Corporate finance in a nutshell 3rd edition

OVERVIEWPublicly-traded companies have their securities—most typically shares of common stock —listed and traded on an organized stock exchange.. The first time a company offers and sell

WEST ACADEMIC PUBLISHING’S

LAW SCHOOL ADVISORY BOARD

JESSE H CHOPERProfessor of Law and Dean Emeritus,University of California, Berkeley

JOSHUA DRESSLERProfessor of Law, Michael E Moritz College of Law,

The Ohio State University

YALE KAMISARProfessor of Law Emeritus, University of San Diego

Professor of Law Emeritus, University of Michigan

MARY KAY KANEProfessor of Law, Chancellor and Dean Emeritus,

University of California,Hastings College of the LawLARRY D KRAMERPresident, William and Flora Hewlett Foundation

JONATHAN R MACEYProfessor of Law, Yale Law School

ARTHUR R MILLERUniversity Professor, New York UniversityFormerly Bruce Bromley Professor of Law, Harvard University

GRANT S NELSONProfessor of Law, Pepperdine UniversityProfessor of Law Emeritus, University of California, Los Angeles

A BENJAMIN SPENCER

Earle K Shawe Professor of Law,

University of Virginia School of Law

JAMES J WHITERobert A Sullivan Professor of Law Emeritus,

University of Michigan

The publisher is not engaged in rendering legal or other professional advice, and thispublication is not a substitute for the advice of an attorney If you require legal or otherexpert advice, you should seek the services of a competent attorney or otherprofessional

Nutshell Series, In a Nutshell and the Nutshell Logo are trademarks registered in the U.S.Patent and Trademark Office

© 2004 West, a Thomson business

© 2011 Thomson Reuters

© 2015 LEG, Inc d/b/a West Academic

444 Cedar Street, Suite 700

To my father, Mike, who inspired my interest in business and finance

Corporate finance is unique in that it is an amalgam of substantive disciplines Thosewith even a tangential familiarity with it are likely aware of the crucial role thatmathematics and accounting play Indeed, it is the math and accounting aspects of acorporate finance course that frequently frighten law students away from taking it.Accordingly, Part 1 makes a serious attempt to explain these concepts in a straight-forward, plain English manner.

Corporate finance, however, is much more than math and accounting, as Parts 2through 3 make clear Under the umbrella of corporate finance falls a whole host of otherdisciplines Especially important is the subject of economics, particularly macroeconomics.Changes in fiscal and monetary policy at the national level directly impact economicgrowth and the interest rate environment, while indirectly affecting corporate growth andearnings Corporations attempt to navigate the economic

While this book is entitled Corporate Finance, much of what it contains applies tobusiness entities other than corporations All businesses, regardless of their form, needcapital to survive and grow While the capital structure of these other entities may differfrom that of the corporation, the ways in which they pursue and, ultimately, raise capitalare similar

For an expanded version of this book in a fully footnoted format, see CORPORATE FINANCE

(HORNBOOK SERIES), ISBN 978-0-314-28964-3

JEFFREY J HAAS

New York, New York

September 1, 2015

E-mail: jeffrey.haas@nyls.edu

First Edition (2004)

Many provided significant assistance in the preparation of this book I would like tothank my colleagues at New York Law School, in general, and Rick Matasar and GraceLee, in particular In addition, a great deal of thanks go to Larry Cunningham, RonSarubbi, Brent Friedman, David Dami and Steve Howard for their substantive

VIII

comments and support Lastly, I tip my hat to my “cocky and funny” researchassistants, Stephen Ginsberg, Sagi Goldberg, Jon Macy, Danny Rehns, Heather Rutman,Rich Rybak, Mariam Sanni and Dimitra Tzortzatos, for their invaluable assistance anddedication

ABBREVIATIONS

_

X

XI

B Exchange Act Reporting Requirements

C Pros and Cons of “Going Public”

(2) Control and Voting

(3) Stock Ownership and Transfer

a Forced Resale Provisions

B Role of the Accountants

§ 5 Fundamental Financial Statements

A Balance Sheet

(1) Introduction

(2) Components

a Assets

b Liabilities

c Shareholders’ Equity

(3) Limitations of the Balance Sheet

(4) Working with the Balance Sheet

C Statement of Changes in Shareholders’ Equity

D Statement of Cash Flows

(1) Introduction

(2) Composition

(3) Measures of Liquidity

(4) Startup Companies and the “Burn Rate”

Chapter 3 Time Value of Money

B The Fed’s Role in the Economy

(1) The Federal Funds Rate of Interest

(2) Open Market Operations

(3) Reserve Requirements

(4) Discount Rate

(5) The Financial Crisis of 2008 and Expanded Fed Powers

§ 9 Key Interest Rates

A U.S Treasury Instruments

C Using PV to Determine Rate of Return

Chapter 5 Bond Valuation

§ 13 Inverse Relationship Between Interest Rates and Bond Values

A Lower Valuation When Interest Rates Increase

B Higher Valuation When Interest Rates Decrease

XVI

C Predicting Sensitivity

(1) Sensitivity to Changing Interest Rates

(2) Sensitivity to Changes in an Issuer’s Creditworthiness

§ 14 Calculating Yield to Maturity

§ 15 Zero Coupon Bonds

§ 16 Bond Market Pricing Terminology

Chapter 6 Valuing Companies

§ 17 Balance Sheet-Based Valuation Methods

A Book Value

B Adjusted Book Value

C Net Asset Value

§ 18 Profit and Loss Statement-Based Valuation Methods

§ 19 Cash Flow-Based Valuation Methods

A Dividend Discount Method (DDM)

B Discounted Cash Flow Method (DCF)

Chapter 7 Efficient Capital Market Hypothesis (ECMH)

§ 20 ECMH in the Courtroom

Chapter 8 Valuation in the Courtroom

§ 21 Appraisal or Dissenters’ Rights

§ 24 Valuation in Other Legal Contexts

PART 2 RISK AND RETURN Chapter 9 Measures of Risk

D CAPM Assumptions and Empirical Evidence

Chapter 10 Derivative Instruments

§ 27 Definition

§ 28 Speculation Versus Risk Reduction

§ 29 The Building Blocks of Derivatives

A Options

(6) Physical Settlement and Cash Settlement

(7) Setting Option Premiums

(8) Reducing Risk Through Options

(9) Distinction from Warrants

(3) Distinction from Options

(4) Counterparty Credit Risk

d Key Definitions and Definitional Matters

e Clearing, Trading and Reporting

f Mandatory Trade Execution Requirements for Swaps

g Business Conduct Requirements

h Capital and Margin Requirements

i Position Limits and Large Swap Trader Reporting

j The Swaps Pushout Rule and Federal Assistance

§ 30 Interpreting the Derivatives Contract

PART 3 CLAIMANTS ON THE ENTERPRISE Chapter 11 Debt Holders

§ 31 The Use of Leverage (Debt) and Its Impact on Capital Structure

A Overview

B Pure Leverage Effect

C Optimal Level of Debt

(2) Qualification of the Indenture

(3) Trustee Eligibility Requirements

(4) Conflicts of Interest

(5) Mandatory and Permissive Indenture Provisions

(6) Legal Actions by Debt Holders

C Duties and Obligations of a Trustee Under the TIA

(1) Pre-Default Versus Post-Default

(2) Limitations on a Trustee’s Liability

§ 34 Key Contractual Terms and Protective Provisions

A The Promise to Pay and Provisions Designed to Support It

d Merger, Consolidation or Sale of All or Substantially All of the Issuer’s Assets

e Dividend and Other Payment Restrictions on Subsidiaries

f Limitation on the Sale or Issuance of Stock of Subsidiaries

g Transactions with Affiliates

a Default in the Payment of Interest or Principal

b Breach of a Covenant, Warranty or Representation

c Bankruptcy/Insolvency

d Cross-Default

(2) Acceleration

§ 35 Legal Treatment of Debt Holders

b Insolvency Entitles Creditors to Sue Derivatively

c Exculpatory Charter Provision Works Against Creditors

B Implied Covenant of Good Faith and Fair Dealing

(3) Absolute Priority Rule and “Cramdown”

(4) New Value Exception

(5) Treatment of Secured Creditors

(6) Equitable Subordination

Chapter 12 Preferred Stockholders

§ 37 Overview

§ 38 Similarity to Debt and Equity

§ 39 The Preferred Stock Contract

XXIII

§ 40 Characteristics of Preferred Stock

A Preference Rights

(1) Dividend Preference

(2) Liquidation Preference

B Noncumulative and Cumulative Preferred Stock

(1) Noncumulative Dividend Rights

(2) Cumulative Dividend Rights

C General Terms of a Preferred Stock Contract

(1) Number of Shares and Price per Share

(2) Yield

(3) Subordination

(4) Voting Rights

a Generally

b Contractual Right to Elect Directors

c Contractual Right to Approve Mergers and Related Transactions(5) Redemption Provisions

(9) Affirmative and Negative Covenants

§ 41 Fiduciary and Good Faith Duties

Chapter 13 Convertible Security Holders

§ 42 Economics of Convertible Securities

A Generally

XXIV

B Investment Value and Conversion Value

C Calling the Security

D Justifications for Convertible Securities

§ 43 Protecting the Conversion Right

Chapter 14 Common Stockholders

§ 44 Characteristics of Common Stock

§ 45 Corporate Governance and Fiduciary Protections

(1) The Duty of Care

(2) The Duty of Loyalty

(3) The Duty of Good Faith

§ 46 Declaration and Payment of Dividends and Distributions

(2) Dividend Policy Theories

a The Traditional Theory

b The Irrelevance Theory

c The Tax Preference Theory

(3) Dividend Payment Process

D Non-Cash Dividends and Stock Splits

(1) Generally

(2) Stock Dividends

(3) Stock Splits

a Forward Stock Splits

b Reverse Stock Splits

(4) Distinguishing Stock Dividends from Stock Splits on the Balance Sheet

a Stock Dividends

b Stock Splits

E Board’s Discretion in Paying Dividends

§ 47 Dilution and Preemptive Rights

A Value Dilution

B Voting Dilution and Preemptive Rights

§ 48 Stock Repurchases and Redemptions

A Overview

XXVI

B Stock Repurchases

(1) Generally

(2) Repurchases by Privately-Held Companies

(3) Repurchases by Publicly-Traded Companies

Exhibit I Future Value and Present Value Factor Tables

Exhibit II Problems Involving Future and Present Value

INDEX

TABLE OF CASESReferences are to Pages

_

AG Capital Funding Partners, L.P v State St Bank & Trust Co………302

Air Products and Chemicals, Inc v Airgas, Inc………495

Alaska Plastics v Coppock ………193

Allen v Biltmore Tissue Corp………184

Anadarko Petroleum Corp v Panhandle Eastern Corp………336, 450, 511, 575

Applebaum v Avaya ………539

Arnolds v Phillips ………389

Aronson v Lewis ………481

Aspen Advisors LLC v United Artists Theatre Co………470

Bank of America Nat’l Trust v 203 North LaSalle Street Partnership ………386

Baron v Allied Artists Pictures Corp………412, 544

Basic, Inc v Levinson ………163

Benjamin v Diamond (In re Mobile Steel Co.) ………389

Blasius Industries, Inc v Atlas Corp………477, 500, 569

Bluebird Partners, L.P v First Fid Bank, N.A., New Jersey ………301

Brane v Roth ………262, 480

Brooks v Weiser ………359

Bunting Bearings, In re ………380

Burton v Exxon Corp………410

Campbell v Hudson & Manhattan Railroad Co………356

Caremark Int’l Inc Derivative Litigation, In re ………478, 480, 507

Case v Los Angeles Lumber Products Co………385, 386

Cavalier Oil Corp v Harnett ………176

Cede & Co v Technicolor, Inc………180, 208

Chrysler, In re ………370, 371, 372

Cofman v Acton Corp………460

Committee of Equity Sec Holders v Lionel Corp (In re Lionel Corp.) ………373, 374Cooper v Pabst Brewing Co………171

Corporate Property Associates 14 Inc v CHR Holding Corp………455

XXVIII

Costello v Fazio ………389

Credit Lyonnais Bank Nederland, N.V v Pathe Communications Corp………337

Delaware Open MRI Radiology Assocs., P.A v Kessler ………180

Dodge v Ford Motor Co………546

Donahue v Draper………145, 190

Donahue v Rodd Electrotype Co………23, 560

Dunlap v State Farm Fire & Cas Co………345

Elliott Associates, L.P v Avatex Corporation ………417, 567

Elliott Associates, L.P v J Henry Schroder Bank & Trust Co………302

Elmira Litho, Inc., In re ………388

Eshleman v Keenan ………545

Eternity Global Master Fund Ltd v Morgan Guaranty Trust Co………260

Evangelista v Holland ………185, 186

F.B.I Farms, Inc v Moore………32

Farmers’ Loan & Trust Co v Northern Pacific Railroad Co………357

Federal United Corp v Havender ………565

FGC Holdings Ltd v Teltronics, Inc………413, 415

Fliegler v Lawrence ………485

Fox v 7L Bar Ranch Co………190

Francis v United Jersey Bank ………478, 480

Gabelli & Co., Inc Profit Sharing Plan v Liggett Group, Inc………545

Gantler v Stevens ………481

Garbayo v Chrome Data Corp………362

Geyer v Ingersoll Publications Co………338

Glazer v Pasternak ………415, 417

Gonsalves v Straight Arrow Publishers, Inc………174

Gottlieb v Heyden Chem Corp………485

Green v Hamilton Int’l Corp………337

Guth v Loft ………490

Guttmann v Illinois Central Railroad………402

Haft v Haft ………25

Halliburton Co v Erica P John Fund, Inc………166

Harbinger Capital Partners Master Fund I, Ltd v Granite Broadcasting Corp………395,397

Indiana State Police Pension Trust v Chrysler LLC………370, 371, 372

International Swaps and Derivatives Association v U S Commodity Futures TradingCommission ………256

Isquith v Caremark Int’l, Inc………574

Jedwab v MGM Grand Hotels, Inc………428, 430

John T Callahan & Sons, Inc v Dykeman Elec Co………518

Joy v North ………203, 478, 481

Kahm & Nate’s Shoes No 2, Inc v First Bank of Whiting ………386

Kansas City Terminal Ry v Central Union Trust Co………385

Katz v Oak Industries ………345, 348

Kaufman v i-Stat Corp………165, 166

Kemp & Beatley, Inc., Matter of ………193

LC Capital Master Fund, Ltd v James ………434

Leader v Hycor Inc………538

Leeds & Lippincott Co v Nevius ………405

Lehman Brothers Holdings Inc., In re ………263

Lewis v S.L.&E., Inc………485

LNC Investments, Inc v First Fidelity Bank, N.A………301

Lohnes v Level 3 Comm., Inc………460

Lyondell Chem Co v Ryan ………509

M.G Bancorporation, Inc v Le Beau………171, 172, 177, 179

Meda AB v 3M Co………351

Meinhard v Salmon ………23

Mercier v Inter-Tel (Delaware), Inc………571

Metlyn Realty Corp v Esmark, Inc………182

Metropolitan Life Ins Co v RJR Nabisco, Inc………124, 309

MM Companies, Inc v Liquid Audio, Inc………500

Morgan Stanley v Archer Daniels Midland Co………327

Moskowitz v Bantrell ………544

Nardini v Nardini ………196, 198

National Century Fin Enterprises, Inc., In re ………343

Nichols Construction Corp v St Clair ………186

Noland, United States v………389

North American Catholic Educational Programming Foundation v Gheewalla ………338,360

Northeast Harbor Golf Club, Inc v Harris ………490, 491

XXX

Norwest Bank Worthington v Ahlers………386

Omnicare, Inc v NCS Healthcare, Inc………499

Pace Photographers, Ltd., In the Matter of ………195, 196

Pasternak v Glazer ………415

Pepper v Litton ………338, 390

Production Resources Group, L.L.C v NCT Group, Inc………343

Pueblo Bancorporation v Lindoe, Inc………174, 175

Quinn v Stuart Lakes Club, Inc………30

Rabinowitz v Kaiser-Frazer Corp………356

Rafe v Hindin ………30

Rapid-American Corp v Harris ………174

Reiss v Financial Performance Corp………458

RSL Communications PLC v Bildirici ………342

Rudbart v North Jersey District Water Supply Commission ………325Sanders v Cuba Railroad Co………405

SEC v WorldCom, Inc………384, 385

Sharon Steel Corp v Chase Manhattan Bank ………318, 326

Simons v Cogan ………335, 355, 450

Sinclair Oil Corp v Levien ………482, 545

Situation Mgt Systems, Inc., In re ………387

Smith v Van Gorkom ………480, 481

Spiegel v Buntrock ………482

Stone v Ritter………507

Stoumbos v Kilimnik ………390

Stroud v Grace ………571

Sunstates Corp Shareholder Litigation, In re ………426

Taylor v Standard Gas & Elec Co………388

Teltronics Services, Inc., In the Matter of ………391

Toner v Baltimore Envelope Co………559

Trados Inc Shareholder Litigation (Trados I), In re………397

Trados Inc Shareholder Litigation, In re ………397

Unitrin, Inc v American General Corp………482, 493, 494

Unocal Corp v Mesa Petroleum Co………481, 482, 493, 500

USDigital, Inc., In re ………343

Van Gemert v Boeing Co………423, 452

Wabash Railway Co v Barclay ………403

Warner Communications, Inc v Chris-Craft Industries ………418, 565Watt & Shand, In re ………136

Weinberger v UOP, Inc………172, 179, 378

XXXI

Whitehorn v Whitehorn Farms, Inc………189

Wilkes v Springside Nursing Home, Inc………560

Wood v Coastal States Gas Corp………468

Zeffiro v First Pennsylvania Banking & Trust Co………300, 301

Zenith Electronics Corp., In re ………156, 158, 375

CORPORATE FINANCE

IN A NUTSHELL®

THIRD EDITION

1

CHAPTER 1 DISTINCTIONS BETWEEN PUBLICLY-TRADED AND

PRIVATELY-HELD COMPANIES

§ 1 PUBLICLY-TRADED COMPANIES

A OVERVIEWPublicly-traded companies have their securities—most typically shares of common stock

—listed and traded on an organized stock exchange Technically speaking, thesecompanies are required to file periodic reports with the SEC under the Exchange Act.Thus, they are also referred to as reporting companies See Nutshell Section 1B Becausethe reports they file are available to the public, publicly-traded companies are “public”from a disclosure standpoint as well as a trading standpoint

The first time a company offers and sells common stock to the public is called an initialpublic offering or IPO Although a company could “go public” through a sale of debtsecurities or preferred stock, this is rarely done Doing so would result in the companybecoming a reporting company under the Exchange Act while not affording the company’sfounding shareholders the ability to become instantly wealthy (as is sometimes the casewith a common stock IPO) Indeed, shares in a common stock IPO are frequentlyunderpriced when offered to the public, and thus when the shares begin to trade they

“pop up” in price

4

A company’s sales of common stock to the public that take place after its IPO arereferred to as secondary or follow-on offerings Through secondary or follow-on offerings,publicly-traded companies raise additional capital for use in their businesses Sometimespublicly-traded companies register additional shares of common stock and othersecurities not for capital-raising purposes, but rather for use as “acquisition currency.”That is, those companies use the registered securities as the consideration needed to buyother companies rather than use up their precious cash reserves for that purpose

Public offerings of securities are heavily regulated in order to protect investors TheSecurities Act requires each prospective issuer to register its offering on a prescribedregistration statement filed with the SEC The registration statement consists of twoparts The first part, called the prospectus, is the disclosure document that the issuer andthose underwriting the offering use as a selling brochure The second part, referred to asinformation not required in the prospectus, sets forth additional information that an issuermust file with the SEC but need not send to prospective investors Exhibits to the

registration statement (such as corporate governance documents and material contracts)make up the bulk of the second part of the registration statement Prospective investors,however, may still access the second part of a registration statement Indeed, completeregistration statements are available at the

5

Electronic Data Gathering and Retrieval (EDGAR) section of the SEC’s website located atwww.sec.gov

SEC scrutiny of a given registration statement depends on the type of offering involved

as well as the issuer For example, the SEC will review very carefully the registrationstatement of a company conducting a common stock IPO, while it generally will notreview a follow-on offering by a Fortune 500 company During the IPO registrationprocess, which can take several months to complete, the SEC will provide detailed writtencomments on the issuer’s registration statement The issuer must address thesecomments to the SEC’s satisfaction before the SEC will declare that issuer’s registrationstatement effective Upon receiving an order of effectiveness, that issuer mayconsummate sales of its securities to the public It will typically do so with the assistance

of a syndicate of intermediaries known as “underwriters.”

Underwriters are normally investment banks (e.g., Goldman Sachs and Morgan Stanley)with the expertise necessary to place the issuer’s stock into the hands of public investors

In other words, underwriters are an outsourced sales force that the issuer hires to get theoffering sold In return for their services, underwriters receive a commission, traditionallyseven percent of the per share public offering price for IPOs of common stock

Not only must a company register its securities under the Securities Act prior to sale,but it also must register the class of security being offered under the Exchange Act (oneither Exchange Act

Moreover, that company must “devise and maintain a system of internal accountingcontrols sufficient to provide reasonable assurances” that, among other things, itsfinancial statements are prepared in conformity with generally accepted accountingprinciples (GAAP).

B EXCHANGE ACT REPORTING REQUIREMENTS

In order to level the playing field between buyers and sellers of securities in thesecondary market, the Exchange Act requires each reporting company to file certainprescribed periodic reports with the SEC Because those reports are public documents,they provide important information about the company and its securities to themarketplace

7

Section 13(a) of the Exchange Act requires each reporting company to file with the SECsuch information and documents as the SEC may prescribe “as necessary or appropriatefor the proper protection of investors and to ensure fair dealing” in that company’ssecurities This includes “such annual reports, certified … by independent publicaccountants, and such quarterly reports” as the SEC may prescribe Each reportingcompany must file duplicate copies of those reports with each securities exchange onwhich that company’s securities are listed for trading purposes

Exchange Act Rule 13a–1 requires the filing of an annual report on Exchange Act Form10-K Within Form 10-K, a reporting company must, among other things:

• Discuss its business, properties, and material legal proceedings it has brought,and those brought against it;

• Discuss the most significant risk factors applicable to it and its securities;

• Provide certain specified trading information relating to its securities as well asinformation relating to the frequency and amount of cash dividends declared oneach class of its common stock;

• Set forth its financial highlights as well as its complete audited financialstatements;

• Provide, from management’s perspective, a thorough description of its financialcondition

the committee members and how they came to recommend to the company’sboard that the audited financial statements be included in the company’s Form 10-K;

• Provide extensive information about directors, management and executivecompensation if that information is not incorporated by reference from thecompany’s definitive proxy materials;

• Provide quantitative and qualitative disclosure about its financial instruments thatare sensitive to market risk (i.e., derivatives);

• Disclose any changes in, or disagreements with, its principal accountants andchanges in accounting methods and financial disclosure;

• Disclose the audit fees, audit-related fees and tax fees it paid to its principalaccountant for each of the last two fiscal years;

• Disclose conclusions of the company’s principal executive and principal financialofficer regarding the effectiveness of the company’s disclosure controls andprocedures; and

SOX, signed into law in 2002, requires a company’s principal executive officer andprincipal financial officer to include certifications in the company’s Form 10-K and 10-Qreports See SOX § 302 Among other things, each of these executives must certify that

he or she has reviewed the report in question Then, based on his or her knowledge, eachmust certify that the report does not contain any untrue statement of a material fact oromit to state a material fact necessary in order to make the statements made, in light ofthe circumstances

under which they were made, not misleading Moreover, each of these executives mustcertify that, based on his or her knowledge and on the other financial informationincluded in the report, the financial statements included in the report fairly present in allmaterial respects the financial condition and results of operations of the company as of,and for, the time periods presented in the report

Exchange Act Rule 13a–11 requires reporting companies to file “current reports” onExchange Act Form 8-K That form provides the market with timely information aboutimportant events that may occur between quarterly reports; hence, the name “currentreport.” Events that a reporting company must disclose include, among others:

• A change in control of the company;

• The acquisition or disposition of a significant amount of assets (including financialstatements for an acquired business);

• Bankruptcy or receivership;

• A change in the company’s certified accountant;

• The resignation of one or more of the company’s directors;

• A change in the company’s fiscal year;

• Entry into, or the early termination of, a material contract not made in theordinary course of the company’s business;

11

• The creation of a direct, material financial obligation or becoming directly orcontingently liable for a material obligation arising out of an off-balance sheetarrangement;

• Any triggering event that accelerates or increases a direct financial obligation or

an obligation under an off-balance sheet arrangement;

• Any sales of unregistered securities;

• The delisting of the company’s securities from its principal stock exchange ornotice that the company no longer meets listing standards;

• Material impairments to goodwill or securities held by the company;

• A conclusion by the company’s board of directors that previously issued financialstatements should no longer be relied on;

• Information the company elects to disclose pursuant to Regulation Fair Disclosure(Regulation FD);

• Amendments to the company’s corporate charter or Bylaws;

• Amendments to the company’s code of ethics or any waiver of a provision of thatcode; and

• Any other event not otherwise called for by Form 8-K but which the company atits option wishes to disclose

Under Section 16(a), a reporting person must file her initial statement of beneficialownership on Exchange Act Form 3 within 10 days after the event that resulted in herbecoming a reporting person She must file Exchange Act Form 4 to report changes in herbeneficial ownership before the end of the second business day following the day onwhich she executed a transaction resulting in a change in her beneficial ownership Shemust file an annual statement on Exchange Act Form 5 on or before the 45th day afterthe end of the issuer’s fiscal year Form 5 must include her total beneficial ownership ofthe issuer’s securities as of the end of the issuer’s fiscal year and certain transactionsimpacting on her beneficial ownership if not previously reported

C PROS AND CONS OF “GOING PUBLIC”

“Going public”—selling securities to the public through an IPO—is not for everycompany

13

Certainly, substantial benefits result from going public However, serious drawbacksexist as well

(1) Pros

Among the benefits of “going public” are the following:

Lower Cost of Capital When equity markets are strong, the cost of capital raisedthrough a public offering is typically lower—often substantially lower—than the cost ofcapital raised in the private market (e.g., through venture capital firms, private equityfirms, etc.)

Liquidity By going public and listing its securities on an organized stock exchange, acompany creates a liquid, secondary trading market for its stock This allows existinginvestors to sell their stakes in the company quickly and easily, and for other investors topurchase stakes in the company.

Establishing a Market Value Secondary market trading establishes a market value for acompany’s shares A market-determined per share trading price facilitates the company’sability to motivate its executives through the granting of stock options and related stock-based compensation The company then can use a market-determined per share tradingprice as the exercise or “strike” price of options when it grants those options to a givenexecutive If the company’s stock price increases over time (a proxy for good managerialperformance), the executive’s options become valuable By exercising

14

the options, the executive may purchase shares from the company at the exercise price

of the options and resell those shares in the secondary market at the higher currentmarket price Because the market determines the value of the shares, that valuation isdeemed to be “objective.” By contrast, the value of options granted to employees ofprivately-held companies is highly subjective in nature because the board of directorstypically determines that value

Exit Strategy By going public, a company gives its existing stockholders (many of whomare company founders) an avenue to “cash out,” i.e., turn their illiquid stock into coldhard cash Resales of their stock, however, are subject to the holding period and otherrequirements of Securities Act Rule 144 Their stock also is often subject to lockupagreements with underwriters which prohibit resales typically for a six-month periodfollowing the company’s IPO Most investment banks underwriting an IPO insist thatfounding stockholders, directors and other key pre-IPO stockholders sign lockupagreements, because having these individuals selling shares shortly after an IPO iscompleted could undermine investor confidence in the company

Acquisition Currency By going public, a company can use its stock to more easilyacquire other companies in a stock-for-stock acquisition, a stock-for-assets acquisition or

a stock swap statutory merger Management of a given target company feels morecomfortable from a valuation perspective

each of whom owns a relatively small percentage of a company’s outstanding shares, islikely to permit current management to continue to control the company Indeed, it wouldmake no financial sense for the typical public stockholder to spend the time and resources

to challenge management in any significant way In a private financing, by contrast, acompany very often has to transfer a certain degree of control to private investors Forexample, as part of a private deal, the issuer may have to yield one or more board seats

to the private investors or risk losing their investment

Analyst Coverage A company that goes public typically receives periodic coverage byone or more stock analysts who focus on the industry in which that company operates.This coverage helps keep the company in the minds of the members of the investmentcommunity It is worth noting that one way a prospective underwriter distinguishes itselffrom other underwriters competing to underwrite the IPO of a privately-held company is

by promising to provide that company with superior stock analyst coverage once the IPO

is completed Most financial services firms which provide underwriting services also haveresearch departments employing numerous analysts Providing analyst coverage is onetype of “aftermarket support” underwriters provide to the companies they underwrite

16

Prestige A company typically increases its exposure and prestige by going public Thismay help the company in its business dealings with others The act of going public canalso serve as a marketing event for a company, thus creating additional interest in thecompany and its products or services

(2) Cons

Among the disadvantages of going public are the following:

Commitment of Management’s Time Preparing a Securities Act registration statementand the process of going public is terribly time consuming and absorbs significant blocks

of senior management time—time management could spend running the company Itoften takes anywhere from three to six months (or even longer) from the time a companyfirst begins preparing a registration statement to the date on which the SEC declares thatregistration statement effective

Cost Going public is expensive and underscores the fact that it takes money to raisemoney Typical costs range from $500,000 to $2 million, exclusive of underwritingcommissions These commissions, in turn, typically soak up close to seven percent of thegross proceeds of a common stock IPO Of course, if the public offering fails, the companynever recoups the money it spent on the offering There are many variables that couldcause the offering to fail Some of these variables are company-specific: the company’squarterly earnings that become available

during the registration process are disappointing; the FDA fails to approve thecompany’s new cancer drug; a much larger competitor begins to focus on the company’smarket, etc Others have nothing to do with the company: interest rates dramaticallyincrease; hostilities in the Middle East flare up; Europe’s financial distress increases; amajor terrorist attack occurs in the U.S., etc

Living in a “Glass House.” By going public, a company becomes a reporting companyunder the Exchange Act This means the company must satisfy continuous and formalreporting requirements Doing so is both time consuming and expensive Moreover, theinformation the company discloses is open to the public, in general, and to thatcompany’s competitors, in particular

Hostile Takeovers Going public could open the company up to a hostile takeoverattempt, as a hostile party could entice public shareholders to part with their shares forthe right price If a hostile party acquires enough shares in the company through a hostiletender offer, it can oust existing senior management completely Most companies installone or more takeover defenses (e.g., a classified or staggered board of directors) prior togoing public in order to minimize the possibility of a hostile takeover

Reduced Communication with Stockholders Once a company is public, its managementcannot communicate as easily with the company’s stockholders as it did when thecompany was privately-held Indeed, reporting companies must

on management to focus on short-term results, often to the detriment of creating term shareholder value This pressure boiled over during the accounting scandals of theearly 2000s, as several prominent public companies (e.g., Enron, Tyco and WorldCom)were forced to restate their earnings downward before ultimately imploding due to overlyaggressive accounting practices designed to show impressive earnings growth

long-SOX and the Potential for Liability Public companies have additional reporting andprocedural obligations since the passage of SOX, many of which are costly for a company

to comply with These include, among others, requirements relating to internal controlsystems over financial reporting SOX also creates some restraints on corporate

operations, in that the CEO and CFO have to provide certifications with respect to thecompany’s financial statements, disclose all known control deficiencies, and disclose acts

of fraud In addition, SOX requires disclosure as to whether at least one member of thecompany’s audit committee is a

to the public through an IPO Unlike publicly-traded companies, privately-held companies

do not have a liquid, secondary trading market for their shares Thus, no readily availablemarket price exists for their shares

Financial and other information for privately-held companies is proprietary and cannot

be viewed unless the party requesting the information has enough leverage to demand it.For example, a commercial bank contemplating loaning money to a privately-heldcompany will insist on seeing that company’s financial statements If the companyrefuses, the bank simply will not make the loan under most circumstances

20

Chart 1 below highlights some of the major differences between publicly-traded andprivately-held companies

Chart 1 Major Distinctions Between Publicly-Traded and Privately-Held Companies