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Understanding Test-the-Waters Communications for IPO Investors

Initial public offerings (IPOs) are a major milestone for private companies going public. Before launching an IPO roadshow, companies are allowed to gauge investor interest and get feedback through Test-the-Waters (TTW) communications under securities laws. As an investor, it's important to understand what TTW communications entail and how to approach them.

What are Test-the-Waters Communications?

TTW communications permit companies to have discussions with qualified institutional buyers (QIBs) and institutional accredited investors (IAIs) before or after publicly filing an IPO registration statement. This allows companies to measure investor appetite, valuation expectations, marketing strategy and more before committing extensive resources to an IPO roadshow. The rules around TTW were expanded in 2019, allowing all issuers to use TTW before filing a registration statement. Previously, only emerging growth companies could use TTW prior to filing. The primary benefit of TTW is that it gives companies additional flexibility to sound out investors confidentially and make more informed decisions about size, timing and pricing of a potential IPO. At the same time, TTW gives investors early insight into upcoming IPOs. TTW can take many forms, including:

  • One-on-one meetings between company executives/bankers and investors

  • Investor presentations or "test-the-waters" meetings

  • Written communications like PowerPoint decks or preliminary prospectuses

Investor Considerations for TTW

For investors, it's important to understand that information shared during TTW periods is still subject to compliance rules around selective disclosure. Companies cannot share material non-public information that could represent an unfair advantage. At the same time, TTW communications provide an early peek into an issuer's strategy, financial profile and growth prospects. QIBs and IAIs may gain valuable insight by participating in TTW meetings or reviewing materials shared. However, investors should apply appropriate due diligence and skepticism to TTW materials until the registration statement is publicly filed and final. Information could be oudated or intentionally omit key details in these preliminary stages.

IPO Pricing and Valuation Impacts

One of the key reasons companies use TTW is to get investor feedback on potential IPO pricing and valuation ranges. By sharing financial models, growth projections and comparable public companies, issuers can gauge where investor demand and expectations lie. This information is critical for setting an IPO price range that will ensure sufficient deal subscriptions while leaving some upside on the table. TTW feedback can lead companies to adjust the expected price range up or down based on investor sentiment.

Issuers may also use TTW to get feedback on IPO timing based on market conditions, the competitive environment and investor appetite at that moment. TTW meetings happening closer to the actual IPO typically provide the most relevant pricing signals. For investors, participating in TTW provides an early look under the hood that public filings alone may not show. Asking probing questions about models, assumptions and risk factors during TTW can reveal an issuer's true confidence in their prospects.

Confidentiality Considerations

A key rule around TTW is that companies must make it clear the communications are TTW interactions governed by specific securities laws. This puts investors on notice about limitations and compliance obligations. TTW materials are still confidential, cannot be shared externally, and may omit or contain outdated information compared to the final public filings. Additionally, TTW interactions are still subject to Regulation FD prohibitions on selective disclosure of material non-public information. Companies should use data walls, code names and redaction to protect sensitive details during TTW. Investors must be mindful about handling TTW materials as they would any other confidential, non-public company information.

Looking Ahead

As TTW communications become more widely adopted, the scrutiny and expectations around them are likely to increase for issuers and investors alike. Regulators may push for more consistency, disclosure and record-keeping requirements related to the TTW process. For investors granted this valuable pre-IPO access, maximizing time with management and performing rigorous diligence on preliminary TTW materials will be paramount. Those able to gain quality insights from TTW while exercising proper confidentiality may secure an important competitive edge. In the fast-paced IPO market, Test-the-Waters aims to bring more transparency and certainty for all parties involved. Taking full advantage in a compliant manner will be crucial for companies and investors seeking to optimize IPO timing, pricing and execution.

Ultimately, TTW is a valuable tool for companies and investors alike to test the waters before an IPO. It provides increased transparency while still allowing confidential discussions to take place. Paying close attention to these communications can give investors an edge when it comes time to evaluate a new public offering.

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