The Roberts court has been helpful to him thus far. If he gets a pick it could affect business cases for a generation.
10) Although many complain that he has overused his executive order authority, is there more that he should do?
I don’t know if I will have answers to these questions by tomorrow but I certainly have a lot to think about before I go on air. If you have any thoughts before 8:30 am, please post below or feel free to email me privately at email@example.com.
July 16, 2015 in Constitutional Law, Corporate Finance, Corporate Governance, Corporations, Current Affairs, Financial Markets, International Business, Marcia Narine, Securities Regulation, Television, White Collar Crime | Permalink | Comments (0)
Wednesday, July 1, 2015
As I earlier noted, on June 23rd, I moderated a teleconference on proposals to shorten the Section 13(d) reporting period, currently fixed by statute and regulation at 10 days. If you don't mind registering with Proxy Mosaic, you can listen to the program. The link is here.
The discussion was lively--as you might well imagine, given that one of the participants represents activist shareholders and the other represents public companies. A number of interesting things emerged in the discussion, many (most) of which also have been raised in other public forums on Schedule 13D, including those referenced and summarized here, here, and here, among other places.
- Exactly how does the Section 1d(d) reporting requirement protect investors or maintain market integrity or encourage capital formation? Or is it just a hat-tipping system to warn issuers about potential hostile changes of control, chilling the potential for the market for corporate control to run its natural course? Of course, the answer to many questions about Section 13(d) depends on our understanding of the policy interests being served. It's hard to tinker with the reporting system if we cannot agree on the objectives it seeks to achieve . . . . (Read the remaining bullets with this in mind.)
- We're not in the 1960s, 1970s, or 1980s any more. If market accumulations are deemed to present dangers to investors today (and that case needs to be made), why are they not just an accepted risk of public market participation? Shouldn't every investor know that market accumulations are a risk of owning publicly traded securities? And how does the reporting requirement really protect them from harm? Is this just over-regulation that treats investors as nitwits?
- Not all activist investors are the same. Some act or desire to act as a Section 13(d) group; others don't. Some seek effective or actual control of an issuer; some don't.
- Provisions within the Section 13(d) filing requirements interact. So, can we really talk about decreasing disclosure time periods without also talking about triggering thresholds and mandatory disclosure requirements?
- Why is 5% beneficial ownership the triggering threshold for reporting? What's the magic in that number--and if it were to be changed, should it be lower or higher?
- Schedule 13D is a disclosure form fraught with complexity. Many important judgment calls may have to be made in completing the required disclosures accurately and completely, depending on the circumstances. Is all this complexity needed? In particular, can the Item 4 disclosure requirement be simplified? And is the group concept necessary?
- What is the value, if any, in looking at the issue from a comparative global regulatory viewpoint? Toward the end of the call, international comparisons were increasingly being made and used as evidence that a change in U.S. regulation is needed or desirable. But are other markets and systems of regulation enough like ours for these comparisons to work? E.g., although other countries require Schedule 13D-like filings fewer days after attainment of a triggering threshold of ownership, does that mean we also should reduce the time period for mandatory disclosure here in the U.S.?
Lots of questions; I am beginning to think through answers. Regardless there's much food for thought here. Any reactions? What do you think, and why?
Wednesday, June 17, 2015
SEC Commissioner Kara M. Stein provided remarks at the Brookings Institute's 75th Anniversary of the Investment Company Act on Monday, June 15th. Now if that isn't an exciting introduction to a post, I just don't know what is. She addressed a topic that is of great interest to me and a focus of my research: retail/retirement investors. I tend to call them Citizen Shareholders in my writing, and it is sentiment shared by Commissioner Stein:
"By retail investor, I mean the everyday citizen or household that is investing – not institutional investors or pension funds. Eighty-nine percent of mutual fund assets are attributable to retail investors." (emphasis added).
In her remarks she detailed several troubling aspects of the mutual fund industry--a primary investment source for retail investors-- liquidity, leverage and disclosure. She also highlighted future SEC rule making initiatives related to these issues. For example, the Commission recently proposed new rules to enhance data reported to the Commission by registered funds. The proposed rule is available here (Download SEC proposed disclosure rules) and received comments can be tracked on the SEC's website here.
Noting that a major function of the 1940 Investment Act was transparency and accuracy through disclosures, she lamented the mission drift in the mutual fund industry which she described as:
"[T]he liquidity of registered funds is one area where it seems that regulation has drifted into “buyer beware.” A retail investor looks at a mutual fund and expects that he or she will be able to get money out of a fund very quickly if needed. A retail investor is generally not performing cash flow analyses on mutual funds to test their true liquidity."
SEC rules require redemption within 7 days and only 15% of mutual fund assets can be invested in illiquid funds. Bank loans and ETF funds, increasingly dramatically in popularity since 2009 (by over 400%) take over one month to settle and thus threaten the redemption rights and liquidity of funds in times of financial stress.
Additional "drift" comes from interpretation that the 15% threshold is at the time of purchase, not at the time of settlement so there is no true 15% threshold.
Promising high liquidity, which all mutual funds must do, on illiquid assets, that have not traditionally been a part of mutual funds, does not seem in keeping with the intent of the Investment Company Act.
Commissioner Stein identified a second problem: leverage. Another cornerstone principle in mutual fund regulation has been the requirement for relatively low leverage, as mandated by Section 18 of the Investment Company Act. Section 18 of the Investment Company Act requires low leverage with senior securities mandating a coverage ratio of 3:1 (300% asset coverage for senior securities). Commissioner Stein described the SEC's enforcement on leverage restrictions as "ad hoc" beginning in 1970 through the 30 subsequent no-action letters issued by the Commission.
Additionally Commissioner Stein addressed the rapid evolution and popularity of alternative mutual funds that attempt to mimic hedge fund returns based on mutual fund liquidity: propositions that she finds troubling.
Assets under management in alternative mutual funds have exploded in recent years. In 2008, there were approximately $46 billion in assets under management for these funds. By the end of 2014, the number had surged to over $311 billion in assets under management. This is an increase of over 575%.
[T]oday, alternative mutual funds promising the upside of hedge fund investments with the liquidity of traditional mutual funds are all the rage. I think that this trend should give everyone pause, and regulators and the public need to be asking questions about this development. ..... Should we consider regulating these funds differently than plain vanilla, traditional mutual funds?
Commissioner Stein's remarks highlight several areas in the mutual fund industry that are being reevaluated by the SEC and should be interested developments to watch if you are an attorney representing mutual fund companies and investment advisers, an academic or simply an average "retail" investor.
Wednesday, June 10, 2015
My recent scholarship (e.g., Outside Investor & Retirement Revolution) has focused on retirement and institutional investors. On the retirement investor side, I frequently address the impact that fees have on retirement investment returns, in part, as a critique of the opacity and lack of choice in the defined contribution plans (i.e., 401K and 457 plans). A focus on fee reduction (as well as simple diversification) has driven growth in the index and electronically-traded (ETF) funds, which charge lower fees because they are passively managed. These simple lessons in finance are not just relevant to the individual investor. Earlier this week, CalPERS announced that it would cut fund management fees by reducing (nearly in half) the number of active fund managers overseeing the investment of its over $300 billion in assets. The New York Times reported that:
Eliminating some external managers will help Calpers shore up its investments by reducing fees. Last year, it paid $1.6 billion in management fees, $400 million of which was a one-time payment for its real estate managers, a Calpers spokesman said.
With larger pools of assets shifted to the remaining asset managers, CalPERS should have more leverage to demand lower fees and cost savings of the chosen few. CalPERS, as a leader in the pension world, may pave the way to increased pressure on Wall Street fees by other pension funds.
Monday, June 8, 2015
I was reading an article on securities crowdfunding in China and came across this description of Chinese practice:
Generally, in China, equity-based crowdfunding capital-seekers rely on the strength of experienced, leading investors to advise “follow-up” investors in locating investment projects. Leading investors are usually professionals with rich experience in private offerings and label themselves as holding innovative techniques in investment strategies and possessing sound insights. On the contrary, follow-up investors usually do not have even basic financial skills, but they do ordinarily control certain financial resources for investment. When a leading investor selects a target investment project through an equity-based crowdfunding platform, the leading investor usually invests personal funds into the project. Crowdfunding capital- seekers then take advantage of the leading investor’s funds to market the project to follow-up investors.
(This is from a recent article by Tianlong Hu and Dong Yang, The People’s Funding of China: Legal Developments of Equity Crowdfunding-Progress, Proposals, and Prospects, 83 U. CIN. L. REV. 445 (2014).)
This is not unique to China. Private offerings to accredited investors in the United States often follow a similar path. Smaller investors are more likely to commit once a well-known, sophisticated investor has made a commitment. But the article made me wonder if we could use that structure to create a new securities offering exemption—one that responds to some of the policy concerns people have about the existing exemptions.
Most unregistered primary offerings of securities in the United States are pursuant to Rule 506 of Regulation D, the regulatory safe harbor for the private offering exemption in the Securities Act. Offerings pursuant to Rule 506, either by law [Rule 506(c)] or for practical reasons [Rule 506(b)], are limited to “accredited investors,” a defined term.
Many people have argued that the definition of accredited investor in Regulation D is too broad. Some of the investors covered by the definition are sophisticated institutional investors who clearly can fend for themselves. But the definition also includes many unsophisticated individuals who meet relatively low net worth and income requirements. Many of these investors, it is argued, cannot adequately evaluate the merits and risks of Rule 506 private offerings.
On the other hand, some people have complained that limiting these offerings to accredited investors privileges wealthy people at the expense of “ordinary” investors. Rich people have the opportunity to participate in these sometimes-lucrative offerings, but the rest of us cannot. That was one of the arguments for the not-yet-implemented section 4(a)(6) crowdfunding exemption added by the JOBS Act.
One way to resolve the tension between these two arguments, and deal with both concerns, would be to allow unsophisticated investors to invest in an offering only after a sophisticated investor has made a commitment. Ordinary investors might not be able to protect themselves, but they could free ride on the sophisticated investor’s evaluation of the offering.
We could create a new category of super-accredited investors, consisting only of institutions or individuals who clearly have the sophistication to protect themselves. Once one of those investors purchases a significant stake in an offering, other investors could purchase on the same terms.
For example, if Startup Corporation wanted to raise $50 million in an unregistered offering, it could first sell $10 million of the securities to a large venture capital firm. After that, it would be free to sell the remaining $40 million on the same terms to any investor, accredited or non-accredited, wealthy or not.
The lead investor’s evaluation of the offering wouldn’t completely protect the other investors. In particular, the lead investor’s tolerance for risk might be much higher than most ordinary investors’. But lead investor's evaluation would help protect against fraud and overreaching by the issuer.
The exemption would have to include some additional requirements to make sure that the other investors can reasonably rely on the lead investor’s decision to invest:
1. No conflicts of interest. The lead investor could not have a relationship to the issuer. Otherwise, the lead investor’s decision to invest might be due to that relationship, not because it believes the investment is a good one.
2. Minimum Investment. There should be a minimum investment requirement for the lead investor, to give the lead investor sufficient incentive to review the deal. To take an extreme example, a lead investor’s decision to invest $1 in a $50 million offering tells us little about the quality of the deal.
3. Same Terms. The lead investor must be investing on the same terms as the subsequent investors. The lead investor’s decision that an investment is worthwhile offers no protection at all to subsequent investors if those subsequent investors are getting a materially different deal.
4. Exit. If the lead investor’s decision to invest provides a signal to the other investors, so does the lead investor’s decision to exit the investment. At a minimum, the lead investor should have to disclose to the other investors when it sells. And, if the issuer is repurchasing the lead investor’s securities, we might want to impose a requirement that the issuer also offer to repurchase the securities of the other investors who purchased in the exempted offering.
This is just a sketch of what such an exemption would look like, about as far as one can go in a blog post. The proposed exemption would not be perfect. It wouldn’t guarantee that investors were getting a good deal, or even that the offering was not fraudulent. But even registration can’t do that. And I think the proposal is a nice compromise between investor protection and capital formation concerns.
Tuesday, June 2, 2015
Earlier I blogged (on the BLPB here and CLS Blue Sky Blog here) about my co-authored piece, Institutional Investing When Shareholders Are Not Supreme--a 30-year empirical and case review study analyzing institutional investors' response to constituency statutes as one lens into the question of institutional capital available for alternative purpose firms, like benefit corporations. On Monday, I wrote a short post on our article for the Harvard Law School Forum on Corporate Governance and Financial Reform, which is available here.
Wednesday, May 27, 2015
This week I have found myself reading the co-authored, empirical piece by C.N.V. Krishnan, Frank Partnoy, and Randall Thomas titled, Top Hedge Funds and Shareholder Activism. Through their sample they observe that top hedge funds have repetitional capital in that the market responds more positively to announcements by certain hedge funds with certain features, like a longer track record, larger assets under management and management participation through board of director seats. Its an interesting and insightful article on the role, and value, of hedge funds. The authors conclude that
The market appears to anticipate the superior performance of these top hedge funds even before announcement of intervention. Moreover, post-intervention target-firm operating performance associated with these top hedge funds is significantly superior to that of other hedge fund activists.
The focus on reputation reminded of Elisabeth de Fontenay's good work on reputation in private equity. Her article, Private Equity Firms as Gatekeepers, 33 Review of Banking & Financial Law 115-189 (2014). de Fontenay argues in her piece that:
private equity firms act as gatekeepers in the debt markets. As repeat players, private equity firms use their reputations with creditors to mitigate the problems of borrower adverse selection and moral hazard in the companies that they manage, thereby reducing creditors’ costs of lending to these companies. Private equity-owned companies are thus able to borrow money on more favorable terms than standalone companies, all else being equal. By acting as gatekeepers, private equity firms render the debt markets more efficient and provide their portfolio companies with an increasingly valuable borrowing advantage.
Updated to add: Frank Partnoy informed me that he and Elisabeth presented these 2 papers collaboratively to the Duke law faculty with each commenting on the other. This either proves once again that I have no original ideas OR this validates my insights about the overlapping observations in these papers.
Wednesday, May 20, 2015
Some of you may recall that I blogged last summer about a SEALS (Southeastern Association of Law Schools) discussion group on "publicness." That post can be found here. My contribution to the discussion group was part of a paper that then was a work-in-process for the University of Cincinnati Law Review that I earlier had blogged about here.
That paper now has been released in electronic and hard-copy format. I just uploaded the final version to SSRN. The abstract for the paper reads as follows:
Conceptions of publicness and privateness have been central to U.S. federal securities regulation since its inception. The regulatory boundary between public offerings and private placement transactions is a basic building block among the varied legal aspects of corporate finance. Along the same lines, the distinction between public companies and private companies is fundamental to U.S. federal securities regulation.
The CROWDFUND Act, Title III of the JOBS Act, adds a new exemption from registration to the the Securities Act of 1933. In the process, the CROWDFUND Act also creates a new type of financial intermediary regulated under the Securities Exchange Act of 1934 and amends the 1934 Act in other ways. Important among these additional changes is a provision exempting holders of securities sold in crowdfunded offerings from the calculation of shareholders that requires securities issuers to become reporting companies under the 1934 Act.
This article attempts to shed more light on the way in which the CROWDFUND Act, as yet unimplemented (due to a delay in necessary SEC rulemaking), interacts with public offering status under the 1933 Act and public company status under the 1934 Act. Using the analytical framework offered by Don Langevoort and Bob Thompson, along with insights provided in Hillary Sale’s work, the article briefly explores how the CROWDFUND Act impacts and is impacted by the public/private divide in U.S. securities regulation. The article also offers related broad-based observations about U.S. securities regulation at the public/private divide.
I hope that you are motivated to read the article--and that you get something out of it if you do read it. The thinking involved in creating the article was often challenging (even if the expressed ideas may not reflect or meet that challenge). Yet, writing the article, in light of the super work already done by Don Langevoort, Bob Thompson, and Hillary Sale, was joyful and illuminating for me in many ways.
I often say that I stand on the shoulders of giants in my teaching and scholarship. That was transparently true in this case. If only all academic research and writing could be so rewarding.
Thursday, May 14, 2015
Last week, I looked lovingly at a picture of a Starbucks old-fashioned grilled cheese sandwich. It had 580 calories. I thought about getting the sandwich and then reconsidered and made another more “virtuous” choice. These calorie disclosures, while annoying, are effective for people like me. I see the disclosure, make a choice (sometimes the “wrong” one), and move on.
Regular readers of this blog know that I spend a lot of time thinking about human rights from a corporate governance perspective. I thought about that uneaten sandwich as I consulted with a client last week about the California Transparency in Supply Chains Act. The law went into effect in 2012 and requires retailers, sellers, and manufacturers that exceed $100 million in global revenue that do business in California to publicly disclose the degree to which they verify, audit, and certify their direct suppliers as it relates to human trafficking and slavery. Companies must also disclose whether or not they maintain internal accountability standards, and provide training on the issue in their direct supply chains. The disclosure must appear prominently on a company’s website, but apparently many companies, undeterred by the threat of injunctive action by the state Attorney General, have failed to comply. In April, the California Department of Justice sent letters to a number of companies stating in part:
If your company has posted the required disclosures on its Internet website or, alternatively, takes the position that it is not required to comply with the Act, we request that – within 30 days of this letter’s date – you complete the form accessible at http://oag.ca.gov/sb657 and provide this office with (1) the web links (URLs) to both your company’s Transparency in Supply Chains Act disclosures and its homepage containing a link to the disclosures; and/or (2) information demonstrating your company is not covered by the Act.
There are no financial penalties for noncompliance. Rather, companies can face reputational damage and/or an order from the Attorney General to post something on their websites. A company complies even if that disclosure states that the company does no training, auditing, certification, monitoring or anything else related to human trafficking or slavery. The client I spoke to last week is very specialized and all of its customers are other businesses. Based on their business profiles, those “consumers” are not likely to make purchasing decisions based on human rights due diligence. I will be talking to another client in a few weeks on the California law. That client is business to consumer but its consumers specifically focus on low cost—that’s the competitive advantage for that client. Neither company-- the B2B nor the B2 (cost conscious)C-- is likely to lose significant, if any business merely because they don’t do extensive due diligence on their supply chains. Similarly, Apple, which has done a great job on due diligence for the conflict minerals law will not set records with the sale of the Apple Watch because of its human rights record. I bet that if I walked into an Apple Store and asked how many had seen or heard of Apple’s state of the art conflict minerals disclosure, the answer would be less than 1% (and that would be high).
People buy products because they want them. The majority of people won’t bother to look for what’s in or behind the product, although that information is readily available through apps or websites. If that information stares the consumer in the face (thanks Starbucks), then the consumer may make a different choice. But that assumes that (1) the consumer cares and (2) there is an equally viable choice.
To be clear, I believe that companies must know what happens with their suppliers, and that there is no excuse for using trafficked or forced labor. But I don’t know that the use of disclosures is the way to go. Some boards will engage in the cost benefit analysis of reputational damage and likelihood of enforcement vs cost of compliance rather than having a conversation about what kind of company they want to be. Many board members will logically ask themselves, “should we care if our customers don’t care?”
My most recent law review article covers this topic in detail. I’ll post it in the next couple of weeks because I need to revise it to cover the April development on the California law, and the EU’s vote on May 19 on their own version of the conflict minerals law. In the meantime, ignorance is bliss. I’m staying out of Starbucks and any other restaurant that posts calories- at least during the stressful time of grading exams.
May 14, 2015 in Corporate Finance, Corporate Governance, Corporate Personality, Corporations, CSR, Current Affairs, Ethics, International Business, Law Reviews, Marcia Narine, Securities Regulation | Permalink | Comments (3)
Wednesday, May 6, 2015
Monday, I had the privilege of moderating a discussion on structuring merger and acquisition transactions that I had organized as part of a continuing legal education program for the Tennessee Bar Association. Rather than doing the typical comparison/contrast of different business combination structures (with charts, etc.), I organized the hour-long discussion around the banter that corporate/securities and tax folks have in structuring a transaction. We used the terms of a proposed transaction (an LLC business being acquired by a public corporation) as a jumping-off point.
The idea for the format came from a water cooler conversation--literally--among me (in the role of a corporate/securities lawyer), one of my property lawyer colleagues, and one of my tax lawyer colleagues. The conversation started with a question my property law colleague had about the conveyance of assets in a merger. I told him that mergers are not asset conveyance transactions but, rather, statutory transactions that have the effects provided for in the statute, which include a vesting of assets in the surviving corporation. I told him that I call this "merger magic." I showed him Section 259(a) of the Delaware General Corporation Law:
When any merger or consolidation shall have become effective under this chapter, . . . all property, real, personal and mixed, and all debts due to any of said constituent corporations on whatever account, as well for stock subscriptions as all other things in action or belonging to each of such corporations shall be vested in the corporation surviving or resulting from such merger or consolidation . . . .
We discussed the possibility of an assignment/transfer of assets by operation of law under that provision and more generally under Delaware law in connection with different types of mergers, including recent case law regarding reverse triangular mergers. Ultimately, my property law colleague decided that a direct merger involved an asset sale by the target entity and a purchase transaction by the surviving corporation, as a matter of property law, notwithstanding my "merger magic" explanation I was forwarding as a descriptor under state corporate law.
The tax guy thought all this (both descriptions of a merger) was balderdash. These descriptions were too complex and stilted for his taste. Not to be outdone, he offered that all merger and acquisition transactions are either asset sales or sales of equity. At least, he allowed, that's how federal income tax law looks at them . . . . I told him that asset and equity sale transactions are joined by mergers (direct, reverse triangular, and forward triangular) and share exchange transactions (which are also statutory transactions, available in Tennessee and other Model Business Corporation Act states, but not available in Delaware) in the corporate lawyer's business combination toolkit. I also noted that federal securities law voting and reporting requirements work off these different corporate law descriptors.
Fascinating! Three lawyers, three different conceptions of business combination transactions. The moderated discussion on Monday was, in effect, an attempt by me to recreate, albeit in a different form, parts of that conversation. The discussion was, in my view, decently successful in achieving its limited purpose in the program. Nevertheless, I really wish I had a transcription of that original conversation by the water cooler. That was truly priceless . . . .
Wednesday, April 29, 2015
Perhaps this post would have been timelier before the spring submission cycle, but hopefully it will be helpful in framing title options for pieces being developed this summer. One of the many benefits of co-authorship is learning substantive and procedural knowledge from your collaborators. On a recent article, I worked with three economists who have different skill sets, perspectives, and discipline standards. When we were trying to finalize our title, we came up with several different categories or types of article titles—a framework that I will utilize again in the future and which I am sharing with you today. We selected the “themed” based title for our article, Institutional Investing When Shareholders Are Not Supreme, and a play on words, Institutional Investors’ Appetite for Alternatives, for a shorter piece appearing on Columbia Blue Sky Blog.
SOBER: Institutional Investing after Constituency Statutes
QUESTION: Does Changing Shareholder Value Maximization Standards Change Institutional Investors’ Behavior?
CONTRAST: Institutional Investors Behavior Before and After Constituency Statutes
PLAY ON WORDS: Appetite for Alternatives: Institutional Investors’ Behavior in the Fact of Shareholder Value Maximization Pressures
FORWARD THINKING: What Does Institutional Investors Behavior after Constituency Statutes Tell Us Regarding Benefit Corporations?
HISTORICAL: The Changing Landscape of Directorial Duties: Constituency States to Alternative Purpose Firms
SLATE/OP-ED: Who’s Afraid of Alternative Purpose Firms?
THEME: Agency Investing When Shareholders Are Not Supreme
For those interested and perhaps to put the title options in perspective, here is a little background on our article, Institutional Investing When Shareholders Are Not Supreme. In an earlier BLPB post, I linked to our short piece appearing in Columbia Blue Sky Blog. Our article examines institutional investors’ response to corporate director duty changes embodied in constituency statutes and links our findings to current questions of institutional investors’ potential acceptance of alternative business entities. Our paper surveys the 30+ year literature debate on directors’ duties to maximize shareholder value, a case law analysis of constituency statute litigation, and an empirical study (utilizing a difference-in-differences approach) of institutional investors’ divestment of stock held in companies incorporated in constituency statute jurisdictions. We first verified that courts enforced constituency statutes, or in other words, that constituency statutes represented at least a small change to directors’ legal duties. In our empirical section, we found no statistically significant departure of institutional investors after the passage of constituency statutes, focusing specifically on institutions with high fiduciary duties. If institutional investors had fled constituency statute investments, which are subject to lower director duties changes than with say benefit corporations, then there would be grounds to think that institutional investors would not invest in alternative purpose firms. Finding no such negative reaction to constituency statutes does not conclusively indicate institutional investor’s acceptance of alternative purposes firms, especially given the greater deviation from shareholder value maximization by requiring (rather than permitting) directors to consider nonshareholder interests codified in benefit corporation statutes. It does suggest, however, some latitude for institutional investors to consider alternative purpose firm investments without running afoul of fiduciary duties. If I were explaining the results to a student, I would say that our study could have produced strong evidence shutting the door on this possibility, but instead the findings leave the door open. This paper is valuable in the absence of direct information on the question, and will certainly give way to findings utilizing empirical data directly on point with publicly-traded benefit corporations and/or B Corporations.
Monday, April 27, 2015
The following guest blog post on my recent article, Institutional Investing When Shareholders Are Not Supreme, is available at Columbia's Blue Sky Blog discussing institutional investors' attitudes towards alternative business forms and similar issues raised by Etsy's IPO.
Wednesday, April 8, 2015
For thirty years, I have had a pet peeve about the media's routine reporting on mergers and acquisitions. I have kept this to myself, for the most part, other than scattered comments to law practice colleagues and law students over the years. Today, I go public with this veritable thorn in my side.
From many press reports (which commonly characterize business combinations as mergers), you would think that every business combination is structured as a merger. I know I am being picky here (since there are both legal and non-legal common parlance definitions of the verb "merge"). But a merger, to a business lawyer, is a particular form of business combination, to be distinguished from a stock purchase, asset purchase, consolidation, or statutory share exchange transaction.
The distinction is meaningful to business lawyers for whom the implications of deal type are well known. However, imho, it also can be meaningful to others with an interest in the transaction, assuming the implications of the deal structure are understood by the journalist and conveyed accurately to readers. For instance, the existence (or lack) of shareholder approval requirements and appraisal rights, the need for contractual consents, permit or license transfers or applications, or regulatory approvals, the tax treatment, etc. may differ based on the transaction structure.
Monday, April 6, 2015
Yesterday was the third anniversary of the JOBS Act. President Obama signed it into law on April 5, 2012. The JOBS Act, as regular readers of this blog know, requires the SEC to adopt rules to enact an exemption for crowdfunded securities offerings. The statutory deadline for the SEC to do so was December 31, 2012. The SEC proposed the required rules on October 23, 2013, but it still has not adopted them.
It is now
- 1096 days since Congress passed the JOBS Act
- 826 days since the deadline for the SEC to adopt the required rules
- 530 days since the SEC proposed the rules
. . . and still no crowdfunding exemption.
If I treated my tax returns like the SEC has treated the crowdfunding rules, I would be in jail.
SEC Chair Mary Jo White has recently said that the SEC hopes to finalize the rules by the end of the year. I certainly hope so.
Thursday, April 2, 2015
In connection with the current legislative debate on benefit corporations in Tennessee (which has been gathering momentum since I last wrote on the topic), I have repeatedly asked about the impetus for the bill. Of course, there is the obvious "push" for benefit corporation legislation by the B Lab folks, who have gotten the ear of folks at the Chamber, convincing them that the legislation is needed in Tennessee to protect social enterprise entities from the application of a narrow version of the shareholder wealth maximization norm (a conclusion that I dispute in my earlier post). But what else? What real parties in interest in Tennessee, if any, have expressed a desire that Tennessee adopt this form of business entity?
There is anecdotal information from one venture attorney that some Tennessee entrepreneurs have indicated a preference for the benefit corporation form and have specifically requested that their business be organized as a Delaware benefit corporation. Leaving aside the Delaware versus Tennessee question, why are these entrepreneurs looking to organize their businesses as benefit corporations? Where does this idea come from?
Earlier this week I went to a really useful workshop conducted by the Venture Law Project and David Salmon entitled "Key Legal Docs Every Entrepreneur Needs." I decided to attend because I wanted to make sure that I’m on target with what I am teaching in Business Associations, and because I am on the pro bono list to assist small businesses. I am sure that the entrepreneurs learned quite a bit because I surely did, especially from the questions that the audience members asked. My best moment, though was when a speaker asked who knew the term "right of first refusal" and the only two people who raised their hands were yours truly and my former law student, who turned to me and gave me the thumbs up.
Their list of the “key” documents is below:
1) Operating Agreement (for an LLC)- the checklist included identity, economics, capital structure, management, transfer restrictions, consent for approval of amendments, and miscellaneous.
2) NDA- Salmon advised that asking for an NDA was often considered a “rookie mistake” and that venture capitalists will often refuse to sign them. I have heard this from a number of legal advisors over the past few years, and Ycombinator specifically says they won't sign one.
3) Term Sheets- the seminar used an example for a Series AA Preferred Stock Financing, which addressed capitalization, proposed private placement, etc.
4) Independent Contractor Agreement- the seminar creators also provided an IRS checklist.
6) Employment Agreement- as a former employment lawyer, I would likely make a lot of tweaks to the document, and vey few people have employment contracts in any event. But it did have good information about equity grants.
7) Convertible Promissory Note Purchase Agreement- here's where the audience members probably all said, "I need an attorney" and can't do this from some online form generator or service like Legal Zoom or Rocket Lawyer.
8) Stock Purchase Agreement- the sample dealt with Series AA preferred stock.
9) IRS 83(b) form- for those who worry that they may have to pay taxes on "phantom income" if the value of their stock rises.
10) A detailed checklist dealing with basic incorporation, personnel/employee matters, intellectual property, and tax/finance/administration with a list of whether the responsible party should be the founders, attorney, officers, insurance agent, accountant, or other outside personnel.
What’s missing in your view? The speakers warned repeatedly that business people should not cut and paste from these forms, but we know that many will. So my final question- how do we train future lawyers so that these form generators and workshops don't make attorneys obsolete to potential business clients?
Wednesday, April 1, 2015
On March 25, 2015, the SEC Commissioners unanimously adopted final rules amending Regulation A, effective in 60 days, extending an existing exemptions for smaller issues as required under Title IV of the Jumpstart Our Business Startups (JOBS) Act. SEC information on the new regulations are available here and commentary is available here.
The SEC Release states that:
The updated exemption will enable smaller companies to offer and sell up to $50 million of securities in a 12-month period, subject to eligibility, disclosure and reporting requirements.
The final rules, often referred to as Regulation A+, provide for two tiers of offerings: Tier 1, for offerings of securities of up to $20 million in a 12-month period, with not more than $6 million in offers by selling security-holders that are affiliates of the issuer; and Tier 2, for offerings of securities of up to $50 million in a 12-month period, with not more than $15 million in offers by selling security-holders that are affiliates of the issuer. Both Tiers are subject to certain basic requirements while Tier 2 offerings are also subject to additional disclosure and ongoing reporting requirements.
The final rules pre-empt states from reviewing and approving Tier 2 offerings to "qualified purchasers." For a further discussion on merit review and preemption, see The SEC's New 'Regulation A+' and the States' 'M' Word, posted on JDSupra.
Supporters have commended the change as decreasing reliance on costly gate keepers to capital such as investment bankers, and facilitating an easier path to raise capital by allowing qualifying companies to offer their stock directly to the public. Initial reaction quotes in the alternative finance world are available here.
Friday, March 27, 2015
After teaching my early morning classes, I will spend the rest of the day at Vanderbilt Law School for their Developing Areas of Capital Market and Federal Securities Regulation Conference.
This is Vanderbilt's 17th Annual Law and Business Conference and they have quite the impressive lineup, including Commissioner Daniel Gallagher, Jr. of the U.S. Securities and Exchange Commission.
I am grateful to the Vanderbilt faculty members who invited me to this event and others like it. Vanderbilt is only about 1 mile from Belmont and I have truly enjoyed getting to know some of the Vanderbilt faculty members and their guest speakers.