I’ve been thinking: Debt IPOs?

A debt initial public offering (IPO) provides a viable alternative to the challenging traditional equity IPO to gain access to public markets for growth capital. For the right company at the right time under the right circumstances, it might make sense.

Unfavorable market conditions for new equity issues are pushing firms to consider accessing U.S. public markets to raise debt rather than equity. For the right company at the right time under the right circumstances, it might make sense. In 2023, there were only 150 new equity issues in the United States, the lowest annual total since 2016, and the IPO market has not significantly improved in 2024. An initial public offering of debt securities, or a debt IPO, may provide a viable alternative over a traditional equity IPO for issuers seeking to raise public capital and establish a trading market for its securities.

Registering a debt IPO closely follows an equity IPO in terms of the form and substance requirements under the Securities Act of 1933. In both cases, an issuer files a registration statement on Form S-1 detailing its business, the offering terms, the risks involved, and its management and beneficial owners. The primary differences in a debt IPO registration statement are (i) the description of the notes, including the aggregate face or principal amount of the issue, the interest rate and payment dates, maturity date, optional redemption by the issuer, ranking with other indebtedness of the issuer, and certain financial and operating covenants that may be included in the indenture governing the notes, (ii) specific debt risk factors, including the potential negative effect of leverage on the issuer’s operating flexibility and the severity of the consequences of a default, and (iii) the absence of disclosure regarding dilution, dividends and common stock trading.

After the registration statement is declared effective, a debt IPO issuer will be subject to periodic reporting on SEC Forms 10-K (annual report), 10-Q (quarterly report) and 8-K (current report) pursuant to Section 15(d) of the Securities Exchange Act of 1934. As long as the debt securities are not listed on a registered national securities exchange, the debt IPO issuer will be free from other Securities Exchange Act requirements including regulations concerning proxy solicitations and tender offers, beneficial ownership reporting and short-swing profit restrictions. Additionally, if it has fewer than 300 holders of the public notes, the debt IPO issuer can suspend its SEC filing obligations with a Form 15 following the filing of the issuer’s Form 10-K for the year in which its registration statement is declared effective. An indenture for the notes may nevertheless require the issuer to provide the indenture trustee and noteholders with equivalent information (including audited financial statements) or summaries of the foregoing reports while the public notes are outstanding.

There are a number of benefits associated with conducting a debt IPO.

  • For the debt IPO issuer, debt financing is more predictable as its cost is limited to the original aggregate face or principal amount of the notes plus accrued interest and related fees and expenses. Equity financing can be costly to founders and early venture capital investors whose ownership percentage (and voting rights) in the issuer is diluted with each financing round and their investment in the issuer is subject to volatile stock prices, often for reasons outside their control.
  • Debt IPO investors may be more comfortable holding less-risky debt securities. Indentures for public debt often include safeguards such as (i) mandatory sinking fund payments to retire a portion of the principal amount prior to maturity, (ii) requirements to offer to repurchase the notes from certain asset sale proceeds, (iii) events of default if the issuer fails to meet certain operating and/or financial covenants (such as maintaining a minimum net worth) or a fundamental change occurs, and (iv) caps on the issuer’s leverage level or ratio of earnings to fixed charges.
  • Public capital markets reach a large pool of potential public investors, with investment banking firms specializing in underwriting a debt IPO and making a market in the public notes or accessing alternative trading systems. Banks, financial institutions and other institutional lenders generally have a lower credit risk profile than public investors, who may be more flexible with a liquid secondary market to trade the notes.

A debt IPO may not be suitable for all companies. Some companies may chafe at some of the covenants and restrictions that will apply so long as the public debt is outstanding. Unprofitable companies and ones with unpredictable or uneven cash flows that cannot regularly service the debt, or companies without significant collateral assets, may not be considered ideal candidates for a debt IPO.

More recently, early-stage and smaller growth companies have completed debt IPOs, particularly as Tier 2 offerings under Regulation A+, which are not subject to state blue sky review or state investor and solicitation restrictions. The structures of these offerings may include notes sold at a discount representing an interest factor, rather than as interest bearing obligations, with retail-sized minimum purchase amounts and, in some cases, may be conducted on a continuing “best efforts” basis by the issuer through the underwriter. These smaller issuers have also indicated that they intend to opportunistically consummate an equity IPO in the future, and expect that a portion of the net proceeds of such offering would be used to repay some or all of the prior public debt. Companies in this position would be expected to benefit from a history of public reporting and compliance.

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