Liquidity and Exits

Artificial intelligence (AI) continues to reshape healthcare delivery, particularly in diagnostics, imaging, and care coordination. For established healthcare platforms seeking to integrate innovative capabilities, effective transactions are not always single-step acquisitions. Phased relationships, beginning with commercial alignment and structured with the potential for full-scale integration, can provide a disciplined path to innovation.

For technology and life sciences transactions counsel, this raises a critical question: How can parties structure an initial collaboration to accelerate deployment while preserving long-term strategic optionality?

Phase I: Exclusive Commercial Alignment With Strategic Investment

In the healthcare sector, initial alignment frequently takes the form of an exclusive or field-limited license coupled with a minority equity investment. This structure enables a healthcare platform to secure access to differentiated technology, influence product development, and evaluate performance in a live clinical setting while mitigating integration and regulatory risk.

The effectiveness of this model turns on careful coordination in drafting foundational agreements.

Exclusivity

Exclusivity must be defined with intent and precision. In healthcare technology transactions, scope may be tied to specialty, site of care, modality, patient population, geography, or some combination of the foregoing. Performance milestones often are incorporated to ensure continued development and commercialization progress. Overly broad exclusivity may constrain a developer’s growth and create valuation tension; overly narrow drafting may undermine the strategic value of the arrangement. The objective is to balance long-term alignment with operational flexibility. Of course, in an AI context, parties need to address whether exclusivity extends to future model iterations, retrained versions, or algorithmic enhancements; consideration must be given to the dynamic nature of machine learning systems.

Intellectual Property and Data Rights

Healthcare collaborations frequently involve a convergence of technology developers and data-rich platform organizations. Clear delineation of background intellectual property, derivative works, algorithm improvements, and data usage rights is essential. Platforms typically seek rights to deploy and refine technology across their networks and express concerns around the control and use of their data; developers seek to preserve core intellectual property ownership and the integrity of their models having been trained with partner data. Sophisticated collaborators increasingly distinguish between ownership of model weights, fine-tuned models, embeddings, and generated outputs. Platforms also may be concerned with limiting use of their input data to improve only customer-specific instances rather than also generalized models. These provisions must be drafted with careful attention to the Health Insurance Portability and Accountability Act of 1996, state privacy regimes, cybersecurity obligations, and evolving regulatory scrutiny of AI-enabled tools.

Several intellectual property questions are distinctive in the AI context. First, where a party’s product is a layer built on a third-party foundation model (commonly referred to as a “wrapper”), the scope of any exclusivity grant requires careful scrutiny. The underlying model weights may remain owned and broadly licensed by the third-party foundation model provider. What a wrapper may practically protect is the specific configuration, fine-tuning, and proprietary data contributed by the parties; however, it likely cannot fence off the foundational capabilities beneath. Exclusivity in this context protects differentiation, not the underlying foundation model.

Second, ownership of AI-generated output remains legally unsettled, and third-party platform terms of use continue to shift in ways that increase that uncertainty. Current copyright doctrine in most jurisdictions requires human authorship; outputs produced autonomously by a model may provide no copyright protection at all. In practice, many organizations treat proprietary prompts, fine-tuning approaches, retrieval architectures, and workflow integrations as confidential know-how rather than relying on copyright protections in the outputs themselves. This approach can be effective, but trade secret protection is contingent on maintaining secrecy and on contractual controls that prevent disclosure. Strategic agreements governing AI development should address both the allocation of any rights that do arise as well as the confidentiality obligations, access controls, and use and disclosure restrictions necessary to sustain appropriate trade secret protection.

Third, background intellectual property carries additional complexity when applied to AI development. A developer’s model may incorporate vast quantities of third-party content, potentially including works subject to copyright claims or contested licensing. Training data provenance and any unlicensed works used in the development or subsequent retraining of a model represent material and ongoing diligence considerations. Parties collaborating on the development or deployment of a model should conduct appropriate diligence into training data lineage and should seek representations, warranties, and indemnities addressing third-party intellectual property infringement claims flowing from the model’s underlying composition.

Investment and Governance

A minority equity investment can accompany the commercial arrangement, aligning incentives and providing capital for continued development. Effectively structured governance rights, such as board observation rights, information rights, and other protective provisions, can provide strategic visibility without creating unintended control or regulatory implications. Coordination between the commercial agreement and the investment documents is critical, particularly with respect to transfer restrictions and change-of-control provisions. Moreover, AI governance may extend to oversight of model validation, change management processes, and any regulatory filings associated with algorithm modifications.

At this stage, sophisticated parties also frequently incorporate structural mechanisms that preserve a potential path to acquisition while maintaining flexibility for both parties.

Phase II: Commercialization Proving Grounds

The initial commercial phase often functions as live diligence. The healthcare platform gains insight into clinical adoption, workflow integration, model performance, regulatory positioning, and scalability. This operational visibility informs valuation and integration planning should the relationship mature. This phase can also serve as a period to assess real-world performance drift, explainability, robustness across diverse cohorts, and the sufficiency of monitoring systems required for ongoing compliance.

To preserve optionality for a transition toward a future acquisition, parties often incorporate structural tools with respect to equity, such as rights of first refusal or first offer, exclusive negotiation periods, call options, prealigned valuation frameworks, or some combination of the foregoing. Drag-along and tag-along rights associated with the equity may also be calibrated with a future acquisition scenario in mind. These mechanisms should be drafted with attention to enforceability and regulatory constraints. Early coordination among corporate, regulatory, and competition counsel can materially affect downstream optionality.

Phase III: Acquisition and Integration

If the collaboration demonstrates sustained strategic value, a full acquisition may enable a deeper operational integration and broader commercialization as well as enhance the platform’s market differentiation.

At this stage, issues addressed during the initial licensing phase assume heightened importance. Clear chain of title for intellectual property, documented rights to data and improvements, regulatory compliance history, and alignment across commercial agreements are central to confirmatory diligence. Particular scrutiny is given to training data lineage, model documentation, audit trails demonstrating controlled updates, and explainability materials required for U.S. Food and Drug Administration or equivalent regulatory submissions. Retention and incentive arrangements for founders, developers, and technical personnel often become critical to preserving innovation postclosing.

If lifecycle planning is embedded in the original agreements, the acquisition process typically becomes more efficient. Change-of-control consequences are understood, equity positions are aligned, and commercial rights do not require fundamental restructuring. The transaction can therefore focus on valuation, integration strategy, and long-term growth.

Deliberate Deal Architecture

As technology-enabled innovation continues to transform healthcare delivery, staged collaborations are likely to remain a defining feature of strategic transactions. A phased approach, beginning with commercial alignment and investment while preserving a clear path to integration, allows organizations to validate technology in practice before committing to full-scale acquisition.

For technology and life sciences transactions counsel, the task is not merely to document a license or negotiate a purchase agreement. It is to architect a relationship that accommodates immediate commercialization and future strategic flexibility within a highly regulated environment. Thoughtful lifecycle structuring at the outset can materially shape the trajectory, and ultimate success, of the deal. As AI becomes more deeply embedded in clinical workflows, deal architecture increasingly must anticipate issues such as ongoing model governance, regulatory obligations tied to adaptive algorithms, and safeguards around the responsible use of patient-derived data — all core components of strategic value and risk.

After a US$750 million acquisition, the parties ran the usual post-closing true-up that adjusts the price based on the target’s actual financials at closing. It turned out the seller had misapplied a revenue-recognition accounting standard in its pre-closing books, and once the standard was applied correctly the buyer owed roughly US$38.3 million more. The buyer paid, then sued separately for indemnification, arguing the seller had promised its financial statements complied with accounting standards and that promise was false. The Delaware Court agreed and let the buyer recover the extra payment.

The Court rejected the seller’s arguments that the buyer should have caught the error in due diligence, that the claim belonged in the earlier case, or that a contract clause barring double recovery blocked it. Diligence is not an audit, the claim was not ripe until the true-up concluded, and the anti-duplication clause was meant to prevent collecting twice, not to eliminate indemnity claims. The Court determined that a price true-up fixes the number, but does not by itself decide who bears the cost of an inaccurate representation.

Several U.S. treaty partner jurisdictions have recently become aggressive in extending their taxation rights to cross-border acquisition transactions and the movement of assets, such as intellectual property. As a result, multinational companies should consider seeking advance unilateral or bilateral advance pricing agreements (also referred to as “APAs”) to resolve potential disagreements with foreign tax authorities and avoid lengthy and expansive audits and litigation proceedings.

What are “APAs”?

Commonly, following an acquisition of a foreign company by a U.S.-based multinational company, certain IP assets of the foreign target may need to be integrated with such company’s other operating assets to better align the ownership of IP assets with such company group’s operating structure, functions, other assets, and risks. Such an alignment of assets could involve the license, sale, or transfer of IP to the U.S. parent company or to another member of the multinational company group located in a jurisdiction different than that of the target. A cross-border transfer of assets could result in income recognition based on the value of the assets being transferred.

An APA is an agreement between a multinational company and a taxing authority or authorities regarding the transfer pricing methodology, valuation, and pricing of assets and certain transactions. A bilateral or multilateral APA (which involves the multinational company and two or several tax authorities, respectively) provides a non-adversarial alternative to resolving potential cross-border transfer pricing disputes, among many other benefits. Furthermore, the IRS is expected to be more likely to support valuation methodologies and adjustments that are based on acceptable international tax principles and valuation methodologies. The IRS’s support of a company’s valuation methodology in an APA process could be helpful in a dispute or litigation with a treaty partner jurisdiction in support of a company’s position. As a result, a bilateral or multilateral APA process provides an opportunity to set the stage and level the playing field with the treaty partner country(ies). A bilateral or multilateral APA may be a viable alternative to consider for both treaty partners (including Canada, Germany, India, Israel, Japan, Korea, Switzerland, and others) and other jurisdictions.

As a primary benefit, a bilateral or multilateral APA could eliminate the need for uncertain tax position reporting and provide for penalty protection. It would also help parties avoid repetitive tax and transfer pricing audits; limit tax authorities’ ability to change transfer prices retroactively; allow parties to manage transfer pricing real-time (rather than responding to audits years later); and mitigate the risk, cost, and burden of an audit or potentially harmful tax litigation in the U.S. and in the treaty partner jurisdiction. Other benefits may include the suspension of current tax audits or assessments relating to the transactions covered by the bilateral or multilateral APA negotiations until the APA process has been concluded, which could take several years.

For instance, recently at least one tax jurisdiction has gone so far as to argue on several occasions that the value of a target company’s IP could be higher than the entire purchase price paid to acquire such target company. The argument has been that, surely the buyer has taken into account the tax cost associated with moving the IP following the acquisition and, thus, discounted the purchase price paid for the target company and all of its assets, including its IP. Such a result, in the absence of an APA, can have a significant effect on deal structure, outcome, and consideration if not addressed in advance.

While the taxing authorities and the multinational company are not obligated to reach an agreement, they are generally required to try to reach a mutual agreement pursuant to the applicable income tax treaty, including relevant provisions for the relief from double taxation and mutual agreement procedure.

In a welcome development in the U.S., the IRS released additional guidelines on the IRS’s Advance Pricing and Mutual Agreement Program (APMA), a program that looks to identify multinational companies and matters early in the process that are more likely to successfully reach an APA resolution based on the facts at issue. Multinational companies can contact APMA for a pre-submission review and receive a preliminary opinion on whether to proceed with the APA process within just a few weeks of submitting a pre-filing memo and providing additionally requested information.

APMA considers a number of factors, including: the significance of the transaction; the probability that transfer pricing compliance will be significantly enhanced by engaging with the treaty partner; the scope, materiality, and complexity of the company group-covered transactions in the U.S.; whether there is an actual or potential transfer pricing dispute that would be most efficiently resolved through a bilateral or multilateral APA based on the APMA’s experience; country-specific strategy considerations; and the input of the treaty jurisdiction regarding the APA.

In addition to transactions involving IP assets, a bilateral or multilateral APA can cover the provision of services by a non-U.S. entity, the provision of services by a U.S. entity, sale of tangible property into and from the U.S., use of intangible property by a U.S. entity and by a non-U.S. entity, and other transactions. In the majority of “APAs”, the covered transactions involve numerous business functions and risks.

The Delaware Court of Chancery dismissed a stockholder suit claiming that directors of B. Riley Financial breached their fiduciary duties by failing to catch problems with an investment that later went bad. The suit was framed as a Caremark claim, the label Delaware uses for lawsuits arguing that a board failed to conduct oversight. The Court reaffirmed why those claims are so hard to win: a board’s oversight duty is aimed at the company’s own internal compliance and risk systems, not at policing misconduct by outside parties the company does business with, even where the company has significant money on the line. A failed investment, on its own, is not evidence of bad faith, and stockholders cannot repackage hindsight criticism of a bad bet as a breach of duty. Delaware courts scrutinize process, meaning they evaluate whether the board informed itself and had systems in place, rather than whether that process led to a good outcome.

On March 25, 2025, Delaware Governor Matt Meyer signed significant amendments to the Delaware General Corporation Law that provide greater predictability and clarity for conflicted transactions. The amendments create statutory safe harbors under Section 144 that preclude equitable relief and damage claims when transactions involving controlling stockholders or control groups are approved through either a properly functioning special committee of at least two disinterested directors or an informed, uncoerced vote of disinterested stockholders (with both mechanisms required only for controller go-private transactions). The amendments also define key terms including “controlling stockholder” (with a one-third voting control floor), “control group,” and “disinterested director,” extend duty-of-care exculpation to controlling stockholders, and narrow stockholder books-and-records inspection rights under Section 220 to core materials while adding heightened requirements for accessing additional records. The amendments apply to acts and transactions regardless of when they occurred, but do not apply to legal proceedings or demands commenced on or before February 17, 2025.

On February 27, 2026, in a unanimous 37-page opinion, the Delaware Supreme Court upheld the constitutionality of significant changes to the Delaware General Corporation Law (DGCL) enacted in March 2025 via Senate Bill 21 (SB 21). This decision permits Delaware corporations and their advisers to confidently rely on these amendments for transactions with interested fiduciaries (including controlling stockholders), thereby increasing transaction planning flexibility and certainty while decreasing litigation risk under Delaware law.

Background of SB 21

As previously discussed in this Sidley Update, SB 21 provided greater statutory clarity in a number of important areas that had been the subject of common law development. It amended Section 144 to, among other things, create new statutory safe harbors for transactions with interested fiduciaries, including controlling stockholders. Although these safe harbors are akin to previously existing common law standards, they reflect important changes thereto that decrease transaction planning risk beyond those prior tests. These include (i) offering safe harbor protection in all interested-fiduciary transactions (except for going private transactions) by the use of either disinterested committee/director approval or a majority-of-the-minority vote (not both), (ii) incorporating a definition of “controlling stockholder,” and (iii) codifying standards for director independence and disinterestedness. SB 21 also amended Section 220 to clarify the scope of books and records inspections. These changes applied retroactively to all acts or transactions whether occurring before, on, or after enactment, subject only to a carveout for litigation commenced or demands made before February 17, 2025 (when SB 21 was announced). The constitutionality of the Section 144 amendments, and their retroactivity, was promptly challenged.

Constitutional Questions and Answers

In Rutledge v. Clearway Energy Group LLC, No. 248, 2025 (Del. Feb. 27, 2026), the Delaware Supreme Court considered two constitutional challenges to Section 144, focused on its safe harbor provisions and retroactive application. It rejected both.

1. First, the Delaware Supreme Court held that Section 144’s safe harbors, which preclude equitable relief and eliminate damages claims against fiduciaries, do not improperly limit the Court of Chancery’s equity jurisdiction.

Highlighting the Delaware General Assembly’s long-respected and regularly employed legislative power to amend the DGCL, including in response to common law developments, the Delaware Supreme Court held that the Court of Chancery was not improperly divested of its equitable jurisdiction via SB 21’s amendments to Section 144. The Supreme Court reasoned that the Court of Chancery remains empowered to adjudicate fiduciary duty claims and to determine whether the prerequisites for the safe harbor protections in Section 144 are achieved. Although two remedies previously available to the Court of Chancery — equitable relief and awards of monetary damages against directors, officers, controllers, or control groups — are now unavailable where the Section 144 safe harbor prerequisites have been met, the Court of Chancery retains jurisdiction over fiduciary duty claims. The Supreme Court viewed SB 21 as “a legitimate exercise of the General Assembly’s authority to enact substantive law that, in its legislative judgment, serves the interests of the citizens of our State.”

2. Second, the Delaware Supreme Court held that the retroactive application of SB 21 to transactions occurring prior to its enactment does not violate due process by eliminating vested fiduciary claims.

The Delaware Supreme Court held that SB 21’s retroactive application does not extinguish vested rights of action in a manner violative of constitutional due process rights. The Delaware Supreme Court questioned the premise that Rutledge had a vested property right prior to SB 21’s enactment because his interest was more in the form of an “anticipated continuance of” existing law. But it concluded that even assuming he had such a right, the Delaware General Assembly clearly intended that the statute apply retroactively and “exercise[d] its legislative authority in conformity with the dictates of due process” by crafting a statute reasonably related to a legitimate objective. As a result, SB 21 does not strip away vested claims in violation of due process and will apply equally to all acts and transactions on or before February 17, 2025, unless already then subject to an action, proceeding, or demand.

Key Takeaways for Boards and Dealmakers

Safe Harbor Certainty

First and foremost, Clearway preserves SB 21’s empowerment of disinterested decisionmakers to protect investors in transactions with interested fiduciaries. Corporations engaging in transactions with fiduciaries may confidently rely on the safe harbor frameworks in Section 144, which will continue to increase predictability and flexibility in corporate dealmaking while reducing litigation risk. Significantly, transaction planners can be confident that any act or transaction involving an interested director, officer, controller, or control group (other than a going private transaction) may be cleansed by either a special committee approval or by a majority-of-the-minority stockholder approval. Although Clearway settles SB 21’s constitutionality, all corporate law statutory frameworks necessarily reflect some degree of unpredictability when first enacted that will be reduced over time through case law development.

Compliance and Documentation

Parties and practitioners should take into account these amendments and design transactions to fit within Section 144’s safe harbor protections to avoid potential application of the “entire fairness” standard of review. Corporations and their counsel should continue to deploy best practices to monitor and carefully document compliance with the contours of the safe harbors. Some key areas for monitoring and documentation include:

• analysis of the disinterestedness of decisionmakers;
• disclosure of all material facts to disinterested directors;
• processes supporting a “good faith” approval of any such transaction by disinterested directors “without gross negligence”; and
• disclosure of material facts in connection with any disinterested stockholder approval of a transaction.

Reincorporation Considerations

Underpinning the Delaware Supreme Court’s constitutional analysis was a deep deference to the Delaware General Assembly’s ability to amend (often swiftly) Delaware’s corporate law statutes. The decision therefore bolsters one of the reasons many corporations have chosen to incorporate in Delaware: a fast-acting and responsive legislative branch. The substance of SB 21 is likewise an important consideration in any reincorporation discussion, because the Section 144 amendments provide a roadmap for transaction planners to follow that reduces unpredictability and overall litigation risk, although we anticipate that litigation challenges will be brought to develop the contours of the statute’s application.

In more challenged private company financing environments, down rounds (i.e., an equity financing at a lower valuation than a prior equity financing) often go from a relatively uncommon occurrence to a more common aspect of many growth equity and venture capital financings. The interrelated impact of geopolitical and macroeconomic events such as valuation resets from post-pandemic highs, public and private market liquidity constraints, prolonged fundraising cycles, and shifts in bargaining power can have profound effects on growth equity and venture capital financing dynamics, making down rounds and valuation pressure more common. Down rounds have significant implications for all participants in the venture ecosystem: founders and management teams, investors, employees, and fund limited partners.

This article focuses on the basic mechanics of conversion price-based anti-dilution protections for convertible preferred stock. Anti-dilution protections need to be considered in the context of the impact on the pricing of the down round in question, and also on the potential impact of future adjustments.

Anti-Dilution Protections

In any equity financing, two types of dilution can occur when a company issues new shares: (1) percentage dilution occurs because the issuance increases the number of outstanding and fully-diluted shares, reducing an existing holder’s ownership percentage if that holder does not maintain their ownership percentage through additional investment, and (2) economic (or price) dilution occurs when a company issues shares at a price that is lower than the conversion price applicable to an investor’s shares, reducing the value of that investor’s position on an as-converted basis.

The conversion price-based anti-dilution protections discussed below are intended to mitigate economic (or price) dilution and the resulting percentage dilution on an as-converted basis. Investors may also help protect against percentage dilution through preemptive rights, which can permit pro rata participation in later financings, whether those are up rounds or down rounds.

Below is a simple illustration of how dilution can occur:

• Before a down round, if Investor A purchased 2,500,000 shares of convertible preferred stock at a price of US$5 per share, and after that financing there were 10,000,000 shares of the company outstanding, Investor A’s US$12,500,000 investment would represent a 25% ownership stake in the company.
• In the down round, the company sells 5,000,000 new shares to investors (other than Investor A) at a price of US$4 per share.
• Following the down round, Investor A continues to own 2,500,000 shares of convertible preferred stock, now out of 15,000,000 outstanding shares of the company, representing a decreased ownership stake in the company of 16.67%, valued at approximately US$10,000,000.

To help protect against the scenario above, Investor A would typically have negotiated for price-based anti-dilution protection when it originally purchased its convertible preferred shares. In a down round, these protections operate to adjust Investor A’s conversion price and therefore the rate at which those shares ultimately convert into common stock. There are two main types of conversion price-based anti-dilution protection: (i) full ratchet and (ii) weighted average.

Full Ratchet

While less common in practice, there has been an increased use of full-ratchet anti-dilution protections to bridge valuation gaps (sometimes, with a sunset date). When used, they can have a profound impact on down-round financing. With full ratchet anti-dilution protection, the conversion price applicable to Investor A’s convertible preferred shares is reset to the new lower price per share from the down round (which is US$4 in the example above), meaning each preferred share from then on would convert into 1.25 shares of common stock.

Now, as a result, if those preferred shares convert, Investor A would own 3,125,000 shares of common stock out of 15,625,000 outstanding shares, meaning Investor A would therefore have a 20% ownership stake (which is less than Investor A’s initial 25% stake, but greater than the 16.67% stake Investor A would have been left with without this full ratchet protection).

Full ratchet protection is not common, but when it does exist, the resulting impact in a down-round financing can be profound.

Weighted Average

Weighted-average anti-dilution protection is far more customary. With weighted-average anti-dilution protection, a formula is used to determine a new conversion price that will apply to existing preferred shares following a down round:

• New Conversion Price = Old Conversion Price * [(X + Y) / (X + Z)]
  • X = the number of shares outstanding on a fully-diluted basis before the down round.
    • Note that the nuances of the X variable are sometimes negotiated, with a company preferring a broader approach (often referred to as the “broad-based” weighted-average formula) that includes all shares on a fully diluted basis, and an investor preferring a narrower approach (often referred to as the “narrow-based” weighted-average formula) that excludes certain types of derivative shares such as options and warrants. The broad-based weighted-average formula is more commonly used.
  • Y = the number of shares that would have been issued to new investors in the down round had the full investment been made at the old price per share (which is US$5 in our example above).
  • Z = the number of shares issued to new investors in the down round at the new price per share (US$4 in our example).

In our example, the resulting math would be:

New Conversion Price = US$5.00 * [(10,000,000 + 4,000,000) / (10,000,000 + 5,000,000)]

• US$5.00 * [(14,000,000) / (15,000,000)]
• US$5.00 * [0.933]
• US$4.67

Under this approach, the adjusted conversion price applicable to Investor A’s convertible preferred shares is now US$4.67, meaning each of Investor A’s preferred shares is convertible into 1.07 shares of common stock.

Now, if those preferred shares convert, Investor A would own 2,675,000 common shares out of 15,175,000 outstanding shares, meaning Investor A would therefore have a 17.63% ownership stake (which is less than Investor A’s initial 25% stake, and less than the 20% stake Investor A would have had with full-ratchet protection, but more than the 16.67% stake that would have resulted without any protection).

Economic Dilution

As mentioned above, conversion price-based anti-dilution protections are designed to reduce the impact of percentage dilution, but they also mitigate economic dilution. Continuing with our example:

• Before the down round, the value of Investor A’s as-converted stake in the company was US$12,500,000.
  
  • Value = (Price Per Share * Number of As-Converted Shares)
    
    • (US$5.00 * 2,500,000)
    • US$12,500,000

• Without any anti-dilution protection, the value of Investor A’s as-converted stake in the company would drop to US$10,000,000.
  
  • Value = (Price Per Share * Number of As-Converted Shares)
    
    • (US$4.00 * 2,500,000)
    • US$10,000,000

• With full-ratchet anti-dilution protection, the value of Investor A’s as-converted stake in the company would remain US$12,500,000.
  
  • Value = (Price Per Share * Number of As-Converted Shares)
    
    • (US$4.00 * 3,125,000)
    • US$12,500,000

• With weighted-average anti-dilution protection, the value of Investor A’s as-converted stake in the company would drop to US$10,700,000 instead of US$10,000,000.
  
  • Value = (Price Per Share * Number of As-Converted Shares)
    
    • (US$4.00 * 2,675,000)
    • US$10,700,000

Down Round Pricing Must Be Modeled Holistically

These anti-dilution mechanics may be familiar to and understood by most management teams, investors, and advisors, but the practical implications are often not as straightforward. In practice, the negotiated enterprise value, or pre-money valuation, of a company is typically set at the outset of a negotiation, but the resulting per-share price often is not. The per-share price must generally be solved for after giving effect to anti-dilution adjustments, any option pool increase, and the resulting post-closing capitalization. When solving for this price per share, if anti-dilution adjustments would be triggered, the result is that the end-result number of as-converted shares outstanding will be higher than otherwise, which can prompt an iterative calculation. The end-result number of as-converted shares outstanding, and therefore the preferred price per share, must be solved for again.

Existing investors’ anti-dilution protections typically create a direct economic tension with the investors proposing to lead the down-round financing. This is because new investors typically bargain for a specified ownership percentage and expect their investment to buy it. Existing investors may seek to maximize the value of their anti-dilution adjustments. Common stockholders and other unprotected holders, including management and employee option holders, end up bearing much of the resulting dilution and often are most heavily “crammed down.” On the other hand, existing and new investors typically want to ensure that the management team is protected and appropriately motivated, so the option pool increases, the number of end-result fully diluted shares outstanding again changes, and the entire iterative calculation dance begins again. Add in the fact that many down rounds are led by some subset of existing investors, and the tension around the per-share price calculations increases further.

Because of these dynamics, down-round pricing should not be modeled by simply picking a per-share price. Instead, the agreed pre-money valuation, anti-dilution adjustments, option pool increase, and post-closing ownership targets should be modeled together and holistically to ensure that the intended transaction is delivered.

Discussions over a down-round transaction often expand well beyond pricing mechanics and can raise questions about participation, including the potential emergence of a pay-to-play dynamic, board fiduciary duties, voting power, minority equityholder protections, contingency planning for future financing, potential waivers of anti-dilution protections, control-investor risks, the consent process, and the consensus-building required to secure key approvals.

In Fortis Advisors v. Krafton, the Delaware Court of Chancery awarded a striking equitable remedy: it ordered the reinstatement of a CEO who was wrongfully terminated using a strategy developed with ChatGPT, and extended the earnout period by the full duration of his improper exclusion. The buyer had used AI to strategize avoidance of a US$250 million earnout, but because that advice was generated outside the attorney-client relationship, it was not privileged and became damning evidence at trial. The decision puts buyers on notice that depriving seller-managers of bargained-for post-closing operational control may result in not just damages, but equitable remedies that restore control and reset the earnout clock.

For companies considering an IPO, relationships with investment bankers should often begin well before the company formally mandates its IPO syndicate. Early banker relationships can provide valuable market perspective while there is still time to act on it — helping companies understand how public investors may view the business, pressure-test the equity story, and identify issues that may matter when an IPO becomes more immediate. As the IPO becomes more concrete, the relationship should evolve from market intelligence and relationship-building toward positioning, syndicate selection, and execution. The takeaway: engage with bankers early; formally mandate them later when the company is ready to pursue an IPO.

The Stages of Banker Engagement

Companies often think about engaging bankers as a discrete step in the IPO process — running a “bake-off,” selecting the syndicate and moving toward an organizational meeting. But the most productive banker relationships often begin much earlier. The purpose of those relationships, however, should change as the company moves closer to a potential IPO.

Relationship-Building (as early as 24–36 months out)

For many high-growth companies, banker relationships begin years before a potential IPO. At this stage, there is no mandate to award and no syndicate to construct. The objective is to develop relationships with a thoughtful group of bankers and to leverage their perspective to understand how the public markets are likely to view the company.

Bankers can be a valuable source of market intelligence during the pre-mandate period. They can provide periodic market and valuation perspectives, invite management to industry conferences, make introductions to potential investors, and help management understand how the public markets are likely to frame the business. These interactions also give bankers an opportunity to develop their understanding of the company well before they are competing for a formal role. Just as importantly, the company can use this period to assess various banks over a long horizon, rather than solely in the compressed setting of a formal pitch process.

This early dialogue can be particularly useful because the feedback comes while there is still time to act on it. Bankers may identify a disconnect between the companies that management views as peers and the comparables public investors are likely to use, a KPI that investors will expect but the company does not yet track rigorously, or an aspect of the business model that may require additional explanation or proof. Receiving this feedback early is important because some issues require time, not simply better messaging. For example, it requires time to build the systems that produce key metrics reliably, quarter after quarter, such that at the IPO the company can present multiple years of history against the very measures investors will use to value it. More broadly, early feedback can help management identify a weakness in the equity story — or in the business itself — while management still has time to address it. The goal is not to let bankers author the company’s strategy or equity story, but to use their perspectives to distinguish a messaging issue from a business issue early enough to address either. Companies should also develop relationships across several banks: each bank’s perspective naturally reflects its own franchise, coverage, and views of the market and triangulating among them can provide better intelligence than relying on any single relationship.

Testing the Story (roughly 12–24 months out)

As an IPO becomes a more realistic near- or medium-term objective, banker interactions should become purposeful and market-facing. Bankers can help companies deepen relationships with research analysts and begin appropriate investor education, including through bank-sponsored conferences, non-deal meetings, and, where relevant, late-stage or crossover financings. This engagement is best intensified once a company has genuine visibility into a potential IPO horizon, rather than merely the aspiration to go public. The objective is not simply earlier or greater exposure, but appropriately timed engagement once the company is ready to benefit from — and make a strong first impression in — those interactions.

One of the most consequential relationships is with research analysts. The investment banking team’s role is concentrated in the offering itself; the research analysts who cover the company will remain part of its public-market life for years afterward — publishing estimates, framing quarterly results, and interpreting the company’s strategy and performance for institutional investors. Their sector standing and understanding of the company can meaningfully influence how the company is understood in the public markets following the IPO. Prior to mandating the banks, conversations with research analysts can be genuinely two-way, including by analysts sharing perspectives on the sector. Once banks are formally mandated and an offering process is underway, analyst-independence rules effectively make these interactions one-directional. Nevertheless, even in the pre-mandate period, these conversations should be structured with care and should not extend to valuation or to any bank’s pursuit of an underwriting role, both to preserve analyst independence and to avoid complicating the process later.

In addition, bankers can help build investor familiarity before a formal IPO process begins. Once the process is underway, investor communications become significantly more regulated — and as a practical matter, the quiet-period and “gun-jumping” constraints of the federal securities laws generally begin to attach around the time underwriters are formally mandated, well before any public filing — and investor education is compressed into a limited series of interactions, including testing-the-waters meetings and the roadshow. Investors who already understand the company, its business model, and the key drivers of its financial performance are better positioned to use those interactions to evaluate the equity story and valuation, rather than learning the business for the first time. Bank-sponsored conferences, organized investor meetings, and other appropriate investor-education opportunities allow management to build that familiarity while also giving management an earlier view into the questions public investors actually ask before formal testing-the-waters meetings and the roadshow.

Earlier engagement, however, should not be confused with casual engagement. A premature meeting can be counterproductive: first impressions can be difficult to reverse, and investors and analysts do not simply forget information or expectations communicated in earlier interactions. Companies should think about consistency across private financing materials, investor communications, testing-the-waters materials, and ultimately the registration statement, rather than treating each interaction as a standalone conversation. Information shared in private financings or other pre-IPO interactions can also create legal and practical issues later in the process — for example, projections or other material nonpublic information provided to an investor can complicate that investor's participation in a subsequent IPO if the information remains material nonpublic information. These interactions also consume management attention that may be better spent building the business if an IPO remains too remote. Early outreach should therefore be deliberate, appropriately structured, and coordinated with securities counsel.

The Mandate and IPO Execution (roughly 8–12 months out)

The formal mandate marks the transition from pre-IPO engagement to execution of the IPO itself. As an IPO becomes an execution priority, companies typically conduct a competitive “bake-off” and formally mandate their lead bookrunners. The organizational meeting then kicks off the IPO-specific workstreams, including preparation of the registration statement, valuation and positioning, testing-the-waters and investor education, analyst preparation, roadshow planning, and, ultimately, pricing, allocation, and distribution.

From that point, the banks become part of the core working group and are actively involved in the IPO-specific workstreams. They are closely involved in drafting the registration statement — particularly the business and marketing sections that carry the equity story — and in translating that story into the framework investors will use to evaluate the offering. They lead investor education: identifying the institutions best positioned to anchor the order book, arranging testing-the-waters meetings, and synthesizing investor feedback into refinements of positioning and, ultimately, valuation. And they drive the offering's rhythm — advising on when to convert the confidential submission to a public filing, when to launch the roadshow against the market backdrop and the competing IPO calendar, and how to sequence analyst preparation alongside the offering itself. As a result, banks are typically one of the first groups of advisors formally engaged for an IPO process.

Bank selection should reflect more than proposed valuation or league-table position. Companies should consider the strength and availability of the specific team that will staff the transaction, relevant sector experience, distribution capabilities, and — importantly — the research analysts. Syndicate size and composition should also be deliberate. A broader syndicate can expand distribution and prospective research coverage, but additional banks add coordination and dilute economics and attention across the group. Companies typically select the lead bookrunners at the mandate and add other bookrunners and co-managers later, allowing the core working group to remain relatively small during the early stages of execution.

For private companies backed by venture capital investors, acquisition is frequently the most likely path to liquidity. Founders are often laser-focused on product development, market expansion, and fundraising, without devoting the same early-stage discipline to ensuring the company is well-positioned for a future exit via a merger or acquisition.

M&A preparedness is not a late-stage exercise, but an operational strategy to position your company as an attractive, high-value target to potential acquirors.

Corporate Governance

Some of the most common obstacles to efficient M&A processes stem from issues related to corporate governance. Complex capitalization tables, unclear chain of equity ownership, and unresolved governance issues can create transaction delay and, depending on the structure of the transaction, loss of leverage.

Companies should consider focusing on three key areas of corporate governance to be prepared for future M&A processes: capitalization table discipline, stockholder rights, and board and stockholder alignment.

Capitalization Table Discipline

Maintain clear documentation of all equity issuances with proper board and stockholder approvals; confirm board minutes are complete, approved by the board, and signed; verify that 83(b) elections have been timely filed with respect to restricted stock grants to founders and early employees; and ensure 409A valuations are updated following major events that may impact valuation (such as a financing) and, absent such events, at least annually.

Stockholder Rights

Ensure all stockholders have signed the relevant stockholder agreements and that the company’s management team understands the protective provisions embedded within such agreements; similarly, ensure that the company’s management team is familiar with relevant provisions of any investor side-letters (think drag-along mechanics, rights of first refusal, and co-sale rights).

Board and Stockholder Alignment

Understand what approvals are required to approve a sale or merger of the company and whether any investor has blocking rights.

Contracting Discipline

Material contracts, such as key vendor and customer agreements, collaboration agreements, and licensing arrangements, are some of the first diligence requests in an M&A process. These contracts often contain assignment or change-of-control provisions that can require third-party consent, accelerate payment obligations, or trigger termination rights or other contractual rights that could significantly impact the trajectory of a deal. Accordingly, it is important for companies to maintain clear records of all material contracts, ensuring that all contracts are fully executed and include all attachments, exhibits, amendments, and restatements. Companies should track whether any material contracts have upcoming renewals or expiration dates. Additionally, tracking key provisions in such material contracts that may be triggered by an M&A (such as third-party consent requirements) will help streamline the M&A diligence and consent process.

Intellectual property is another value-driver for life sciences companies and technology companies, making it vital for companies to have documentation that clearly delineates intellectual property ownership. Companies should verify that all employees and contractors have signed Proprietary Information and Inventions Assignment Agreements (PIIAAs), review consulting agreements to confirm that intellectual property created by consultants/contractors has been validly assigned to the company, and obtain confirmatory assignments from founders and early contributors, if needed, and at the appropriate time. For companies with affiliated entities, confirm that the company’s core intellectual property assets sit within the target entity and not within any affiliated entities.

Being proactive can save time and expense during the M&A diligence process.

Regulatory Compliance

Depending on industry and geography, regulatory risk can become a gating diligence issue. Companies should identify areas of risk and preemptively resolve any outstanding compliance risks (e.g., data integrity, marketing, industry-specific licensing, etc.). In particular, life sciences companies should consider pursuing regulatory planning with the assistance of healthcare and/or FDA counsel (as needed) to ensure, among other things, that regulatory filings, communications, and approvals are complete and accessible.

Deal Team Preparation

Once the company has decided to start a sale process, identify at the outset who will be part of the core deal team, which will typically consist of a select number of employees and outside advisors. Members of executive management and other key internal personnel with specialized knowledge about the company’s corporate governance, labor and employment practices, employee benefits structure, assets (IP, real estate, etc.), litigation exposure, and regulatory compliance are typically included within the core deal team. Further, at the appropriate time, companies should engage outside advisors, such as outside legal counsel, financial/tax advisors, and investment bankers, all of whom can help quarterback the transaction and efficiently drive the deal process.

After the deal team is in place, consider implementing deal confidentiality procedures to maintain the integrity of the sale process:

• assign code names to the project and company participants;
• limit working group size and access; and
• consider antitrust issues and the use of “clean team” agreements and data rooms.

Data Room Readiness

Prepared companies treat diligence readiness as an ongoing process and not an exercise triggered by a letter of intent or term sheet. First, select a virtual data room that provides strong security and activity tracking. Second, build the company’s data room with organizational discipline, using logical folder structures (corporate, IP, finance, regulatory, benefits, etc.) and uploading documents in a searchable, digital format with consistent document naming conventions. Lastly, in connection with building the data room, flag with the guidance of deal counsel any confidentiality concerns and access restrictions that need to be put in place. For example, are there any documents that need to be redacted or anonymized? Does the transaction present antitrust sensitivity requiring documents to be shared through a “clean room”?

In all, a well-maintained and categorically organized data room significantly accelerates a sale process and signals sophistication to potential acquirors.

The most successful exits rarely begin when a banker is engaged. Ideally, they begin years earlier with strategic and operational foresight. Companies that understand the value of M&A preparedness can preserve negotiation leverage and act more decisively when M&A opportunities arise. After all, engineering an exit is more than closing a deal — it is positioning the company so that the right deal finds you.

Whether a company is gearing up for an acquisition, a growth equity financing, or an IPO, a due diligence review will be an inevitable part of that transaction, and that review will test not only the current business but also the integrity of a company’s historical records. Readiness for that review is critical, as once a diligence process begins, gaps in corporate approvals, equity records, contract management, intellectual property ownership, and regulatory compliance can quickly become leverage for purchase price adjustments, closing conditions, and/or special indemnities. At best, diligence gaps can consume management attention at a time when a company has little bandwidth to spare. At worst, they can detract from a company’s credibility and can have a meaningful impact on deal speed and certainty. Most issues are fixable, but the available solutions often narrow after a deal is already on the table. This article provides an overview of actionable steps leadership at mid- to late-stage private companies can take to make transaction readiness an ongoing discipline rather than a pre-signing scramble.

Set Up and Maintain a Virtual Data Room

Rather than waiting until a letter of intent is signed, companies should stand up and maintain a virtual data room (VDR) early, using records they already keep locally, and treat it as a living repository of critical corporate documents. Management teams that prepare to address anticipated diligence focus areas and maintain organized virtual records early are better positioned when a process launches than teams that start flat-footed. Companies can get a head start by asking outside counsel for a standard due diligence request list, which serves as an organizational and gap-identification tool, as well as an organized table of contents for their VDR. This ensures that documents are comprehensive and indexed by categories prospective investors and acquirers will expect.

The VDR should contain current, fully executed, and dated documents together with all amendments, statements of work, and side letters. Superseded and terminated agreements should be archived, not deleted or mixed with operative versions. One small but time-saving step in setting up a VDR is using a consistent and intuitive naming convention as documents are uploaded, which will help not only management but also third-party reviewers quickly navigate the VDR’s contents. Once a diligence process begins, access should be staged and subject to tiered permissions, with additional controls for competitively sensitive information, compensation data, and litigation files; privileged materials should be withheld or handled through a process designed to preserve privilege. Particularly when a potential buyer is a competitor, or when the underlying material is subject to confidentiality restrictions that do not permit sharing with a potential acquirer or investor, counsel should advise prior to upload and contemplate redactions, clean-team arrangements, and restrictions on downloading or printing. When in doubt, leave it out; it is easier to pause early and evaluate permissions and other protections than to pull back a document after it has been shared.

A word of caution: prospective investors now run AI review tools that can scan an entire data room in minutes, and while that process can generate false positives, it can also magnify every internal inconsistency across the VDR, including in the cap table, contracts, and other materials. As a best practice, keeping the VDR updated quarterly helps identify issues early and positions the company and management to earn credibility from the moment that transaction diligence begins.

Maintain a Corporate Record Book and Organizational Documents

M&A buyers and growth equity investors will expect clean and current corporate governance records. This means prospective investors will review: current versions of the certificate of incorporation (including all amendments) and bylaws; board and stockholder minutes; and fully executed, dated written consents. An improperly compiled consent with a missing signature page or date can cost the company meaningful time and resources to track down or, worse, require corrective action to cure. Every material corporate action should tie out to a corresponding board and/or stockholder approval, including equity issuances, option grants, director and officer elections, and subsidiary formations.

Companies should also at least annually confirm good standing in their state of incorporation and in every jurisdiction in which they are qualified to do business. Outside counsel can obtain verbal good standing confirmations from third-party service providers, often for a nominal or no cost to the company. Good standing lapses can trigger fees, taxes, and penalties and, in many states, can bar the company from bringing suit in local courts until the lapse is cured, although a lapse does not typically invalidate contracts executed while the company was not in good standing. For an additional layer of caution, companies can consider ordering lien and litigation searches from third-party service providers in the same set of jurisdictions.

Ensure Vigilant Capitalization Table Hygiene

The company should expect buyers or investors to request a current copy of the capitalization table and, in the case of an equity financing, a pro forma cap table reflecting the completed round. Most cap table hygiene issues exist well before a contemplated transaction and surface in the diligence process. Common hiccups include unsigned option grants, undocumented stock issuances, unrecorded convertible note draws, and inconsistencies between vesting schedules and employment terms. Cap table accuracy is key: a company’s representations about its capitalization are often treated as fundamental representations, giving buyers or investors the ability to claim breach even for minor discrepancies. Moreover, a messy cap table can be perceived as poor ownership discipline by the company or its management.

With assistance from outside counsel, the company should reconcile the cap table against the stock ledger and equity grant documentation, ensuring that every stock and option issuance is supported by board resolutions, grant agreements, evidence of payment of the exercise or purchase price, and, if applicable, an approved, unexpired equity incentive plan. Each option grant should also be supported by a current 409A valuation that supports the board’s determination of the fair market value of the underlying shares.

Importantly, companies should develop a clear understanding of how antidilution provisions operate and how change-of-control acceleration clauses (single-trigger and double-trigger) may affect the equity/distribution waterfall in a transaction. Modeling these scenarios in advance allows management to communicate the deal economics clearly to all stockholders and avoids last-minute surprises that can derail negotiations.

Understand Key Provisions in Material Contracts

Counsel for buyers and investors will expect the opportunity to review each contract that is material to the business. These typically include: contracts with key customers and suppliers above certain revenue or expense thresholds; license agreements; leases; employment and severance agreements with key personnel; and other contracts that are important to the business. These contracts often contain change-of-control consent triggers, rights of first refusal, out-licensing restrictions, most favored nation provisions, exclusivity, non-solicit, non-compete, and other restrictive covenants. In certain circumstances, a counterparty may have a notice, consent, or termination right in connection with a transaction. Accordingly, with the help of outside counsel, a company should be generally aware of which key agreements contain those provisions and should have a plan for obtaining consents or providing timely notice in advance of entering into a transaction process. Seeking consent late in the process can give leverage to the counterparty, which can increase overall costs and decrease deal certainty.

Confirm Intellectual Property Ownership and Assignment of IP

Depending on the company’s core business, clean IP title is often a significant driver of the diligence process. One consideration that comes up time and again is whether every founder, employee, and contractor who contributed to the company’s IP portfolio has executed an invention assignment agreement that assigns all intellectual property rights to the company. It isn’t uncommon for advisors and early contributors in early-stage companies, often compensated in equity, to miss the assignment paperwork altogether, or to execute, but not date, the assignment. Any gaps in assignment should be addressed ahead of the buyer or investor diligence process, which can be done with the help of outside IP counsel. Companies should also routinely conduct an audit of open-source software usage to confirm compliance with applicable license terms.

Maintain Compliance with Industry-Specific Regulatory Requirements

Companies operating in regulated industries, such as healthcare, financial services, energy, and government contracting, should confirm that all material licenses, permits, and registrations are current and in good standing. Identifying regulatory approvals or notices that would be required in connection with a change-of-control or assignment of a license can avoid an additional layer of investor diligence caused when gaps are identified later in the deal negotiation process. Regulatory non-compliance discovered during diligence can significantly delay closing or reduce deal certainty.

In an IPO, due diligence is best understood as the working group’s disciplined effort to (1) identify and assess potentially material issues in the company’s business, history, and financial reporting, (2) translate those issues into accurate and appropriately balanced disclosure in the prospectus and related offering communications, and (3) pressure-test factual assertions so the offering record can be supported if challenged later.

A thorough due diligence investigation is designed to identify not only “problems,” but also facts that could disappoint investors if they emerge later without having been fairly described. Because an IPO is often the first time a company describes its business, results, and risks in significant detail, investors rely heavily on the prospectus as the principal disclosure document when evaluating the company and the investment.

The Due Diligence Investigation Runs from Day 1 Through Pricing and Closing

Companies should begin preparing their documentary data room in advance of kicking off an IPO process by identifying employees with subject matter ownership and assigning responsibility for collecting the relevant materials. Documents should flow to a single point of contact who will ensure materials are loaded into an organized virtual data room.

At the organizational meeting, having a substantially complete data room enables the working group to begin immediately and complete initial document review earlier, allowing diligence to run in parallel with drafting. This helps avoid a common frustration: marketing-forward disclosure drafted early in the process later must be rewritten based on diligence findings. Ideally, the working group incorporates diligence input as the disclosure is developed.

While the most intensive diligence typically wraps up around the initial SEC submission or filing, the work needs to continue through pricing and closing (including effectiveness and any bring-down diligence). New disclosure added in subsequent filings should be vetted, and new information and documentation should be added to the data room on a rolling basis. Maintaining an open issues log, with clear owners, next steps, and deadlines, helps avoid last-minute diligence scrambles that can disrupt the timing of amendments and the overall IPO schedule.

No Surprises

While it may not be enjoyable to share all of the company’s more challenging issues, companies should strive to ensure that underwriters’ counsel is not learning about issues for the first time late in the process. Early identification and resolution also avoids a common dynamic: issues are significantly easier to manage if the company or its counsel shares relevant details early, along with appropriate context, so that matters can be evaluated and framed appropriately from the outset.

This approach also protects against “over-reactions,” where diligence counsel believes it has identified a significant issue and therefore expands review and follow-up. That dynamic can devolve into time-consuming exercises and unnecessary “all-hands” calls, often avoidable where the issue was presented proactively rather than discovered.

Create a Record and Document Support

A thorough diligence record maintained by counsel helps to track progress, monitor efficacy, and create an audit trail in case of a later challenge.

Counsel should maintain a back-up book linking factual statements in the prospectus to supporting sources. Subject matter owners at the company should prioritize responsiveness to support requests and avoid treating the process as a check-the-box exercise.

The process itself should also be documented. Counsel can circulate written questions for diligence calls in advance and cover those questions on the call. A memo should capture attendance, and follow-up items should be tracked to resolution. The open issues log should be shared among the company, its counsel, and underwriters’ counsel and updated regularly.

Don’t Rely on the “Belief” Crutch

One of the most repeated phrases in an IPO prospectus is “we believe.” A statement of belief can be an appropriate way to express judgments or expectations that cannot be definitively verified, and it can help avoid overstating certainty. However, a belief qualification is not a free pass to make claims that are not supportable. Where management expresses a belief, there should be a reasonable basis for that belief and the diligence process should confirm that basis exists and that the disclosure is appropriately calibrated.

For example, a biotechnology company developing a new drug may state in the prospectus: “We believe our product candidate may offer clinically meaningful benefits to patients.” While there may not yet be clinical data demonstrating that outcome, there should be a sound scientific rationale and supporting pre-clinical evidence that provides a reasonable basis for the statement as framed.

Check with Experts

Counsel will review large volumes of material as part of the investigation, but that does not guarantee the working group will fully understand highly technical, specialized, or cutting-edge topics. In appropriate cases, diligence should include calls with relevant subject matter experts (whether technical, regulatory, cybersecurity, accounting, tax, or otherwise) to ensure the record supports the disclosure.

Diligence is More Than Lawsuit Avoidance

A properly conducted due diligence investigation can reduce the likelihood of securities claims for IPO participants. It cannot eliminate the possibility of litigation, but a thorough process can create a defensible record for those who may need it.

The credibility of the working group is also at stake. Underwriters care deeply about successful offerings. Their reputation is their biggest asset and missed diligence issues can cause real reputational harm.

More broadly, accurate IPO disclosure is a long-term asset. Companies will live with their disclosure regime as public companies, updating it regularly under ongoing investor scrutiny. Strong diligence helps public company executives spend more time executing their strategy and less time responding to avoidable surprises.

Moving ahead with an IPO is a major commitment of time and resources. The companies that execute efficiently are the ones that start managing the process well before the organizational meeting by building a realistic base-case timeline, staffing internal owners, and making a small set of initial decisions that drive the critical path.

Construct the Base-Case Timeline Around Key Milestones

A useful approach is to anchor the company’s IPO timeline around three broad windows. At the outset, establish a target IPO pricing date and construct the rest of the timeline to make that achievable. Once determined, establish a target date for the initial confidential submission of the registration statement and a date for the organizational meeting.

1. Readiness planning: preparing for the organizational meeting. The company’s approach to readiness planning can either pave the way for a more efficient process or inadvertently create bottlenecks that cannot be fixed on the back-end. The length of the readiness stage can vary, and more time means better preparation. Completing the key readiness workstreams before the organizational meeting is critical to staying on schedule. As part of readiness planning, companies should identify any third-party consents, waivers, or contractual constraints that may require outreach and turnaround time, because those items can create non-negotiable lead times that compress the schedule later.
2. Confidential execution: organizational meeting to initial confidential submission. This is typically the most drafting-intensive period and often drives internal resourcing needs. The company’s internal IPO team will be heavily engaged in the process and the IPO demands effectively create a second job for them on top of their day-to-day responsibilities. It’s critical that the company’s internal and external staffing is fully engaged and prepared following the organizational meeting.
3. SEC process: initial submission to public filing, launch/roadshow, and pricing. Companies have the least amount of control over this period as it depends heavily on SEC comment cadence and market performance. In practice, a slower or more complex SEC comment cycle can require additional confidential submissions and can also create financial statement update pressure as quarters roll, which can affect both timing and workload. Addressing challenging SEC comments is often best handled in the confidential submission process, which typically means additional confidential submissions and more time, putting pressure on hitting a financial statement staleness window. External factors are rarely predictable in advance, so the best planning will get the company to the public filing on time and enable business leaders to make a go-forward decision on the planned schedule.

Even in a well-run process, timelines move. Treat the company’s base case as a model that gets updated as the process evolves from factors that the company can control toward factors that the company cannot control.

Assign Ownership

Effective IPO execution requires effective organization. The plan and a company’s ability to hit its milestones become manageable with clearly defined internal roles and assignments given to those with the time and resources to properly manage them. A few readiness decisions tend to pay outsized dividends:

• Create a small internal IPO working group. This should include key decision-makers and functional leaders with responsibilities that touch upon the IPO process. The working group should stay in close contact through regularly scheduled meetings with internal and outside counsel to ensure accountability and focus on key workstreams.
• Identify subject matter owners for each workstream. Identify an individual to take ownership of each specific subject matter workstream, including communications, data room management, finance, accounting, legal, compensation, IP, tax, and regulatory, and then make them responsible for the day-to-day management of their workstream.
• Designate a lead draftsperson and a master-document process. Working with the company’s outside counsel, determine a drafting plan for the registration statement with an initial focus on the business section, the management discussion and analysis (“MD&A”), and financial statements. Company counsel can draft much of the registration statement, but someone at the company who has (i) an in-depth knowledge of the company’s business and mission, (ii) drafting and management skills, and (iii) time, should take the lead on overseeing the drafting of the business section. Assigning an owner enables narrative coherence that is not possible with multiple people drafting independently.
• Corporate housekeeping. Assign a tech-savvy person to oversee the due diligence document collection system to ensure the data room is complete and organized. This individual can also serve as a documentation coordinator for cap tables, stockholder consents, lockup signatures, public company policies, and employee education materials.

The practical theme: clarity on ownership of workstreams and tasks prevents the “everyone is responsible, so no one is responsible” dynamic that turns into schedule compression later. Each workstream owner should have clear escalation paths and decision rights (or access to decision-makers) to avoid bottlenecks and ensure key decisions are given the right attention and made at the right time.

Hire Advisors

Companies often treat the banking process as a separate track from readiness planning. It is not. Several early choices directly affect the company’s ability to run a controlled timeline:

• Underwriter selection and coverage strategy. Underwriter selection is one of the most important early decisions because it shapes execution roles, staffing, and investor positioning. In evaluating banks, companies should focus not only on senior coverage, but also on (i) sector fluency, (ii) the experience and availability of the day-to-day execution team, and (iii) the bank’s ability to support the company’s investor narrative through launch and aftermarket. A strong execution bench matters because it directly affects cadence, responsiveness, and how efficiently the working group can run.
• Outside Counsel. The IPO is also an opportunity to confirm that the company will have an IPO-ready legal team with the capacity and continuity to run a fast, iterative drafting and diligence process. Regardless of whether the company uses existing counsel or adds new counsel, the key is to ensure the team has deep IPO experience, the right specialist bench, and the ability to maintain a disciplined process from the organizational meeting through pricing and closing.
• Compensation Consultants. Public company executives are compensated differently than private company executives. Compensation committees will insist on getting high-quality input from experienced compensation advisors before making any compensation decisions. Additionally, structuring public company equity compensation plans is a significant and strategic undertaking. These plans require stockholder approval, which becomes significantly more challenging as a public company, so designing and implementing a plan to take effect alongside the IPO is essential and getting the details right will make life as a public company substantially easier. Lining up the company’s compensation advisors early enables them to give the right guidance at the right time.
• Communications/Investor Relations. While much of the IPO process is governed by what companies cannot communicate, developing a public company story and hitting the ground running as a public company with a functioning Investor Relations (“IR”) infrastructure will make the transition significantly easier. Companies will want IR professionals who are familiar with the story and involved in crafting it so that they can communicate consistently and clearly once public.

A good planning posture is to treat “advisor selection” as a gating item: once selected, the team can finalize the calendar, set drafting cadence, and schedule key events (including analyst education and investor-facing prep).

Financial Statements, Accounting, and Controls

The biggest internal constraint on an IPO timeline is the availability of audited financial statements. The SEC has strict rules regarding the inclusion of audited financial statements in registration statements, and missing a filing window before a staleness date can have significant consequences for execution of a timeline.

Key decisions and actions that typically belong in the earliest phase of readiness planning include:

• Audit readiness and Public Company Accounting Oversight Board (“PCAOB”) planning. It’s never too early to have financial statements audited under PCAOB standards. If a company thinks an IPO in the next two years is a possibility, then there should be a plan to produce the financial statements.
• Identify and resolve complex accounting issues. Complex accounting issues will require careful analysis and likely involve working with the national office of the auditor. It’s a time-consuming process both to analyze and resolve the issue and then complete the audit and draft financial statements. For discrete, high-risk accounting judgments, companies, in coordination with auditors and counsel, should consider early on whether SEC consultation or pre-clearance may be appropriate, as unresolved accounting issues can materially disrupt an IPO timeline.
• Internal controls and Sarbanes-Oxley Act (“SOX”) planning. Developing internal controls is an intensive process that requires an experienced staff and implementation of complex enterprise reporting systems that need to be deployed across the organization. Having a team ready to handle the rigors of public company reporting before going public is essential, and the earlier they are involved, the better.

The practical point: if finance readiness lags, everything becomes reactive. The financial statements and controls work cannot be “crammed” without creating risk.

Plan the Drafting Strategy

The best registration statement drafting processes are the ones where the company arrives at the organizational meeting with (1) a solid draft of the business section that will enable productive drafting sessions, (2) draft financial statements, and (3) a clear drafting plan. A few decisions matter disproportionately:

• Business section planning. This is the most time-consuming drafting exercise and will be the focal point of a substantial portion of the drafting sessions. Arriving at the organizational meeting with a draft that has a clear narrative will make those drafting sessions significantly more productive. It is substantially easier to refine a message in a drafting session than to write new text in a group setting.

There are different approaches to producing the first internal business section draft, and it’s a useful exercise to discuss the company’s plans with outside counsel. The main point is to formulate a plan and see it through all the way to the organizational meeting.

• Material contracts and redaction planning. The company will likely need to file certain material contracts with the registration statement and will likely want to redact commercially sensitive or confidential information from those contracts. This requires coordination with the contractual counterparty for review. As this requires divulging IPO plans to a third party, the timing of this outreach needs to be carefully considered, but it cannot be left until the last minute because it can become a negotiation process.
• Collect source material. If the company expects to cite third-party sources (market data, industry reports) or discuss internal, non-financial metrics, the company should start collecting those sources and consider how they will be used and supported. These are all key diligence materials, and maintaining sources while drafting can go a long way toward running diligence in parallel with drafting to avoid rewriting the business section if later diligence doesn’t check out.

Drafting is time-consuming and is often more challenging than expected. Private companies do not have prospectus-ready disclosure, so a significant amount of content needs to be created, and that content needs to live up to intense scrutiny that comes along with strict disclosure liability in an IPO. Early effort makes it less painful.

The timeline benefit is straightforward: once the narrative architecture and key performance indicator definitions stabilize, drafting cycles compress; until then, each diligence issue and SEC comment is more likely to trigger downstream rewrites that consume time and management bandwidth.

Plan Ahead for Communications

IPO communications restrictions and “quiet period” discipline are schedule issues, not merely legal issues. The company’s communications calendar (conferences, investor touchpoints, press, social media, internal communications) can create avoidable friction if not planned early. Communications discipline is a timeline issue because avoidable public statements, inconsistencies, or unsupported claims can force last-minute disclosure revisions or create heightened scrutiny at exactly the point in the process when timing is most sensitive.

A disciplined approach typically includes:

• Build a communications schedule. The schedule should cover all planned external events during the IPO period and the first months as a public company.
• Calibrate investor communications. Work closely with counsel to only communicate what is permitted and supportable, with particular care around the risk that public statements get amplified by analysts. Be mindful of investor and third-party consents and plan outreach that is not too early and not too late.
• Tighten internal communications. Provide appropriate guidance at key milestones to employees (including the first confidential submission and the first public filing). How early to inform the whole company is a judgment call that can vary depending on the size of the company, but in the pre-organizational meeting stage, it is generally advisable to keep IPO plans to those with a need to know.

The planning theme: communications discipline reduces the risk of last-minute issues that force drafting changes or create unnecessary SEC sensitivity.

A Note on AI in the IPO Process

Generative AI can be useful in producing some of the “boilerplate” sections of the registration statement and can be useful in incremental drafting (paragraphs, not pages) using structured source materials in an iterative manner. Any AI-generated drafting should be verified against source materials and the company’s actual records, because speed without substantiation can create avoidable disclosure risk and rework later in the process. For example, uploading one slide from the company’s pitch deck into an LLM and using a thoughtfully constructed prompt can produce one or two paragraphs of prospectus-style disclosure that can serve as a useful starting point for human-powered drafting.

“Conversion” drafting is also becoming increasingly used. For example, summary financial sections or MD&A tables can be populated from completed financial statements using AI tools. These uses build drafting efficiency, but they are not yet (as of early 2026) revolutionary.

Companies should be mindful of confidentiality when using AI and should ensure that employees are using a closed enterprise system and not a public-facing generative AI tool.

Not every liquidity transaction is a “Tender Offer.” Many private company secondary transactions are one-off, individually negotiated sales of shares by a founder, employee, or early investor to a new or existing investor. These transactions avoid much of the regulatory apparatus discussed in our companion article on Tender Offers, but they are far from unregulated and raise their own legal, tax, and practical considerations for the seller, the buyer, and the company.

Secondary Sales vs. Tender Offers

If a secondary transaction does not meet the definition of a “Tender Offer” (a determination made under the Wellman test discussed in another Catalyst article), the Tender Offer rules – including those mandating minimum disclosures, a minimum offering period, withdrawal rights, and others – will not apply. Instead, the terms of each transaction are negotiated between the buyer and the seller, with the company sitting in the middle as the party whose consent is needed and whose stock records must reflect the transfer.

Documentation and Settlement Mechanics

Secondary sales are typically documented in a secondary stock purchase agreement negotiated between the buyer and the seller. Although such agreements typically follow a similar format, they are usually tailored to the transaction at hand, addressing sale mechanics, representations and warranties, waivers and disclaimers, and any additional rights, and they typically feature company consent, the waiver or expiration of rights of first refusal and co-sale rights, and the allocation of transfer costs and taxes.

Settlement mechanics deserve more attention than they often receive. Because private company shares are not held through a clearing system, closing is a coordinated exercise among the buyer, the seller, and the company (or its cap table administrator), and it can get complicated if the seller must first exercise stock options or convert other securities. In that case, the mechanics must often provide an advance of the exercise price to the seller (whether by the buyer or the company), the company’s processing of the exercise, and the calculation and processing of any associated tax withholdings. The agreement should spell out the sequence of events and the responsibilities of each party clearly; note also that option exercises may take several days to process, so the timeline should be clear and precise.

Securities Law Considerations

Exemption from Registration

As these are still transactions in private company stock, they must be conducted in reliance on a valid exemption from the registration requirements of Section 5 of the Securities Act of 1933 (the “Securities Act”). Because the seller is not the issuer, the question is whether the seller can resell its shares without being deemed an “underwriter.” Two approaches have become the most common over the years:

1. The “Section 4(a)(1½)” exemption: Historically the most commonly used exemption, especially prior to the introduction of Section 4(a)(7), this is a product of practice and case law rather than statute. The idea is that a resale by a non-issuer should be exempt under Section 4(a)(1) (which exempts transactions by persons other than issuers, underwriters, and dealers) so long as it is conducted in the manner required of an issuer’s private placement under Section 4(a)(2): generally, a sale to a limited number of sophisticated or accredited purchasers with access to information about the issuer, with no general solicitation and with the purchaser taking the shares for investment. The full list of conditions is longer, and although the Section 4(a)(1½) exemption is typically viewed as a well-trodden path, it requires careful analysis and structuring of each transaction. Note also that there is no statutory safe harbor and no preemption of state blue sky requirements when this exemption is invoked.
2. Section 4(a)(7): Added to the Securities Act by the FAST Act in 2015, Section 4(a)(7) effectively codified the Section 4(a)(1½) exemption into the Securities Act, although it introduced a number of additional requirements (including that each purchaser be an accredited investor, that no general solicitation be used, and that the securities have been outstanding for at least 90 days). Notably, where the issuer is not a reporting company, the seller must make available to the purchaser prescribed information about the issuer, including a description of its business, the names of its officers and directors, and its most recent balance sheet and two years of income statements. Securities sold under Section 4(a)(7) are “covered securities” exempt from state registration requirements, although they remain restricted securities in the buyer’s hands. Section 4(a)(7) was not intended to invalidate the Section 4(a)(1½) exemption when it was introduced and is typically viewed as a more certain path to an exemption for individual secondary transactions.

There are other exemptions that may be available to sellers, including Rule 144, but these are much less frequently used due to compliance complexity and limited availability in light of the typical structure of such transactions.

Antifraud – Rule 10b-5

Secondary sales are frequently marked by an asymmetry of information between the parties. An employee seller may know the company’s operations but not its financing plans; an investor buyer may sit on the board and know both. Whatever the direction of the asymmetry, Rule 10b-5 still applies to the purchase or sale of any security – public or private – and prohibits material misstatements and omissions in connection with the transaction. Insiders who trade with less-informed counterparties while in possession of material nonpublic information face real exposure, as does a company that facilitates such a trade. Parties commonly manage this risk through “big boy” letters and non-reliance provisions, in which each side acknowledges that the other may possess undisclosed material information. These provisions help but are not a complete defense, as their enforceability often turns on the facts and circumstances and their specific wording. As with Tender Offers, any information material to an investment decision should be disclosed to both parties before they commit to the transaction (including by the company, even though it is not a direct party to the transaction).

Corporate Law Considerations

Transfer Restrictions and Protective Provisions

Many VC-backed companies restrict transfers of their shares to third parties. These restrictions typically include a right of first refusal in favor of the company and major investors, co-sale rights, a board consent requirement, and – especially for preferred stock – protective provisions requiring the approval of a majority of the preferred holders for specified actions. Each must be reviewed, waived, or complied with before closing. Protective provisions are easy to overlook: a transfer of shares, a repurchase, or other distribution by the company on account of its stock, or a sale large enough to change the outcome of a class vote may require consents beyond the board. Larger sales should also be checked against “Deemed Liquidation Event” definitions and interested party transaction rules.

Capital Impairment and Distribution Requirements

Where the company itself is the buyer, the transaction is a repurchase and is subject to statutory limits on distributions. Under Delaware law, for example, a corporation may not repurchase its shares when its capital is impaired or when the repurchase would cause impairment, and directors who approve an unlawful repurchase face personal liability. Debt agreements and preferred stock terms frequently add restrictions on repurchases and restricted payments. A company repurchase should therefore be supported by a board determination of available surplus and reviewed against all contractual covenants and protective provisions.

Using the Company’s Consent as Leverage

Because the company’s consent is almost always required, a secondary sale is an opportunity for the company to tidy up its relationships with both the incoming buyer and the departing seller. Companies regularly condition consent on the following:

1. Additional obligations on the buyer, including:
   1. A joinder to the company’s voting, right of first refusal and co-sale, and drag-along agreements, often without the information or registration rights afforded to lead investors.
   2. A market standoff or lock-up agreement in anticipation of an IPO.
   3. Confidentiality obligations and limitations on further transfers of the shares, including to competitors.
2. Releases and confirmations from the seller, including:
   1. A general release of claims against the company.
   2. Confirmation of the seller’s remaining equity, if any.
   3. Reaffirmation of confidentiality, invention assignment, and other continuing obligations, particularly for current and former employee sellers.

Tax Considerations

Tax consequences to both the seller and the buyer deserve special attention and are too often addressed only after the price has been agreed. For the seller, the central questions are whether the gain is capital or ordinary, whether the holding period qualifies for long-term treatment, and whether the shares are qualified small business stock eligible for the Section 1202 exclusion (i.e., QSBS). Employee sellers face additional issues: a purchase price above the company’s most recent 409A valuation may be treated in part as compensation; shares acquired on exercise of incentive stock options may suffer a disqualifying disposition; and so on. Both sides should understand these issues before the price is set, and structuring matters. Parties also often negotiate separate tax obligations and indemnities directly into the agreement.

Secondary sales offer flexibility that Tender Offers do not, but that flexibility comes with the burden of getting each transaction right individually. While that burden is real, it also carries a benefit: the parties can be more thoughtful about structuring, and the company can control timing and negotiate for terms that benefit it.

Despite cautious optimism following an upturn in biotech M&A in mid-2025, development-stage biotech companies continue to face significant financial headwinds including increased layoffs, higher borrowing costs, healthcare pricing reforms, and ongoing market correction following the pandemic-era investment boom. Companies should take proactive steps to build financial resilience: routinely identifying clinical and regulatory inflection points that could threaten liquidity; maintaining robust contingency plans that account for insolvency regimes in all relevant jurisdictions; engaging in fact-finding during periods of financial health to identify potential cash shortfalls; evaluating hypothetical liquidation scenarios early to understand timing and resource requirements; running structured strategic alternative processes (including asset sales, mergers, or licensing deals) well before reaching a crisis point; and budgeting for the time and cost of navigating financial distress, including the reality that dissolution processes can take three or more years to complete.

On April 16, 2026, the Division of Corporation Finance (Division) of the U.S. Securities and Exchange Commission issued an exemptive order (Order), effective immediately, that changes certain rules pertaining to tender offers of securities. The Order covers tender offers for both reporting and nonreporting companies.

The Division’s stated rationale for the Order is threefold: (1) to address market inefficiencies created by the 20-business-day minimum offer period; (2) to reflect technological advancements that enable faster dissemination of, and access to, offer materials; and (3) to reduce offerors’ and security holders’ exposure to unnecessary market fluctuations during the offer period.

Shorter Offer Period for Private Companies

Most notable in the Order, tender offers conducted by private companies, as well as by wholly owned subsidiaries of such issuers for the issuer’s own securities, will now be subject to a 10-business-day minimum offer period.

There are some conditions for this new relief to apply:

• Cash-only, fixed-price consideration. The consideration offered must consist solely of cash at a fixed price.
• Early notice of price or percentage changes. Any change to the percentage of securities sought (beyond the 2% de minimis threshold) or to the amount of cash offered must be communicated to holders no later than 9 a.m. Eastern time on the fifth business day before expiration.
• Notice of other material changes. Any other material change in the terms of the offer must be communicated no later than 9 a.m. Eastern time on the second business day before expiration.

Notably, the Order does not grant any relief to third-party led tender offers, which is expected to result in a clear timing advantage for issuer-led liquidity transactions for private companies.

Shorter Offer Period for Public Companies

For third-party tender offers subject to Regulation 14D, a shortened 10-business-day period is available but only when (i) the offer is made pursuant to the terms of a negotiated merger agreement or similar business combination agreement between the target company and the offeror and (ii) the offer is made for all outstanding securities of the subject class. In addition, the target company must file and disseminate a Schedule 14D-9 no later than 5:30 p.m. Eastern time on the first business day following commencement.

By contrast, for issuer self-tenders subject to Rule 13e-4, the abbreviated period is available when the offer is made for less than all outstanding securities of the subject class.

Conditions Applicable to All Public Company Tender Offers

Regardless of whether the tender offer is a third-party offer or an issuer self-tender, all of the following conditions must be satisfied:

• Cash-only, fixed-price consideration. The consideration offered must consist solely of cash at a fixed price.
• No going-private transactions. The offer must not be subject to Exchange Act Rule 13e-3.
• No cross-border exemptions. The offer must not be made in reliance on the cross-border exemptions under Exchange Act Rule 14d-1(d) or Rule 13e-4(i).
• No competing offer at launch. At the time the offer is publicly announced, the subject securities must not already be the subject of another pending or previously announced tender offer by a different offeror.
• Extension required if a competing offer emerges. If a competing tender offer is publicly announced after commencement, the initial offeror must extend its offer so that it remains open for at least 20 business days from the date it originally commenced.
• Press release with hyperlink at launch. The offer must be announced via a widely disseminated press release or wire service by 10 a.m. Eastern time on the commencement date, including basic terms (identity of offeror, class of securities, consideration, and expiration date) and an active hyperlink to a website where holders can access the tender offer materials.
• Early notice of price or percentage changes. Any increase or decrease in the percentage of securities sought (beyond a 2% de minimis threshold) or any change in the consideration offered must be publicly announced no later than 9 a.m. Eastern time on the fifth business day before expiration.
• Notice of other material changes. Any other material change in the terms of the offer must be publicly announced no later than 9 a.m. Eastern time on the second business day before expiration.

Key Takeaways

The Order offers meaningful practical improvements for liquidity transactions structured as tender offers.

Most significantly, and in light of the increased prevalence of liquidity transactions, including tender offers, in tech among privately held venture capital and private equity-backed companies, parties should now give serious consideration to the meaningful timing advantage that an all-cash issuer-led tender offer would present as compared to other structured liquidity transactions. In addition, for public companies, the Order now offers greater flexibility in aligning tender offer timelines with other typical deadlines that arise in such transactions, including proxy timelines, antitrust, equity compensation, and the Committee on Foreign Investment in the United States.

Of course, the Division expressly noted that all antifraud and antimanipulation provisions of the federal securities laws continue to apply — including Sections 10(b) and 14(e) of the Exchange Act and the rules promulgated thereunder — and that responsibility for compliance with all applicable federal securities laws rests with the offeror.

In a US$250 million acquisition, the buyer refused to pay one stockholder his merger proceeds unless he first signed a joinder agreement that included a sweeping release of any claims he might have against the companies. After trial, the Delaware court held that withholding payment on that condition breached the company’s charter. A stockholder cannot be forced to give up legal claims just to collect money he is already owed, unless he receives something extra in exchange for that release. The company eventually conceded the point.

The last few years have seen a wide proliferation of secondary liquidity programs among VC- and PE-backed technology companies. Late-stage private company VC and growth financings now typically feature a secondary component, and it is not unusual to see secondary-only transactions among revenue-positive technology companies. The wide adoption of these transactions has brought with it a changing landscape of liquidity timeline expectations, valuations, and terms. Additionally, these programs often require careful structuring and a variety of legal and business considerations that are novel even to many experienced executives in technology companies.

Tender Offers vs. Secondary Transactions

When a high-growth company begins thinking about providing liquidity to its shareholders while it is still private, the first question that arises is whether the proposed transaction will be a “Tender Offer” (a legal term that brings with it a number of additional regulatory requirements) or a one-off secondary (a less regulated bilateral agreement between two parties). The determination is often made by legal counsel with reference to the Wellman test, a fairly dated eight-factor legal test that stems from a case called Wellman v. Dickinson. That said, the Wellman test is fairly straightforward and most of the eight prongs are usually met in a “typical” secondary program, in which case the analysis often comes down to the first two prongs, which are determined by reference to the number of potential eligible sellers and what percentage of the overall outstanding company capitalization they represent. The standard is subjective and depends on facts and circumstances – for instance, if an offer is made to hundreds of shareholders representing 10%+ of the company’s outstanding capitalization, you are most likely looking at a Tender Offer.

Tender Offer Rules

Tender Offers implicate U.S. corporate, tax, and securities law, and can equally implicate foreign laws when the eligible sellers are abroad. Private company Tender Offers, however, do offer significantly more flexibility than public company Tender Offers (i.e., no schedules, no SEC review, and more structuring flexibility with respect to the offering terms):

Securities Law

Section 14(e) of the Securities Exchange Act of 1934 (the “Exchange Act”), including the antifraud and antimanipulation provisions contained therein, as well as the extensive rules and regulations promulgated thereunder, including Regulation 14E, must always be considered and consulted when conducting a Tender Offer. Most notably, Tender Offers typically require a disclosure document, a reasonable means to tender the securities, and a minimum open period during which eligible sellers can consider whether or not to participate in the Tender Offer.

It is important to note that, on April 16, 2026, the U.S. Securities and Exchange Commission (SEC) issued an exemptive order that changed some of the rules pertaining to Tender Offers, including the minimum offering period for offers conducted by the company itself rather than directly by a third-party purchaser. An article summarizing these changes is also available on Sidley Catalyst.

In each jurisdiction where an offer is made, including foreign jurisdictions and any relevant U.S. state, local securities laws should also be reviewed.

Corporate Law

Tender Offers conducted by a third-party purchaser implicate corporate law governing transfers of securities and, as is typical for VC-backed technology companies, potential transfer restrictions. Tender Offers may also inadvertently trigger “Deemed Liquidation Event” provisions in the company’s governing documents.

Tender Offers conducted by the company that issued the securities in the first place may implicate rules concerning repurchases or redemptions of securities, impairment of capital, and dividends.

Of course, shareholder protective provisions and other restrictive covenants in equity and debt agreements must be consulted.

Lastly, Tender Offers often implicate interested party and corporate opportunity considerations, as executives and board members are also often eligible to participate, and careful consideration must be given to cleanse any such issues via relevant corporate law provisions.

Tax Law

Tender Offers require extensive tax planning, both with respect to the impact on eligible sellers and on holders of stock options or other employee equity. Section 409A deferred-compensation rules, dividend rules, compensatory versus capital gains treatment, and other tax rules may all be implicated if not carefully structured. It is typically expected that eligible sellers will receive some level of disclosure with respect to potential tax implications of their investment decision.

Structuring Considerations

There are two primary decisions that any company contemplating a Tender Offer must consider at the outset:

1. Eligibility Criteria. Who should be eligible to sell their securities in the Tender Offer? A number of factors are typically considered here, including:
   1. Will the Tender Offer proceeds have a positive or negative impact on employee retention?
   2. Are there early investors who require returns for their funds?
   3. Will there be a “consolidation” effect on the cap table? Will some shareholders be happy to sell and separate from the company sooner than others?
   4. Will there be an expectation of continued liquidity programs?
   5. Will there be a positive or negative impact on the company’s valuation?
   6. How will this impact public perception of the company and its shareholders?
2. Identity of Purchasers. Will this be a direct third-party purchase by a single purchaser or a group of purchasers, or will it be conducted as a repurchase by the company of its own securities? The differences between the two can impact the following:
   1. Time period required for the Tender Offer to remain open.
   2. Primary responsibility for preparing the Tender Offer documents and for the accuracy of those documents.
   3. Difference in fees and costs associated with the Tender Offer.
   4. Whether the company has funds to conduct the Tender Offer or whether such funds must be raised from third-party sources.

Less pressing, but nonetheless important, considerations include which party will pay the fees and costs of the Tender Offer, whether the purchaser will require additional investor rights or side letters, whether any third-party portals or paying agents will be used, and how decisions regarding eligibility, extensions, and the like will be made.

Pricing the Tender Offer

The price offered for the company’s securities in a Tender Offer is often the result of negotiation. That said, there are a few considerations that repeatedly come up as the potential purchaser is considering what price to set for the Tender Offer:

1. The price paid for the company’s securities in the most recent fundraising round. Law firms, secondary market platforms, banks, and others with significant experience in these transactions now have plenty of statistics to share with their clients regarding typical pricing for Tender Offers vis-à-vis the last round, how much time has passed, any discounts, and so on.
2. The likely impact on future fundraising and liquidity opportunities. Tender Offers in companies nearing a liquidity transaction are very common, and pricing in the Tender Offer may indicate the likely valuation the company’s securities will receive in an IPO or M&A transaction. Thus, the pricing serves as a “signal” out to the marketplace as much as to the selling shareholders.
3. The likely impact on the shareholder base. If the company’s shareholders have been signaled for years that they are holding very valuable stock, a discounted price in the Tender Offer may lead to disappointed employees and investors, even though the offer may look like a great deal to the purchaser.
4. Impact on equity incentives. A highly priced Tender Offer may have an impact on the valuation of the company’s securities, including the exercise price of its stock options and the value of its RSAs and RSUs. Depending on which securities are used for equity incentives at the company, the price paid for securities by a third party may require a change of course after the transaction. Companies may also want to consider an exercise or grant freeze during the Tender Offer period, which may impact the company’s ability to hire or retain talent while the offer is open.

Timing and Disclosures

Finally, any company considering a Tender Offer must do so in the context of potential upcoming major transactions, changes in leadership, launches, or other major events that would be viewed as material to an investment decision and therefore would require disclosure to the eligible sellers. Typically, as well, some level of financial information is provided as part of the Tender Offer disclosures, and companies often think about the publicity and timing implications of this. As such, the likely timing of the offering and how it fits within the company’s and the investors’ broader timelines is an important consideration that should be proactively addressed prior to the launch of any Tender Offer.

Ordinary Delaware law tells a board selling control to get the best price reasonably available; however, by statute, directors of a public benefit corporation must balance stockholders’ financial interests against the interests of other people affected by the business and the company’s stated public mission. In Drakes Landing Associates, L.P. v. Tilden Park Capital Management, L.P., the court held that the Revlon stockholder value maximization standard of conduct does not apply to these directors, though courts may still review their decision-making under an enhanced scrutiny standard. The case was dismissed on a separate ground: the directors were protected by a statutory safe harbor, given that their decision was found to be informed, disinterested, and not one that no sensible person would approve. Here, an independent special committee with its own lawyers and a banker ran a market check before approving emergency financing that heavily diluted existing holders.

IP will be a core focus for a biotech company and its investors through its entire lifecycle. While the company’s IP strategy can and should evolve over time, there are certain steps that an early-stage company can take at the outset to establish a strong foundation. This article identifies several key principles that, in addition to an intelligently crafted IP portfolio, will help set an emerging company up for future success.

Document Ownership

Too many deals — licenses, acquisitions, or otherwise — stumble due to questions about ownership of a company’s core inventions. Fortunately, a few simple documents can avoid most issues. Founders and other employees should have straightforward agreements assigning (using “present tense” assignment language) relevant inventions to the company. Companies should also understand whether key personnel have parallel or prior obligations to academic institutions, and be able to clearly explain those obligations, and ensure that CROs, consultants, and other service providers also appropriately assign IP generated for the company.

Document these arrangements when relationships begin — not several years later when an investor or potential acquirer asks for the paperwork and it may be logistically difficult or expensive to reconstruct a chain of title for IP.

License for the Long-Term

When a company is in its very early stages, there can often be a lot of time pressure to secure any third-party IP rights, such as a foundational IP license from a university. It is also important, however, to keep in mind that licenses are long-term instruments and the same document may be scrutinized several years later in a due diligence process when the company’s situation is very different. While perfection can often be the enemy of good, foresight does not have to be the enemy of speed. Negotiating the material license or collaboration with an eye towards future-proofing in a few key areas can even increase the value of the agreement to the company.

Patent then Publish

Once out of stealth, scientific publications, conference presentations, and other disclosures can be integral to a young biotech company’s success. They can also have irreversible consequences for patent protection if not timed properly — i.e., a publication prior to patent filing can preclude the issuance of the patent.

Early training for employees and a simple process can go a long way in mitigating this risk. A one- or two-hour IP 101 training from counsel can be very effective, and can also roll out a straightforward process to ensure that both technical and other personnel know to check with patent counsel before submitting a manuscript for publication or disclosing proprietary information in a pitch without a confidentiality agreement in place.

The rule of thumb is simple: when potentially patentable technology is about to leave the building, determine whether to file a patent application first.

Joint Ownership Does Not Simplify

Negotiating a transformative IP agreement can sometimes take considerably longer than initially thought, and it can often be tempting to take the negotiation path of least resistance. When it comes to IP ownership, this path equates to “joint ownership” of inventions. On its face, joint ownership sounds like a great solution. It is fair, equitable, and does not require a complex analysis of each party’s contributions to the invention. It is jointly owned, no matter what. The problem lies in operationalizing the joint ownership.

The rules governing jointly owned IP vary by jurisdiction and can create complications around licensing, patent prosecution, enforcement, and commercialization. Joint ownership can also become particularly cumbersome in future transactions — e.g., an acquirer is a competitor of a joint owner. While it may take a little extra negotiation, there are many ways to allocate ownership of IP other than just inventorship that can suit both parties, including ownership based on relation to background IP, subject matter, or type of IP.

Data Is a Key Asset

A biotech’s most valuable assets increasingly extend beyond patents and traditional know-how. Preclinical results, clinical data, biomarker datasets, manufacturing data, and datasets used to develop or validate computational tools may all have substantial strategic value. Data rights and restrictions should be given the same level of focus as the development of an IP strategy. Particular attention should be paid to distinctions among raw data, processed data, derived data, and analytical outputs — and to privacy, consent, or contractual restrictions that may constrain future uses.

Dodiya v. Franklin tested the limits of the safe harbors added in 2025 to Section 144 of the Delaware General Corporation Law. Those amendments can preclude equitable relief and eliminate damages claims in certain conflicted transactions that may involve insiders or a controlling stockholder by having it approved either by disinterested directors acting in good faith and without gross negligence, or by an informed vote of disinterested stockholders. In Dodiya v. Franklin, a company’s CEO leaked confidential valuation and process information to his father’s investment firm, which bought stock cheaply and then took the company private. The board continued to give the CEO access to deal materials and allowed him to attend a board meeting about the deal even after he recused himself, and despite the board’s knowledge of the leak.  Despite this, the proxy statement stated he had not participated in the sale process after his recusal. In August 2026, the Delaware Court of Chancery found that the board acted with “reckless indifference” and that it was reasonably conceivable that the merger proxy statement contained a material misstatement, making both safe harbors unavailable. The safe harbor protection is real, but its availability depends on the board’s process and the accuracy of its disclosures.

Qualified Small Business Stock (QSBS) has become an increasingly central focus for founders and investors, as awareness of its potential tax benefits continues to grow. If stock qualifies as QSBS, a holder may be eligible to exclude up to 100% of federal capital gains on disposition subject to a cap equal to the greater of (a) $10 million, or $15 million for post-2025 issuances, and (b) 10 times the taxpayer’s initial basis in the shares. Further, with careful structuring and planning, founders and investors can maximize the QSBS exclusion.

In practice, founders, investors, and senior executives often seek confirmation, typically in the form of a company-level analysis or determination letter, that the corporation’s stock satisfies the applicable requirements at issuance. As QSBS planning has become more sophisticated, both the importance of this analysis and the consequences of getting it wrong have increased materially.

Background

Before 2010, the Internal Revenue Code Section 1202 generally provided individual taxpayers with what was, in most cases, a very small tax rate reduction for gains recognized from sales of QSBS that had been held for more than five years.

That all changed significantly following the 2008 financial crisis. In the wake of the crisis, Congress passed the Small Business Jobs Act of 2010 to encourage individual taxpayers to make additional equity investments in startup corporations during the remainder of calendar year 2010. The Small Business Jobs Act of 2010 included an amendment to Section 1202 that, for the first time, provided for a complete U.S. federal income tax exemption (with no application of the alternative minimum tax) for specific gains recognized by non-corporate investors on the sale of QSBS held for more than five years but only if the stock was purchased at original issue in the limited window after September 27, 2010 and before January 1, 2011.

Although initially intended as a tax incentive for stock issued during a limited period, the 0% rate for gains on QSBS became so popular that Congress began expanding it. Congress repeatedly extended the applicable window for issuance of the 0%-eligible QSBS in successive one-to-two-year tranches. In 2015, the Protecting Americans from Tax Hikes Act of 2015 made the 0% rate for specific gains from sales of QSBS a permanent tax benefit. The tax benefits of QSBS have significantly increased in both value and accessibility. In 2025, the One Big Beautiful Bill Act (“OBBBA”), which applies to issuances after July 4, 2025, raised the “cap” on tax-free gains and introduced more flexible holding periods for new investments. The following table highlights key differences between the pre-OBBBA rules and the new rules:

Several requirements must be satisfied before those benefits can be realized and, even if those requirements are met, there are important limitations on the amount of gain that can qualify for the 0% rate. These requirements and limitations are further discussed below.

General Requirements

The general requirements for qualifying for the 0% federal tax rate on gains from the sale of QSBS include the following:

1. Original Issue. The taxpayer must still be a non-corporate entity (individual, trust, or estate) and acquire the stock directly from a U.S. domestic C corporation.
2. Tiered Holding Periods. For stock issued after July 4, 2025, a taxpayer can now receive a partial exclusion earlier: 50% after three years, 75% after four years, and the full 100% after five years. Pre-OBBBA stock still requires a strict five-year hold to receive any benefit.
3. Gross Assets Test. For stock issued after July 4, 2025, the corporation’s aggregate gross assets cannot exceed $75 million (up from $50 million) at the time of issuance. Importantly, the amount of a corporation’s assets at any given time is generally measured by the corporation’s adjusted tax basis in those assets, except when any property is “contributed” to the corporation. In that case, for this purpose the property must be taken into account based on its fair market value at the time of the contribution.
4. Active Business Test. During substantially all of the taxpayer’s holding period of the stock, at least 80% of the issuing corporation’s assets must be used by the corporation in the active conduct of one or more qualified trades or businesses. This includes assets used in furtherance of a prospective active business, i.e., startup activities, research and experimentation, and in-house research. It also includes working capital, investments expected to finance research and experimentation or increased working capital within two years, and computer software rights that produce active business royalties. However, after the corporation has existed for two years, no more than half of its assets can be working capital or investments held for future research or working capital. Although many types of trade or business should qualify for this purpose, the following are specifically excluded: any trade or business involving the performance of services in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services, and brokerage services. Also specifically excluded is any trade or business for which the principal asset is the reputation or skill of any of its employees.
5. No Significant Redemptions. The issuer of the stock must not have engaged in specific levels of buybacks (redemptions) of its own stock during specified periods before or after the date of issuance of the stock to the taxpayer.

Exclusion, Limitations, and the Rise of Structured Planning

A non-corporate taxpayer who recognizes gain from the sale of stock meeting the above requirements can thus generally qualify for a 0% federal income tax rate. However, the amount of gain eligible for this 0% rate is subject to a cap. Section 1202(b)(1) states that the aggregate amount of gain for any taxpayer regarding an investment in any single issuer that may qualify for these benefits is generally limited to the greater of (a) $15 million (Post-OBBBA), or (b) 10 times the taxpayer’s adjusted tax basis in the stock. For a taxpayer who invests cash in the QSBS, the basis would generally be equal to the cash purchase price. However, there is a special rule for when a taxpayer instead purchases the QSBS for in‑kind property (that is, other than cash). In those cases, the taxpayer’s basis in the QSBS, solely for purposes of these Section 1202 rules, is deemed to be an amount not less than the fair market value of the property transferred for that QSBS as of the date of such transfer (often referred to as the basis-is-not-less-than-value rule). The general purpose of the basis-is-not-less-than-value rule is to ensure that inherent built-in gain for any property contributed to a corporation in exchange for QSBS does not qualify for the Section 1202 benefits. Only the gains from the sale of QSBS that are attributable to appreciation in value of the QSBS occurring after the date of issuance are potentially eligible for the Section 1202 benefits.

These new rules now theoretically allow for exclusions of up to $750 million for certain large-scale investments and certain other circumstances. As a result, taxpayers increasingly employ planning strategies, such as “stacking” QSBS across multiple taxpayers (e.g., trusts), and “packing” assets into QSBS-eligible entities. These strategies can be effective but require careful implementation and are subject to scrutiny. In May 2026, the Treasury Department signaled that it will be issuing guidance addressing what it sees as abuse of the QSBS “stacking” strategy.

The IRS has shown growing interest in QSBS claims, particularly in large exit transactions. Areas of focus include active business qualification, asset valuation (especially for contributed property), and related-party and restructuring transactions. QSBS remains one of the most compelling tax incentives available to founders and investors, but its benefits are not automatic. As the regime has matured, so have the expectations around compliance, documentation, and planning. For those who get it right, the rewards can be substantial. For those who do not, the cost of missed qualification can be equally significant.

State Conformity

While federal benefits are permanent, state treatment varies wildly. As of 2026, many states, including New Jersey and New York, now align with federal Section 1202 rules, while Alabama, California, Mississippi, and Pennsylvania continue to tax QSBS gains at full state rates. Residents in certain states, including Texas, can achieve a true 0% effective tax rate on QSBS gains by combining the federal exclusion with a lack of state income tax.

Rollover of Gain

A taxpayer other than a corporation (i.e., individuals, partnerships, S corporations, estates, and trusts) may elect to roll over capital gain from the sale of QSBS held for more than six months if QSBS is purchased by the taxpayer during the 60-day period beginning on the date of sale. Accordingly, gain is recognized only to the extent that the amount realized on the sale exceeds the cost of the replacement QSBS purchased during the 60-day period, as reduced by the portion of such cost, if any, previously taken into account. To the extent that capital gain is not recognized, that amount will be applied to reduce the basis of the replacement QSBS. The basis adjustment is applied to the replacement stock in the order in which the replacement stock is acquired.

Treatment for Pass-Through Entities

Gain on qualified stock held by a partnership, S corporation, regulated investment company, or common trust fund is excludable if the entity held it for the required holding period and if the partner, stockholder, or participant to whom the gain passes through held an interest in the entity when the entity acquired the stock and at all times thereafter. However, the partner, stockholder, or participant cannot exclude the gain to the extent that his or her share in the entity’s gain is greater than what it was when the entity acquired the qualified stock.

The Bottom Line

QSBS has evolved from a niche tax benefit into a central component of early-stage investment planning, particularly in light of recent expansions under the OBBBA regime. The increased exclusion caps, more flexible holding periods, and expanded asset thresholds have made QSBS more valuable, and more widely accessible, than ever before. At the same time, these enhancements have accelerated the use of structured planning strategies and heightened IRS scrutiny, raising the stakes for both companies and investors. In this environment, QSBS should be viewed not as a passive benefit but as a strategic framework that requires thoughtful implementation from formation through exit. With proper planning, documentation, and coordination, taxpayers can unlock substantial tax efficiencies; without such planning, the opportunity may be irretrievably lost.

With sweeping cuts to federal research funding driving academic scientists in the life sciences toward entrepreneurship, there are practical steps for navigating this transition: adopting an entrepreneurial mindset that embraces risk and redefines success; leveraging university incubators, tech transfer offices, and alumni networks; broadening professional networks through industry events and mentorship; validating ideas through market research and minimum viable products; understanding regulatory pathways and engaging FDA-specialized counsel early; learning intellectual property fundamentals and working with IP attorneys to build a competitive strategy; developing a comprehensive business plan with milestones and financial projections; securing a diverse mix of funding from grants, angel investors, and venture capital; assembling a multidisciplinary team with complementary expertise; and launching pilot projects to demonstrate feasibility and build credibility with investors and partners.

Successful founders often find themselves stock rich and cash poor, with most of their net worth held in illiquid shares. The usual path to early liquidity is a secondary sale, in which a founder sells a portion of existing shares to investors in connection with a financing. FF preferred stock (also called founders preferred stock or Series FF) is a class of stock adopted at formation to make that future secondary sale cleaner and more streamlined. Despite the name, it generally functions as common stock: it carries no dividend or liquidation preference, and it is distinct from the super-voting share classes sometimes used to concentrate founder control.

How It Works

FF preferred stock has a single distinguishing feature: when sold to investors in connection with a future preferred stock financing, it converts into the series of preferred stock being sold in that round. The investor receives preferred stock rather than common stock, and the founder typically receives the preferred price for the shares. The precise mechanics vary by form. Some versions convert automatically upon the sale, some convert at the holder’s option if the buyer pays the same per share price as the new round, and some require board approval; typical forms also permit conversion into common stock at any time and convert automatically into common stock in a qualified IPO.

Three practical rules follow from the tax analysis. FF preferred stock is generally adopted at formation, when founder shares are first issued; adding the class later can carry tax consequences. It is often, but not always, issued fully vested, because shares subject to forfeiture or repurchase may raise additional tax issues; as a result, any vesting sits on the founder’s common shares. And it typically covers only a modest portion of a founder’s holdings, most often 10 to 25 percent, with the balance in common stock.

Why It Exists

The structure responds to two problems with selling common stock at a preferred stock price. The first is tax. A founder who sells common stock for more than its fair market value (which ordinarily sits well below the preferred price) risks having the excess treated as compensatory ordinary income rather than capital gain, and the risk increases if the company facilitates the sale by converting the founder’s common stock into preferred stock at closing. Since FF preferred stock converts by its terms when sold, no corporate action is required at the time of sale, which is generally viewed as more characteristically the type of transaction that should result in capital gain treatment. However, that treatment is not assured and depends on a variety of factors specific to the underlying transaction; the nature of the security sold is merely one such factor. The second is valuation. A founder sale of common stock at or near the preferred price can put upward pressure on the fair market value of the common stock and, with it, the strike price of future option grants. Alternatively, a sale of FF preferred stock that converts into preferred stock mitigates the repricing effect on the common stock. Note that market practice has evolved on this point: secondary sales of common stock at no or a small discount to the latest preferred round have become customary, and selling parties have found ways to work through the issues that FF preferred stock addresses in its absence. Nonetheless, founders often view the implementation of FF preferred stock as a “just in case” move to improve their chances of a successful secondary transaction in the future.

What to Weigh

FF preferred stock is not the norm. It adds drafting complexity and cost to the certificate of incorporation for a benefit that materializes only if investors are someday willing to buy founder shares, which as a practical matter requires a strong company, an oversubscribed round, and a supportive board. Some investors also read the class as a signal that the founders expect early liquidity, and, when the shares are issued fully vested, the company gives up repurchase rights over that portion of a departing founder’s equity. However, when a secondary sale does happen, the structure may have real advantages: the founder can sell at the preferred price rather than at a discount, the company avoids facilitating a sale of common stock above its appraised value, and an oversubscribed round can be accommodated with less dilution because investors buy existing shares. Additionally, the potential tax consequences of such conversion should be addressed on a case-by-case basis.

In almost all cases, one typical feature of FF preferred stock is that it can convert to common stock at the election of its holder at any time, so founders can always elect to eliminate FF preferred stock at a later time if they find its utility no longer of value. Thus, including FF preferred stock at incorporation gives founders flexibility down the road.

A stockholder of a Delaware e-commerce company sent a formal demand to inspect company books and records while the company was being acquired. The company objected, claiming the demand was too broad and lacked a proper purpose, but offered to negotiate a narrower production. The stockholder did not respond. The merger closed a week later, cancelling the stockholder’s shares, and the stockholder filed suit to enforce her demand 12 days after that. The Delaware court dismissed the case: under the state’s books-and-records statute, often called Section 220, you must actually be a stockholder on the day you file the lawsuit, not merely on the day you send the demand. Once the merger wiped out her shares, she no longer qualified.

The court also refused to excuse the delay on fairness grounds, noting the company had never agreed to produce anything nor promised a schedule, so nothing it did invited her to wait. The court left open, without deciding, whether a fairness exception could ever apply, and cautioned companies that stringing a stockholder along before closing could weaken that defense.

A greenshoe, which is also referred to as an overallotment option, is a provision in an underwriting agreement that allows the investment banks underwriting a public offering to sell more shares than originally planned to help stabilize the stock price after the offering. The term “greenshoe” comes from Green Shoe Manufacturing Company (now Stride Rite), which was the first company to use this mechanism.

Greenshoes are typically 15% of the potential base offering. If demand for an offering is much greater, a company would increase the base deal size. The window to exercise the greenshoe is almost always 30 days. Most typically, greenshoes are additional shares issued by the company but the greenshoe can be comprised of shares held by a selling stockholder.

A greenshoe can exist in both an “initial public offering” (IPO) and a follow-on public offering. Greenshoes are not used in “registered direct offerings” (RDOs) or deals referred to as “underwritten RDOs”.

Here is a simple example of a greenshoe:

• The company plans to sell 10 million shares of its common stock, which are referred to as the base shares, in its IPO.
• The greenshoe would be 1.5 million shares, or 15% of the base shares.
• If the underwriters elect to exercise the greenshoe, they may sell up to 11.5 million shares to investors, which is the sum of the base shares plus the greenshoe.

Why does a greenshoe exist?

The greenshoe helps:

• stabilize the stock price after a public offering;
• meet excess demand if investors want more shares; and
• protect underwriters from losses during the first trading days.

In practice, underwriters use the greenshoe to stabilize the stock price during the first 30 days after a public offering. The mechanics revolve around short-selling and covering that short position depending on where the price trades.

For example, using the example above of a 10 million share base offering, with a 1.5 million share greenshoe, and a public offering price of US$10.00:

• The underwriters will sell 11.5 million shares to investors, even though only 10 million shares are initially issued by the company to the underwriters.
• They do this by borrowing 1.5 million shares from the issuer or selling syndicate and creating a short position of 1.5 million shares.
• As a result, immediately after the offering, investors hold 11.5 million shares, only 10 million of which are actually issued, and the underwriters are short 1.5 million shares.

This short position is the key tool for stabilization. If the stock price falls below the offering price — for example, if the price falls to US$8.00 — the underwriters will buy shares in the open market at US$8.00 and use those shares to cover their 1.5 million shares short position. That open market-buying demand supports the stock price, and the underwriters profit (sold at US$10.00 and bought back at US$8.00). In this case, the greenshoe would not be exercised, the total shares issued in the offering is 10 million, and the company will have raised US$100 million in gross proceeds.

If the stock price rises above the offering price — for example, if it trades to US$15.00 — buying shares in the open market would be expensive for the underwriters. Instead, underwriters exercise the greenshoe and buy 1.5 million shares from the company at US$10.00. They then deliver those shares to cover their short position. In this case, the greenshoe is exercised, the total shares issued in the offering is 11.5 million, and the company will have raised US$115 million in gross proceeds.

Occasionally, the stock price is volatile and, during the greenshoe period, may trade above and below the offering price, which could result in a partial exercise of the greenshoe to cover the portion of the short position that resulted while the stock price was higher than the offering price. Generally, the greenshoe cannot be exercised in an amount that exceeds the net short position at the time of exercise.

In an article for Life Science Leader, partners Sally Wagner Partin, Sharon Flanagan, and Torrey Cope examine how artificial intelligence is reshaping life sciences M&A by changing the pace and economics of drug development. They explore how AI’s growing role in target identification, clinical development, and regulatory decision-making is influencing valuation, due diligence, milestone structures, transaction timing, and risk allocation, and outline key considerations for dealmakers as AI continues to transform the life sciences industry.

In Fortis Advisors, LLC v. Stillfront Midco AB, the Delaware Supreme Court strictly enforced an arbitration clause in a merger agreement, finding that a seller’s bad faith claims regarding earnout manipulation fell within the alternative dispute resolution (ADR) provision’s scope because they were fundamentally a dispute about the calculation of the earnout. The court looked at the substance of the claims, concluding that “why” the earnout calculation was wrong cannot be severed from an arbitration clause covering calculation disputes. The decision is a strong reminder to dealmakers to precisely delineate which disputes are reserved for courts versus arbitration, and to draft ADR provisions with enough specificity to avoid costly threshold litigation over arbitrability.