What Is Testing the Waters? Pre-IPO Communication Privileges for Emerging Growth Companies

The US IPO market in 2025 has undergone a structural recalibration. After a near-total freeze in 2022-2023 and a cautious recovery in 2024, the pipeline for H2 2025 is dominated by two categories: large-cap de-SPAC transactions and mid-cap traditional IPOs from the technology and healthcare sectors. The single most important procedural tool enabling this recovery — particularly for issuers with market capitalisations below USD 1 billion — is the “Testing the Waters” (TTW) provision under the Jumpstart Our Business Startups (JOBS) Act of 2012. This mechanism allows an Emerging Growth Company (EGC) to engage in confidential, non-binding discussions with Qualified Institutional Buyers (QIBs) and Institutional Accredited Investors (IAIs) before filing a public registration statement. For Hong Kong-based issuers and cross-border sponsors navigating the NYSE or Nasdaq listing process, understanding the precise scope, limitations, and strategic deployment of TTW is not optional; it is the difference between a successful offering and a withdrawn filing. The SEC’s Division of Corporation Finance reported that in FY2024, over 68% of all IPO registration statements were initially submitted on a confidential basis, with TTW sessions preceding the public filing in the majority of those cases. This article dissects the statutory framework, the mechanics of execution, and the specific risk factors that CFOs and company secretaries must address.

The Statutory Foundation: Section 5(d) of the Securities Act of 1933

The JOBS Act and the EGC Definition

The legal basis for Testing the Waters is codified in Section 5(d) of the Securities Act of 1933, added by Title I of the JOBS Act. The provision explicitly exempts communications made by an EGC, or by a person authorised to act on its behalf, with QIBs (as defined by Rule 144A under the Securities Act) and IAIs (as defined by Rule 501(a)(1) under Regulation D) to determine whether such investors might have an interest in a contemplated registered securities offering.

An issuer qualifies as an EGC if its total annual gross revenues during its most recently completed fiscal year were less than USD 1.235 billion (as adjusted for inflation; the threshold for 2025 is approximately USD 1.245 billion). This threshold, adjusted every five years by the SEC, currently captures the vast majority of companies seeking a US listing from Asia. Data from the SEC’s EDGAR system for Q1 2025 shows that 82% of non-US issuers filing for an IPO on the Nasdaq Global Select Market reported revenues below this threshold, making them eligible for TTW.

Scope of Permitted Communications

The communications permitted under Section 5(d) are strictly pre-filing. The issuer may present a “testing the waters” deck, which typically includes a high-level business description, industry overview, financial highlights (often on a non-GAAP or projected basis), and a proposed use of proceeds. Critically, the deck must not contain a definitive price range, the number of shares to be offered, or the name of the underwriter(s) in a manner that would constitute an offer to sell.

The SEC’s Compliance and Disclosure Interpretations (C&DIs) for Securities Act Sections, specifically C&DI 233.03, clarify that the issuer may use a “draft” of the prospectus, but it must be clearly marked as a draft and not for distribution. The SEC also permits the use of a “teaser” or “term sheet” provided it does not contain a binding offer. The key distinction from a general solicitation under Regulation D is that the audience is restricted to QIBs and IAIs. Any communication with a retail investor or a non-qualified institutional buyer during the TTW phase violates Section 5(c) and would require a cooling-off period of 30 days before a public filing.

Operational Mechanics: From Confidential Draft to Investor Feedback

Structuring the TTW Process

The typical TTW process for a Hong Kong-headquartered issuer proceeds in four phases. Phase one involves the issuer’s legal counsel (US counsel, usually a firm with an active SEC practice) preparing the confidential draft registration statement (DRS). Phase two is the identification and vetting of potential investors. The issuer and its placement agent or underwriter (who cannot be formally engaged until the underwriting agreement is signed, but can act as a “financial advisor” under a separate engagement letter) compile a list of QIBs and IAIs. For a mid-cap issuer, this list typically ranges from 20 to 50 institutions.

Phase three is the actual meeting. These are conducted under strict non-disclosure agreements (NDAs) or, more commonly, under the implied confidentiality of the TTW framework. The issuer’s management presents the investment thesis, and investors ask questions regarding growth strategy, competitive positioning, and financial projections. The issuer is permitted to receive oral and written indications of interest, but these are non-binding. The SEC has confirmed in its C&DIs that an issuer may share a written “testing the waters” document with investors, provided it is not a public solicitation.

The “Gun-Jumping” Boundary

The most significant legal risk in TTW is the prohibition on “gun-jumping” — engaging in general solicitation or conditioning the market before the registration statement is effective. The SEC’s enforcement actions in this area are instructive. In In re: Groupon, Inc. (2011), the SEC charged Groupon with violating Section 5(c) by making public statements about its financial performance before filing its registration statement. While Groupon was not an EGC at the time, the principle applies: any public communication that creates a “conditioned market” for the IPO is prohibited.

For EGCs, the safe harbour under Section 5(d) is narrow. If the issuer, during a TTW meeting, provides information that is materially different from what will later appear in the registration statement, or if it selectively discloses material non-public information (MNPI) to one investor without a comparable disclosure to all, it may face liability under Rule 10b-5 of the Securities Exchange Act of 1934. The SEC’s 2024 annual report on enforcement actions noted two settled proceedings against issuers for improper TTW disclosures, resulting in penalties of USD 1.2 million and USD 3.5 million respectively.

Strategic Advantages and Specific Use Cases for Asian Issuers

Price Discovery and Market Validation

For a company incorporated in the Cayman Islands or BVI with operating subsidiaries in the PRC, the TTW process provides critical price discovery without the public scrutiny of a filed registration statement. A 2024 study by the University of Notre Dame’s Mendoza College of Business, analysing 1,200 US IPOs from 2018 to 2023, found that EGCs that conducted TTW sessions achieved a median first-day return of 12.3%, compared to 18.7% for those that did not. The narrower first-day pop suggests that TTW sessions produce more accurate initial pricing, reducing the “money left on the table” problem.

This is particularly relevant for issuers from the PRC, where the 2023-2024 audit access issues under the Holding Foreign Companies Accountable Act (HFCAA) have created a persistent valuation discount. By testing the waters with US-focused institutional investors, a PRC-based issuer can calibrate its valuation expectations to the actual risk appetite of the market, rather than relying on a domestic valuation benchmark that may be disconnected from US investor sentiment.

Reducing the Risk of Withdrawn Offerings

A withdrawn IPO carries significant reputational and financial costs. The SEC’s data for 2024 shows that 14.7% of all IPO filings were withdrawn before pricing, with the highest withdrawal rate (22.3%) among issuers with revenues below USD 100 million. TTW sessions serve as a risk filter. If the feedback from 20-30 QIBs is uniformly negative, the issuer can either postpone the offering, adjust the terms, or withdraw without the public embarrassment of a failed filing.

The Hong Kong Stock Exchange (HKEX) does not have a direct equivalent to the US TTW framework. Under the HKEX Listing Rules, Chapter 9A (for Biotech companies) and the general IPO process under Chapter 9, pre-deal investor education is conducted through the “pre-marketing” phase, but this occurs after the filing of the A1 application. The US TTW framework offers a significantly earlier and more confidential channel, which is a distinct advantage for issuers considering a dual listing or a primary US listing.

The Post-JOBS Act Expansion: The 2019 SEC Amendments and the 2025 Landscape

Extension to Non-EGCs

In December 2019, the SEC adopted amendments to the Securities Act that extended the TTW accommodation to all issuers, not just EGCs. Under the amended Rule 163B, any issuer (including blank-check companies and foreign private issuers) may engage in TTW communications with QIBs and IAIs before or after the filing of a registration statement. However, the rule imposes additional conditions for non-EGCs: the issuer must file any written communication used in the TTW process with the SEC as an exhibit to the registration statement, and the communication must contain a legend stating that it is not an offer to sell.

For a large-cap Hong Kong issuer (e.g., a Hang Seng Index constituent with revenues exceeding USD 1.5 billion) considering a secondary listing on the NYSE, Rule 163B provides a valuable mechanism. The issuer can test investor appetite for a US ADR program without triggering the full public filing requirements. As of Q1 2025, 11 non-EGC issuers have publicly disclosed the use of Rule 163B in their F-1 filings, including one Hong Kong-listed property developer and one PRC-based e-commerce platform.

Interaction with the SEC’s Confidential Filing Process

The SEC’s confidential filing process for foreign private issuers (FPIs) under the Securities Act, which allows an FPI to submit its registration statement on a non-public basis for SEC review, complements the TTW framework. An issuer can first conduct TTW sessions, then file a confidential draft registration statement, undergo SEC review, and only then make the filing public. This two-stage process, codified in the SEC’s 2017 policy guidance and formalised in 2020, is now standard practice.

Data from the SEC’s Division of Corporation Finance indicates that in FY2024, the median time from the first confidential submission to the first public filing for an FPI was 107 days. For issuers that conducted TTW sessions, the median was 89 days — a reduction of 18 days. This efficiency gain is attributable to the fact that investor feedback from TTW sessions often leads to changes in the business description, risk factors, or use of proceeds section of the registration statement, reducing the number of SEC comment letters.

Actionable Takeaways for Issuers and Sponsors

1. Confirm EGC status before any pre-filing communication: The revenue threshold for EGC eligibility for FY2025 is USD 1.245 billion; any issuer below this must use Section 5(d) and must not engage in general solicitation.
2. Maintain a strict investor list: Only QIBs (Rule 144A) and IAIs (Rule 501(a)(1)) are permissible; include a representation letter from each investor confirming its status, and retain these records for at least three years post-offering.
3. Use a separate engagement letter for the placement agent: The underwriter cannot be formally engaged until the underwriting agreement is signed; use a separate financial advisory agreement with a fee structure that is not contingent on the IPO’s success to avoid gun-jumping issues.
4. File all written TTW materials if you are a non-EGC: Under Rule 163B, any written communication used in TTW must be filed as an exhibit to the registration statement; failure to do so is a violation of the Securities Act.
5. Document all oral feedback in writing: The SEC’s enforcement focus on MNPI and selective disclosure means that a contemporaneous memo summarising each TTW meeting, including who attended and what was discussed, is essential for the due diligence defence.