Susan Garvin, CEP, Stock & Option Solutions, Inc.

Linda Hart, Box, Inc.

Joanne Wendler, CEP, Demand Media, Inc.

Alison Wright, Baker & McKenzie LLP

July 25, 2012

Success or Big Mess?: Mistakes and Must-dos on the

Road to IPO

Once upon a time, there was a little company

that wanted to grow really big and strong like it’s

brothers and sisters. To do this, the little

company worked long and hard and decided to

move into the public markets by having an IPO.

Because the little company was stubborn and

proud, it didn’t talk to it’s older and wiser

relatives, but instead, tried to go it alone. It made

many mistakes on the way to the IPO, here are

some of the lessons learned.

3

Devil is in the details

Expect underwriter’s counsel to thoroughly

review all books and records of the company

• Equity compensation plans

• Grant agreements

• Board resolutions granting equity awards

Moral of the Story

• Be prepared for last minute amendments to plan documents that do not comply with legal requirements (Code Section 409A)

• Get good advice upfront to avoid last minute "gotchas"

4

Be careful what you say (someone might be

listening)

Communications before, during and after the IPO process are critical and must be thoroughly vetted for correctness/accuracy/clarity

• Employees

• Investors

Moral of the Story

• Make sure all communications, to everyone, are complete and accurate

• Update communications as needed

• Be as honest as possible

5

A rose by any other name……or not

Not all kinds of equity compensation vehicles (or

underlying equity) are the same

• ADRs

• Options vs. Awards

• Types of transactions allowed

Moral of the Story

• Advance preparation and understanding is critical

• Make sure you have the right players at the table

6

A horse is a horse, of course of course

Unilateral adjustments to equity plan data are not allowed, even pre-IPO. Your data and your backup will be scrutinized.

• ISO/NQ

• International “ISO”

Moral of the Story

• Don’t “correct” data in database without documentation

• If data is changed, make sure approvals/communications are undertaken as well

7

My, what a big nose you have

Securities laws limit the amount of equity compensation a private company

can issue

• Rule 701

• Section 12g, as amended

Moral of the Story

• Understand all the rules/regulations, even if you don’t think they apply to you

• Keep running calculations regarding securities law exemptions (Rule 701, Section 12G)

8

Under Pressure

Creativity which can be utilized prior to IPO may not fit once you are a reporting company – Beware!

• Compensation design and consultants can increase/decrease the ability to administer your plans

• As a publicly traded, reporting company, “unique” does not always allow for good ROI once administrative and communication costs are examined.

Moral of the Story

• “Unique” and “special” can cause compliance and administrative issues

• Think long-term

• Pressure to accept new vehicles/different methods can quell dissent and cause problems

9

Delayed gratification

Employees may be hired, investors found, with a certain time goal for an expected IPO. However, market or company changes can delay that date.

• Managing changed expectations

• Communications

• Employee morale

Moral of the Story

• Have a backup plan

• Don’t promise anything you cannot deliver

10

It’s too quiet in there

All the players in the company and any advisors need

to be kept informed about the status of the project.

• Legal filings

• Communications

• Administration

Moral of the Story

• You can take “quiet” too far

• Missing information can cause problems too

11

You can run but you cannot hide

As part of the IPO process expect to find compliance issues of which you may have been unaware

or thought were immaterial

• Income and employment tax withholding and reporting

• Global compliance issues

Moral of the Story

• Immaterial takes on a whole new meaning when preparing for an IPO

• Make the necessary corrections (or take the risk) and move on

12

Through the Looking Glass

There are many rules and regulations which are not obvious. Make sure you are consulting with authorities in equity compensation when designing and administering your plans. Otherwise, your view may end up distorted and missing some elements.

• Definition of “employee”

• Exempt vs. non-exempt status

• International interpretations• LOA

• Discrimination• Age

• Part-timers

Moral of the Story

• Expertise is critical

• Not everyone “doing” administration is an expert

• It takes a team to make equity compensation work (correctly)

13

The serfs are at the gate

Employees will want to have access to sell their stock as soon as possible. This must be weighed against market concerns, underwriters’ concerns, and administrative concerns.

• Perception of employees selling stock immediately into market

• Employees desire not to lose “profit”, especially if they’ve been burned before

• Administration of plans can take time to set in place

Moral of the Story

• Pressure to allow employees to “cash out” should not be the only consideration

• Administration of plans should be balanced with other issues

• Lock up is negotiable

14

Cheap doesn’t mean free

If your company valuations (and associated grant/exercise pricing) are not audit proof, problems can arise

• Cheap Stock

• Accounting

• Taxation

• Administration

Moral of the Story

• Proper valuations are critical

• Ramp up to IPO

• Tax implications

15

Contact Information

Susan Garvin, CEP

Equity Consultant

Stock & Option Solutions, Inc

910 Campisi Way, Ste 2E

Campbell, CA 95008 USA

Bus: (408) 979-8700

sgarvin@sos-team.com

www.sos-team.com

16

Joanne Wendler, CEP

Manager, Stock Administration

Demand Media, Inc.

1299 Ocean Ave , Ste 500

Santa Monica, CA 90401 USA

Bus: (310) 656-6331

Joanne.Wendler@demandmedia.com

Alison Wright

Partner

Baker & McKenzie LLP

Two Embarcadero Center

11th Floor

San Francisco, CA 94111 USA

Bus: (415) 576-3046

alison.wright@bakermckenzie.com

Linda Hart

Director, Payroll & Stock Administration

Box, Inc

4440 El Camino Real

Los Altos, CA 94022 USA

linda@box.com

17

Appendices

18

Regulatory Information

Securities Law

Securities Act of 1933: regulates the process by which

companies sell stock to the investors

Securities Exchange Act of 1934: regulates the

securities markets and the entities that participant

in those markets

Blue Sky Laws – State securities Laws covering both

Public Company

Definition: A company whose stock is publicly traded

on a recognized stock exchange; subject to

regulation, disclosure and related rules enforced

by the SEC. *

Non-listed companies subject to public company

disclosure rules if Section 12 g of the Exchange Act

is triggered.

*Glossary definition from “Selected Issues in Equity Compensation”

published by the NCEO

Securities Act of 1933

Stock sold by a company to investors must be registered with the SEC

– Form S-1 is used to register shares sold in an IPO– Form S-8 is used to register shares sold pursuant to a

stock plan– Prohibits fraud, misstatements and material omissions

in the– registration statement

Includes a number of registration exemptions– Rule 701 exempts shares sold by a privately held

company through a compensatory arrangement– Shares issued pursuant to an exemption are

considered “restricted securities” and must be resold under an exemption

– Rule 144

Section 12g Basics

The holders of record threshold for triggering Section 12(g) registration for issuers (other than banks and bank holding companies) has been raised from 500 or more persons to either (1) 2,000 or more persons or (2) 500 or more persons who are not accredited investors

In calculating the number of holders of record for purposes of determining whether Section 12(g) registration is required with respect to a class of equity security, issuers (including banks and bank holding companies) may exclude persons who received the securities pursuant to an employee compensation plan in transactions exempted from the registration requirements of Section 5 of the Securities Act

22

Rule 701

• Exempts shares sold by a privately held company through a compensatory arrangement

• Shares are “restricted securities” since not registered

• Shares are freely saleable 90 days after IPO

Rule 701 Basics

Written compensatory benefit plan (or written compensation contract) established by the issuer, its parents, its majority-owned subsidiaries or majority-owned subsidiaries of the issuer's parent

For employees, directors, officers, or consultants and advisors, and their family members who acquire such securities from such persons through gifts or domestic relations orders

Former employees, directors, officers, consultants and advisors only if such persons were employed by or providing services to the issuer at the time the securities were offered

Consultants must be natural person

24

Rule 701 Basics

Amounts that may be sold.

• Offers. Any amount of securities may be offered in reliance on this section. However, for purposes of this section, sales of securities underlying options must be counted as sales on the date of the option grant

• Sales. The aggregate sales price or amount of securities sold in reliance on this section during any consecutive 12-month period must not exceed the greatest of the following:

• $1,000,000;

• 15% of the total assets of the issuer (or of the issuer's parent if the issuer is a wholly-owned subsidiary and the securities represent obligations that the parent fully and unconditionally guarantees), measured at the issuer's most recent annual balance sheet date (if no older than its last fiscal year end); or

• 15% of the outstanding amount of the class of securities being offered and sold in reliance on this section, measured at the issuer's most recent annual balance sheet date (if no older than its last fiscal year end)

25

Rule 144 Basics

Exemption for resale of two types of securities:

– Restricted securities

• shares acquired in unregistered offering

– Control securities

• shares owned by affiliates

– persons considered to be in control of the company

– officers, directors, and principal shareholders

• can be registered or unregistered shares

Rule 144 Basics

• Company must be current in public reporting

• Shares to be resold must have been held for one

year

• Shares resold in three-month period may not

exceed the greater of:

– 1% of the company's outstanding stock

– average trading volume of preceding four weeks

• Shares must be sold through registered stock

broker or market maker

• Form 144 filed with SEC at sale (or prior)

Section 16 Basics

Applies to:– Officers

• CEO and president

• CFO, CAO, and possibly controller

• Vice presidents

• Other persons with significant policy-making function

– Directors

– 10% shareholders

Short-swing profits recovery period– Profits must be returned to company if purchase within less than

six months of sale OR sale within less than six months of purchase

• Highest sale price less the lowest purchase price

– No defenses to application of provision

– Most transactions in stock plans are exempt from this rule

Section 16 Basics

Requires holdings and transactions to be reported to the SEC– Form 3

• Holdings

• File within ten days of becoming an insider

• Often filed by company’s legal counsel with IPO

– Form 4• Non-exempt transactions

• Open market purchases and sales

• Exempt transactions that involve the company

• Grants, exercises, restricted stock purchases, sales of stock to the company

• File within 2 days after the transaction occurs

– Form 5:• Exempt transactions that don’t involve the company

• Gifts, transfers dues to inheritance

• File within 45 days after fiscal year-end

• Year-end statement that no Form 5 is required

Taxation

• US and International

• Different timing, rules, withholding obligations

• Stock Options

• ISO/NQ

• SARs

• Stock Awards

• RS

• RSU

• Performance

Taxation

• Income reporting and tax withholding rules apply

regardless of public/private status

• IRS depository requirement applies regardless of

public/private status

• Section 409A applies regardless of public/private

status

IRS Publication 15, Circular E

“In general, you must deposit federal income tax withheld and both the employer and employee social security and Medicare taxes.”

“$100,000 Next-Day Deposit Rule

If you accumulate $100,000 or more in taxes on any day during a monthly or semiweekly deposit period (see Deposit period on page 21), you must deposit the tax by the next business day, whether you are a monthly or semi-weekly schedule depositor.”

“Accuracy of Deposits Rule

You are required to deposit 100% of your tax liability on or before the deposit due date. However, penalties will not be applied for depositing less than 100% if both of the following conditions are met

Any deposit shortfall does not exceed the greater of $100 or 2% of the amount of taxes otherwise required to be deposited

The deposit shortfall is paid or deposited by the shortfall makeup date as described below.”

32

Code Section 409A Basics

Penalties imposed on employees (not on the

employer); 20% Federal penalty and 20%

California state penalty

Incentive stock options and restricted stock are

exempt from Code Section 409A (but ISOs must

comply with Section 422)

Non-qualified stock options and restricted stock units

must comply with or be exempt from Code

Section 409A

33

Code Section 409A Basics

Non-qualified stock options are exempt if

• Exercise price equal to fair market value on the date of grant (see guidelines for determining fair market value)

• Option on common stock

• Watch out for modifications

Restricted stock units are exempt from Code Section 409A if structured to meet the requirements of the short-term deferral rule – payment made within 2 ½ months following the end of the year (calendar or fiscal) is which the RSU vested

34

Accounting

• Cheap Stock

• SEC determination that the valuation of the company’s stock prior to the IPO was not valid

• Stock was issued at prices below the “true” market value

• SEC reviews prices and methodology

• Usually 12-18 months pre IPO are most scrutinized

• Stock (grants) issued in 6 months prior to IPO are targets if less than the IPO pricing

• Compensation Cost to company

• Disclosures

• IRC Section 409A issues for “discounted” stock

• IRS audit of grants/exercises pre-IPO

Accounting

• Financial Reporting

• Valuation model selection

• Inputs

• Database Reconciliations

• How many databases do you have?

• Are they in sync?

• Can you “prove” your numbers?

Administration

• Stock Plan Administrator

• Tracking software

• Staffing

• New Exercise Types

• Same-Day Sale Programs

• Transfer Agent

• Broker

• Setting up a stock plan department

• Automation

• Systems

• Interfaces

38

Toolbox of IPO Topics

Toolbox for IPO

Securities Law Compliance

– Rule 144

– Rule 701

– Insider Trading Program

– Section 16 compliance

• Form 3

• Ongoing

– Rule 10b5-1 plans

– Form S-8 filing

39

Toolbox for IPO

Shareholder Reconciliation– Company must have a complete and reconciled list of all

shareholders (and option/award holders) prior to IPO• Capitalization Table

– Disclose who owns % of company at IPO

– Usually tracked in legal department (internal or external)

• Certificate/Shareholder Legends

– Securities restrictions (i.e., not registered)

– Affiliate restrictions

– Restricted shares (i.e., exercised but unvested)

– Plan to remove

» Make sure you work with BOTH legal and transfer agent for appropriate opinions

• Equity compensation plans

– Reserves

– Issuance instructions

– Signature authority

– Database audit and documentation

40

Toolbox for IPO

Tools and Partners

– Exchange Agent

– Transfer Agent

– Broker(s)

– Software provider

– Underwriters• Lockup?

• Friends and Family?

– Printers

– Legal counsel

– Payroll

– Automation

41

Toolbox for IPO

Employee Compensation Plans

– Review

• Any modifications needed for publicly traded company

• For example, does plan allow for Cashless/Same Day Sale

– Expand or Replace

– New Vehicles

• RSUs/Performance grants

• ESPP

– Evergreen provisions

– Policy & Procedure Updates

• Do you want to continue to grant ISOs after IPO?

42

Toolbox for IPO

Financial Reports

– Define Team

– Utilize administrative platform functionality where

possible

– Understand methodology of tools

• You have to report to auditors

– Set Processes

• For example, require that FV model inputs are set by financial

team 2 weeks prior to quarter close to allow for valuation and

running of reports.

– Make sure you have the necessary

background/knowledge

43

Toolbox for IPO

Employee Communication and Education

– Prepare ahead and have compliance/accuracy review

– Bring in vendors (brokers) for “how to” sections

– Don’t paint only “rosy” pictures

• Stock does drop

– Be open/honest/specific

– Give lots of examples

– Make education available ongoing/on demand

44

Thank You Sponsors…Thank You Sponsors…