Archive for the ‘Innovation’ Category

The SRS 2012 Merger and Acquisition Terms Study: Comments on Key Findings

My comments on the key findings from the Shareholder Representative Services 2012 M & A Deal Terms Study are in bold:

Deal sizes: although the median deal size* rose slightly to $75 million in 2012 from $70 million in 2011, deals $50 million or less grew to 42% of deals in 2012, up from 33% in 2011. An increase in the percentage of smaller deals in and of themselves doesn’t tell us much.  I’d like to know what percentage of those acquisitions are takeunders versus takeovers—a takeunder in this case means that the consideration paid is less than invested capital.  That’s the key statistic on the health of the acquisition market from the 42%-of-the-market-seller’s perspective.

Seller financial performance: acquisitions remain heavily weighted toward Sellers with revenue, and Sellers in the aggregate continue to show improved earnings since 2009. Coupled with a slight increase in Seller-favorable terms generally, data suggests that some degree of market leverage is returning to Sellers that have survived the downturn even as M&A activity remains deliberate. I don’t believe this last point reflects the reality of the market– unless your company is cash flow positive, a ‘slight increase’ in Seller-favorable terms means nothing given the place form which we are starting:  highly favorable terms for the buyer.  The trends absolutely support that buyers are looking for non-dilutive acquisitions.

Cash vs. stock deals: cash is still king in M&A as long-term interest rates decline. That’s for sure!

Earn-outs: usage of financial metrics (revenue and earnings) and multi-metric achievement tests is declining, accompanied by a shift toward longer earn-out periods. Beware the earnout, it is often used by the buyer as a subterfuge for reducing the back-end payment of the acquisition.

Indemnification trends: median R&W survival periods and escrow sizes have leveled off at 18 months and 10–12% of transaction values, respectively, since 2009. Other terms are increasingly Seller favorable, for example, an increase in available offsets against Buyer indemnification claim amounts and requiring that claims exceed a minimum threshold.  I’ve seen very bad behavior here and am glad the median statistics show Seller favorable trends because it can’t get much worse than it has been…

Alternative dispute resolution (“ADR”): mandatory ADR such as mediation and arbitration has steadily declined since 2010, down to 26% of deals in 2012 from 41% in 2010. I am a strong advocate of binding ADR.  Large corporations like to avoid this because they want to wait the little guy out and they have plenty of salaried staff on hand to go to court or posture as if they are prepared to do so.  I’d like to see this trend reverse.

Post-closing expense funds: the median size as a percentage of the indemnification escrow continues to trend upward, at 2.08% in 2012. This is consistent with ADR declining, as more resources that should be going to shareholders are being wasted on post-closing disputes.

I’m Back!

DSCN2594After a one-year hiatus, I am back.  Stay tuned for new posts on venture capital, corporate governance trends, and current public policy issues that impact investors and entrepreneurs. I have also done a lot of hiking throughout America and Europe in the last year and will share highlights from my hiking experiences as a new topic.

Over the past year I’ve made meaningful personal and professional changes. Today I am healthier, happier, and more energized than ever. I look forward to sharing my thoughts with readers and welcome all constructive comments.

Two Important Reports from the NVCA: VC Fundraising Declines 53% in Q3 2011 and U.S. Medical Innovation is in Crisis

medical innovation image 1 Kelly Slone, director of the Medical Industry Group of the National Venture Capital Association (NVCA) posted an important article on October 7 on the NVCAccess blog, clearly calling out that the unintended consequences of FDA regulations have precipitated a full-blown crisis in medical innovation in the U.S. This crisis has already damaged America’s global competitiveness and slowed medical innovation in the U.S.  The report “revealed that US venture capitalists are reducing their investment in biotechnology and medical device companies and shifting focus overseas to Europe and Asia, primarily due to regulatory obstacles at the Food and Drug Administration.”

In related news, Mark Heesen, NVCA President, announced today that U.S. venture capital funds raised a total of  $1.7 billion, a 53 percent decrease in dollars from the third quarter of 2010 and the lowest amount since the third quarter of 2003.  Heesen observed in his blog post what he expects will become apparent when Q3 2011 VC investment statistics are released next week : “you can bet the total dollars invested into start-up companies will be a multiple of the amount raised.  It has been this way since 2008 when the industry began investing more than it was raising.  In fact, by the end of this quarter, the venture industry will have invested at least $20 billion more than it has raised in the last 3+ years.And just like a bubble, this imbalance is not sustainable.  Unless the industry begins to raise more money, we can expect investment levels to decline in the coming years in a significant way.”popped balloon

You can download the full report: Vital Signs: The Threat to Investment in U.S. Medical Innovation and the Imperative of FDA Reform, from the NVCAccess blog.

Some key conclusions from the report follow:

U.S. venture capitalists have been and will continue to:
• Decrease their investment in biotechnology and medical device start-ups
• Reduce their concentration in critical therapeutic areas, and
• Shift focus away from the United States towards Europe and Asia
FDA regulatory challenges were identified as having the highest impact on these investment decisions.
We must act now or lose our leadership position in medical innovation, job creation and access to life-saving treatments in the United States. If the current situation is left unaddressed, the implications to U.S. patients and the economy are significant:
• Many promising medical therapies and technologies will not be funded and therefore will not reach the patients that need them.
• Those that are funded may not be brought to market in the United States first, or at all.
• An estimated funding loss of half a billion dollars over the next three years will cost America jobs at a time when we desperately need employment growth.
• The U.S. leadership position in medical innovation will be placed in further danger and economic growth with suffer.

For more factual background on the decades of neglect that have led us to where we are today, you may find the following links to presentation slides useful:

America’s Slipping Global Competitiveness– Implications for the Next Generation of American Emerging Growth Companies, keynote speech remarks delivered by Pascal Levensohn at ICAP Ocean Tomo conference, March 24, 2010, San Francisco

American Innovation in Crisis,Cybersecurity Applications and Technologies Conference for Homeland Security (CATCH) Conference, Walter E. Washington Convention Center Washington, D.C. Keynote Speech by Pascal Levensohn, March 4, 2009

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Equity Traders Acknowledge that Structural Issues Are Crippling U.S. IPO’s

globe in handsIncreasing numbers of professionals in a position to foment meaningful change in the capital markets are recognizing that structural issues underlie the IPO drought for emerging companies with market capitalizations below $1 billion.  This must become a widely held point of view before any meaningful structural reform can take place, setting aside the legislative delays we can continue to expect from the partisan divisions that have rendered our elected leaders ineffective.

I’ve made this structural argument for over three years on this blog and in public speeches.  Again, I urge readers to make their voices heard on this topic.  On November 24, 2008 I wrote A Case Study in the Unintended Consequences of Financial Regulation:  The Death of the U.S. Small Cap IPO? and invited anyone with constructive, practical ideas on how to revitalize IPO’s in the United States to contact me so that I could pass along their ideas to my colleagues at the National Venture Capital Association. In this post, I made a strong argument that structural market issues were the root cause of the death of the small capitalization IPO:

The lack of IPO’s in the U.S. has broad, negative implications for continued risk taking by U.S. venture capitalists. If we have no public market liquidity for emerging growth companies, there will be no next generation of American technology giants. The demise of the technology IPO has also contributed to the structural breakdown in the broader cycle of research and development that underlies the American innovation crisis…

This post followed my exposition of the argument that America would face an overall crisis in innovation, drawing on work by Judy Estrin and others, in September 2008: The Innovation Crisis Is Coming- Let’s Do Something About it Now!

Sadly, the veracity of these arguments is being proven over and over again, as the venture capital industry continues to shrink and the fallacy of an American jobless recovery becomes apparent.  Pointing to the success of several handfuls of social media companies as an index for the general health of innovation in the U.S. in 2011 is not statistically meaningful and irrelevant to the thousands of startups that are finding it impossible to reach the much greater critical mass necessary to access the public equity capital markets today.  To be clear, publicly traded household names that would not be able to go public today based on current IPO requirements include Dell, Intel, EMC, Yahoo!, Intuit, EA Sports, and many others.

access deniedIn an article published on October 6, 2011 in Traders Magazine.Com, conference remarks by several leading international stock exchange professionals show that they are coming around to understanding the downside to small companies of a trading market infrastructure that treats unknown emerging public companies the same way as multi-billion dollar liquid securities:

“Though trading costs have gone down, that isn’t necessarily a good thing, according to Steve Wunsch, head of corporate initiatives at the ISE Stock Exchange. He said low trading costs have made it difficult for anyone to make money trading smaller names, thus drying up markets for smaller companies.”

Joseph Hall, a partner with the law firm of Davis Polk & Wardell, said the government could have caused part of the problem by repealing the Glass-Steagall Act’s separation of investment banks and commercial banks. That allowed a lot of small brokers to be bought up by big banks, reducing niche trading, he said.

Grant Thornton’s [David] Weild placed more of the blame on Reg NMS, which he said homogenized the markets to the detriment of new issuers. He said a one-size-fits-all market structure does not support smaller, newer companies.

The good news, Weild said, is that Washington seems to be paying attention. …

In my view, the bad news is that it’s taken three years since the global financial crisis erupted for us to get an increasing number of influential people to pay attention.  Meanwhile, millions of jobs have been lost, and innovation in America continues to suffer.

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New Book by Professor Mannie Manhong Liu and Pascal Levensohn– Venture Capital: Theory and Practice, published by the University of International Business and Economics Press, Beijing

I never expected to have my first book published in China, much less in Mandarin, but that goes to show how much the world continues to change.  My contributions to this undergraduate textbook, Venture Capital: Theory & Practice, are the result of two important collaborations.  First, the body of collaborative work on corporate governance best practices that I have developed since 1999 with other venture capitalists and professional service providers to the venture industry; and, second, the direct collaboration on venture capital that resulted from meeting Professor Mannie Manhong Liu in the summer of 2007 at the  Symposium on Building the Financial System of the 21st Century between China and the US, sponsored by the Harvard Law School together with the CDRF (China Development Research Foundation) and PIFS (the Program on International Financial Systems).

Venture Capital started in China in 1985, when the first government-sponsored venture capital firm was established. The industry built slowly until a few years into the new century. In 2006, China’s total venture capital investment reached $1.78 B, becoming number two globally, next to the US; the US venture capital investment was $25.6B that year, accounting for 67.9% of the world total ($37.7b).  While China was far behind, accounting for about 4.7% of the total, nevertheless, China became number two and has kept that status ever since.

Venture Capital is a popular buzzword in China. Renmin University was among the first universities to create a venture capital major in the School of Finance and teach venture capital for undergraduates.  In recent years, many universities have followed, teaching venture capital as an elective course. In October 2010, our new textbook will become available.

Mannie and I share a strong interest in research in the field of venture capital and private equity. Mannie was working for Professor Josh Lerner at Harvard Business School before she returned to China to teach these subjects. The backbone for my contribution to our effort is the best practices work “for practitioners by practitioners” that I have developed in the area of venture capital through the multiple articles and three white papers that I’ve written.

Mannie was invited by a publisher in Beijing to write a textbook for undergraduate students in China; she in turn invited me to join her as the book’s co-author. Writing the book was a very intensive task, and both of us have worked on it for many months, with Mannie and her team translating my work and both of us discussing the context of the content for the Chinese audience.

Venture Capital: Theory and Practice, is in Chinese and is categorized as one of  “China’s National College Major Investment Textbook Series for the ‘Twelfth Five-Year Plan.’” The book has three parts and a total of 12 chapters. The Theory includes chapters on the venture capital concept, entrepreneurship, and a simple history; The Practice covers fundraising, business plan construction and analysis, investment due diligence, post investment monitoring and exit; and The Future emphasizes early stage investment, especially angel investment, as well as Cleantech VCs and socially responsible investment.  In the last chapter, Venture Capital in China, we explore the amazing development of China’s unique venture capital industry.

This textbook combines the strength of my Silicon Valley experiences as a venture capitalist and Mannie’s research as a professor, and it will help strengthen Chinese college-education programs in this particular field.  The book draws on and acknowledges important contributions from the members of the Working Group on Director Accountability and other experts in the field of venture capital.  I’ve donated all of my royalties from the book to the Society of Kauffman Fellows, which reported on the publication of this book in their July report.

Update on America’s Slipping Global Competitiveness– Implications for Intellectual Property Development of Senate Bill 515

ot_logoThis morning I gave the keynote speech at the ICAP Ocean Tomo IP auction in San Francisco.  My remarks explained the relationship between the long-term decline in America’s global competitiveness, the impact of the capital markets crisis on new investment in research and development, and specifically addressed Senate Bill 515, the pending U.S. legislation that will transform the U.S. patent system and broadly impact intellectual property rights in our country.  Some excerpts follow, and you can download the entire speech and slides by clicking at the bottom of this post:

“The absence of cohesion in American public policy can be seen in many areas—with cybersecurity coming immediately to mind.  Mike McConnell, former director of the National Security Agency, recently wrote an opinion piece in the Washington Post on why the U.S. is losing the cyber war, commenting that “The problem is not one of resources; even in our current fiscal straits, we can afford to upgrade our defenses. The problem is that we lack a cohesive strategy to meet this challenge.

This lack of cohesiveness comes from short-term thinking that has become prevalent in many aspects of American society.   The notion that “posterity doesn’t matter” has unfortunately taken root in our country, and this has led to fragmented approaches to public policy solutions across the board, corroded leadership among our elected representatives, and contributed to an entitlement culture and a lack of accountability that permeate much of American society.”

“The key obstacle to moving [patent] reform forward continues to be disagreement between several large high-tech companies, namely the group of Cisco, Microsoft, Hewlett Packard, and Intel, on the one hand, and life sciences organizations such as PhRma, BIO, MDMA, AdvaMed, Universities, several union groups, the NVCA, and others, on the other hand, over the idea of creating a new post-grant review procedure within the PTO and over the proposal on apportionment of damages in infringement cases.

As we consider the broad implications of this polarizing issue, we must first step back and remember that inventors and investors devote time, energy and risk capital to innovate new products and technologies.  Since the drafting of our country’s Constitution and even well prior to the establishment of the United States, it was understood that the greater good was served with a patent system that encourages this type of risk taking by protecting inventions resulting from innovation.  It is also understood, though in our country it appears to have been forgotten, that innovation, and job creation, come not just from large, well-funded enterprises, but in large part result from the efforts of small companies and individuals laboring to make a better mouse trap.

The core principles underlying the patent system have not changed.  We need to encourage and reward those that take risk to innovate new products, services and technologies.  Unfortunately, the patent system that served us so well for so long is under assault.  The cost of filing patents has increased dramatically.  The cost of enforcing patents has gone through the roof.  Injunctions have been taken away except for cases of head-to-head competition in the patented item.  Patents are now easier to invalidate after-the-fact.  A patent holder can no longer offer his/her patents for license without putting himself/herself at risk of litigation that he/she may not be able to afford.  Innovation involving patents has become a rich-man’s game, with an increasingly uncertain chance of return.

At a high level, we need to understand that anything that changes our patent system creates winners and losers.  In general, changes that weaken the patent system hurt inventors and innovators, while benefiting large companies with established market positions (e.g., monopolists) and low cost producers (e.g., offshore companies with lower labor costs, fixed currencies and weaker environmental standards).

Some argue for changes in the patent system based on a claim that non-practicing entities, often pejoratively called trolls, have too much power.  Some extraordinary examples, such as NTP seeking an injunction that would shut down Congress’ use of Blackberrys and some high dollar jury awards and settlements, have been cited by some as sufficient reason to argue for a radical restructuring of the way that patents are filed, challenged and enforced in court.

We need balance in this process, as changes may have the unintended affect of hurting those that we need now more than ever – inventors, entrepreneurs and investors that will innovate and create jobs here in the U.S.”

For a full transcript of the speech, including the slides, CLICK HERE.

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VC Governance FAQ: (9) Does an anemic IPO market deter VC investing?

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This is the ninth in our series of ten frequently asked questions from investors in venture capital partnerships.

Susan Mangiero, CEO of Investment Governance’s Fiduciary X, asked me the following:

Question: Do you think than anemic IPO market will remain a deterrent to VC investing?

Yes I do.  I believe that an entire generation of American innovation is at risk as a result of the lack of IPO’s.  The statistics are overwhelming in support of my position, starting with the fact that over 90% of jobs created by VC-backed companies occur AFTER their IPO—and this has been the case for 40 years.  What concerns me the most about the IPO vacuum is that it is systemic and is the result of a “one size fits all mentality” when it comes to regulation of the securities industry.  A relatively unknown emerging growth public company with a $500 million market cap has different needs for research and trading support to provide liquidity for investors than IBM.  I remain surprised that this seems to be difficult for our policy makers to understand, but I am encouraged that the SEC has recently invited public comments for a 90 day period to address structural problems with the U.S. equity markets.

Specifically, the SEC wants to know if anyone from the public has thoughts on whether the current market structure is fundamentally fair to investors and supports capital raising functions for companies of various sizes, and whether intermarket linkages are adequate to provide a cohesive national market system”. The Commissioners expressed particular interest in receiving comments from a wide range of market participants. Comments on the Concept Release are due within 90 days after publication in the Federal Register.

For more on the SEC Concept Release, click HERE

I believe that the U.S. equity capital markets must be structured with the goal of promoting the growth of publicly held small businesses in America.  America had this structure in place prior to 1997, and we should take a hard look at what has changed to render the small company IPO extinct (contrary to popular belief, it first became an endangered species before the technology bubble).

images-15Compounding this problem is the fact that, with no IPO options, the consideration paid for companies in trade sales—acquisition by larger companies—has been declining.  Why should venture capitalists take the risks associated with starting up a new company, working through all of the difficulties with multiple financing rounds and executive changes over a six-to-eight or even ten-year period, only to get backed into a corner by a large multinational that dominates the sales channel and can wait them out?

The biggest problem the VC industry has today is that, absent access to public market capital, there are too few VC-backed companies that are self sustaining cashflow generators.  The biggest problem that the U.S. economy has today is unemployment.  You would think that maybe the stewards of the U.S. economy, our legislators, could make some structural changes to our small company capital markets regulations to fuel the greatest job creation engine in America—the entrepreneur driving an emerging growth company.  This problem goes way beyond venture capital—as 47% of all IPO’s since 1991 were backed by neither VC’s or private equity firms—this is an American problem.

VC Governance FAQ: (8) How can a limited partner exit from a VC fund?

images-16This is the eighth in our series of ten frequently asked questions from investors in venture capital partnerships.

Susan Mangiero, CEO of Investment Governance’s Fiduciary X, asked me the following:

Question: What happens if an LP wants to exit a VC fund? What are their rights?

Answer: The options here are limited, and they are (1) the LP can try to sell their interest, including the obligation to fund future capital calls, to a fund that acquires secondary interests.  The good news is that a robust market exists for such interests in venture capital partnerships today; or (2) default.  If you do wish to sell, the GP needs to approve the transfer, and the standard partnership agreement language leaves this decision in the “sole discretion” of the GP.  There is no free lunch if you change your mind several years into a 10-year-plus partnership participation. And there shouldn’t be, which also means that either the secondary market buyer will take their pound of flesh by buying the LP’s interest at a substantial discount, or the GP will by offering the interest and its economic value on a discounted basis to the other LP’s.  It is far less disruptive to the GP and to the GP-LP relationship for the exiting partner to sell to a secondary buyer, but these buyers are totally financially driven and are going to get the best deal possible for themselves.

A Wake-Up Call for America– Free Webcast Discusses Systemic Market Failure in U.S. Equities and Formal Release of New Grant Thornton Study, November 9th 12:30 PM EST

Join Grant Thornton for a free Webcast on A Wake-Up Call for America, the greatly anticipated study demonstrating how market structure changes over the past 10 years have had a profound negative effect on the number of publicly listed companies in the United States – ultimately inhibiting economic recovery, worsening the job market and undermining U.S. competitiveness.

wake-up-america_civilizationcalls
Date: Monday, November 9, 2009

Time: 12:30-2:00 EST

Note: Register now,  Company pass code – 710004, Course code – 11738


The Webcast will feature a lively discussion among the study’s contributors and other industry-leading capital markets executives, and will include an in-depth look at the steep decline in U.S. listings, the macroeconomic implications, and recommendations for attainable solutions. A Q&A session will conclude the event, and all participants will receive a copy of the study.

Participants include:

  • David Weild – Former vice-chairman and executive vice president of the NASDAQ Stock Market, and current Senior Advisor at Grant Thornton LLP and founder of Capital Markets Advisory Partners.
  • Edward Kim - Former head of product development at the NASDAQ Stock Market, and current Senior Advisor at Grant Thornton LLP and Managing Director of Capital Markets Advisory Partners.
  • Pascal Levensohn – Founder and Managing Partner of Levensohn Venture Partners, and Director of the National Venture Capital Association (NVCA), where he is chairman of the education committee.
  • Barry Silbert – Founder and CEO of SecondMarket, the largest marketplace for illiquid securities.  SecondMarket was named the top start-up in the entire Northeast by AlwaysOn Media and one of the Top Fifty Startups You Should Know by Businessweek.

Space is limited. Register today. <http://university.learnlivetech.com/gtt>

Follow the steps below to register. You will receive an email confirmation with instructions for attending the Webcast. If you need assistance with registering, please call 206.812.4700.

  • Go to http://university.learnlivetech.com/gtt and choose “New Student Registration” to create your account, then enter company pass code 710004.
  • If you have attended a Grant Thornton Webcast within the past year, simply log in to your account.

Locate the Webcast in the catalog and sign up for A Wake-up Call for America, course number 11738.

New Study: Market Structure is Causing the IPO Crisis

imagesI’ve been speaking publicly for over one year about the disastrous impact of the capital markets crisis in accelerating the demise of small emerging company IPO’s.  To be clear, this process began over eleven years ago and, in my view, it is the single most important issue for the venture capital community because it jeopardizes an entire generation of innovative American companies. In addition to revitalizing America’s slipping global competitiveness, restoring emerging company IPOs in the U.S. will efficiently create new jobs and drive a new, sustainable economic growth cycle in our country.

Grant Thornton LLP’s Capital Markets Group today announced the release of Market Structure is Causing the IPO Crisis, a white paper examining the demise of initial public offerings in the United States, and offering remedies to resurrect the IPO market.  The paper is a follow up to Grant Thornton’s original study, Why are IPOs in the ICU?, which was published in November 2008.

The new white paper provides fresh market data and incorporates additional insight gleaned from discussions with a wide range of key market participants, including former senior staffers at the SEC and senior executives at “bulge bracket” and “major bracket” investment banks.

Co-authored by David Weild, Senior Advisor at Grant Thornton, founder of Capital Markets Advisory Partners and former NASDAQ vice-chairman, and Grant Thornton Senior Advisor Edward Kim, the updated study continues to focus on how technological, regulatory and legislative changes have combined to chisel away at the U.S. IPO market.  Although conventional wisdom holds that the U.S. IPO market has been going through a cyclical downturn exacerbated by the recent credit crisis, the paper points out that in reality, the market for underwritten IPOs, given its current structure, is closed to 80% of the companies that need it.

“Despite the recent uptick in IPO activity, over the last several years, initial public offerings in U.S. have nearly disappeared,” noted Mr. Weild.  “Our findings since publication of the original white paper have served to reinforce our thesis that the loss of the IPO market in the United States is due largely to changes in market structure.  By killing the IPO goose that laid the golden egg of U.S. economic growth, the combination of technology, legislation and regulation undermined investment in small cap stocks, drove speculation and killed the best IPO market on earth.”

The white paper proposes  a solution to this crisis – an issuer and investor opt-in capital market that would make use of full SEC oversight and disclosure, and could be run as a separate segment of NYSE or NASDAQ, or as a new market entrant.  It would offer:

  • Opt-in/Freedom of Choice – Issuers would have the freedom to choose whether to list in the alternative marketplace or in the traditional marketplace.
  • Public – Unlike the 144A market, this market would be open to all investors.
  • Regulated – The market would be subject to the same SEC corporate disclosure, oversight and enforcement as existing markets.
  • Quote driven – The market would be a telephone market supported by market makers or specialists, much like the markets of a decade ago.
  • Minimum quote increments (spreads) at 10 cents and 20 cents and minimum commissions – 10-cent increments for stocks under $5.00 per share, and 20 cents for stocks $5.00 per share and greater, as opposed to today’s penny spread market.  These measures would bring sales support back to stocks and provide economics to support equity research independent of investment banking.
  • Broker intermediated – Investors could not execute direct electronic trades in this market; buying stock would require a call or electronic indication to a brokerage firm, thereby discouraging day-traders from this market.
  • Research requirement – Firms making markets in these securities would be required to provide equity research coverage that meets minimum standards.

To view the full paper including updates, please visit: www.gt.com/ipo.