GOING PUBLIC
An initial public offering (“IPO”) is where a private company files an S-1 registration statement with the Securities and Exchange Commission (“SEC”) in order to publicly sell its stock. This process is often called “going public.” The company whose stock is being sold is referred to as the “issuer.” The sales of the stock can be made by the issuer itself in a self-underwritten direct public offering (“DPO”) or the issuer can engage an underwriter to sell the stock in an IPO. The process of an IPO or DPO is regulated by the SEC and state regulators and, without experienced counsel, can be complicated, expensive, and time consuming.
Section 5 of the Securities Act of 1933, as amended (“Securities Act”), makes it unlawful to “offer” or “sell” securities without a valid effective registration statement, unless an exemption is available. Generally, if a company wishes to sell its securities to the public it must file with the SEC and provide prospective investors, all material information concerning the company and the securities offered. The Securities Act sets gives guidance as to what constitutes material information, and how information must be disclosed. Rule 404(a) of the Securities Act sets forth the basic requirements for a registration statement. Rule 404(a) reads in part:
“A registration statement shall consist of the facing sheet of the applicable form; a prospectus containing the information called for by Part 1 of such form; the information, list of exhibits, undertakings and signatures required to be set forth in Part II of such form; financial statements and schedules; exhibits; any other information or documents filed as part of the registration statement; and all documents or information incorporated by reference in the foregoing.”
Navigating the information requirements can be confusing and a failure to properly disclose required information can delay an offering and make it more expensive. Experienced legal counsel will help ensure all of the required disclosure is contained in any offering documents.
All domestic issuers must use either form S-1 or S-3. Form S-3 is limited to larger filers with a minimum of $75 million in annual revenues, among other requirements. All other Issuers must use form S-1.
There are four primary regulations governing the preparation and filing of Form S-1:
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Regulation C – contains the general requirements for preparing and filing the Form S-1. Included within Regulation C are regulations and procedures related to (a) the treatment of confidential information; (b) amending a registration statement prior to effectiveness; (c) procedures to file a post-effective amendment; and (d) the “Plain English” rule.
2
Regulation S-T – requires that all registration statements, exhibits and documents be electronically filed through the SEC’s EDGAR system and must include interactive data using the XBRL process.
3
Regulation S-K – sets forth, in detail, all the disclosure requirements for all the sections of the S-1. Regulation S-K is the who, what, where, when and how requirements to complete the S-1.
4
Regulation S-X – sets forth the requirements with respect to the form and content of financial statements to be filed with the SEC. Regulation S-X includes general rules applicable to the preparation of all financial statements and specific rules pertaining to particular industries and types of businesses.
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Both the Securities Act and the Securities Exchange Act of 1934, as amended (“Exchange Act”), provide remedies to investors who feel they were defrauded in the IPO and DPO process. In order to avoid any potential liability to prospective investors, officers and directors of issuers must ensure all investors were given an opportunity to review all investment documents prior to investing and all investment documents contain all material information and are not misleading. Officers and directors of issuers who fail to do so could be liable to the SEC and to investors themselves.
Private Placement Followed by Registered Resales
The most common methods for private companies to become a public companies are through IPOs and DPOs. IPOs and DPOs provide companies with a public shareholder base and, thus, make them public companies. Besides IPOs and DPOs, a company may also become a public company (go public) through selling securities in a private placement and then filing an S-1 registration statement with the SEC registering the resales of the securities sold in the private placement. As long as the sales of securities in the private placement were to unaffiliated parties, through the filing of the S-1 registration statement registering the resales of the securities, the company will gain a public shareholder base and will be considered a public company.
There are few differences between an S-1 registration statement filed in an IPO or DPO and an S-1 registration statement filed on behalf of selling shareholders registering for resales the securities sold in a private placement.
Reverse Mergers
A private company may also go public through a reverse merger. Unfortunately, many companies who become public companies fail and, as a result, many public companies become “shell companies.” As defined in Rule 405 and Rule 12b-2 of the Exchange Act, a “shell company” is a company that is now, or at any time previously was, a company with no or nominal operations, and any one of the following: (i) no or nominal assets; (ii) assets consisting solely of cash and cash equivalents; or (iii) assets consisting of any amount of cash and cash equivalents and other nominal assets. Since a public shell company still maintains its public shareholder base, a private company can bypass the going public process by acquiring the public shell. A reverse merger is when the shareholders of the private company purchase control of the public shell company and either merge the private company into the public shell company or make the private company a subsidiary of the public shell company. The most common structure of a reverse merger is a reverse triangular merger in which the public shell company forms a new subsidiary which merges with the private company. At the the closing of the reverse merger, the private company shareholders exchange their ownership for shares in the public company, and the private company becomes a wholly owned subsidiary of the public shell company. Post-merger, the public shell company is no longer considered a shell company.
There are several benefits to choosing to to public through a reverse merger as opposed to an IPO, DPO, or through registering the resales of securities sold in a private offering. One benefit is timing. A reverse acquisition can be completed quickly due to the timing of preparing the S-1 registration statement and getting approval from the SEC. The major benefit of structuring a reverse merger through a reverse triangular merger is the ease of shareholder consents. That is because the sole shareholder of the acquiring entity is the public company, the directors of the public company can approve the transaction on behalf of the acquiring subsidiary, avoiding the necessity of meeting cumbersome and time consuming Exchange Act proxy requirements.
There are also downsides to going public through a reverse merger as opposed to an IPO, DPO, or through registering the resales of securities sold in a private offering. A private company acquiring a public shell company acquires the history of the public shell company including any undisclosed, potential, or contingent liabilities. Going public through a reverse merger can also be more expensive than other going public alternatives due to the fact that the shell company must be purchased by the private company shareholders. In addition, the SEC has rules relating to former shell companies which prevent the public company’s shareholders from selling securities using Rule 144 for at least twelve months following the completion of the reverse merger. Finally, a reverse merger can be complicated and must be done correctly in order to avoid trading difficulties with FINRA and/or DTC.
FINRA and DTC
Once the S-1 registration statement is declared effective, an issuer will need to engage a market maker to file a 15c2-11 application with FINRA on behalf of the issuer in order to quote or trade the stock. The market maker will also assist the issuer with obtaining a symbol for its securities. FINRA is the self regulatory body which overseas trading on the over the counter market. FINRA is responsible for issuing trading symbols for trading securities on the over the counter market (including the OTC Pink, OTCQB, and OTCQX).
The Depository Trust Company (“DTC”) provides the clearing and settlement services for all the electronic trading of securities in the U.S. DTC is responsible for reviewing issuer securities and requiring that an issuer be able to prove, to DTC’s satisfaction, that all shares trading electronically are indeed legally entitled to do so.
In order to obtain liquidity for public shareholders, obtaining and maintaining eligibility is paramount for the smooth trading of an issuer’s securities in the secondary market. In addition, DTC eligibility is a prerequisite for OTC issuers’ shareholders to deposit securities with their brokers and have such securities be placed in street name.
SEC Reporting Requirements
Within four business days of the private company going public, a Current Report on Form 8-K (“Super 8-K”) which requires disclosure of the equivalent of the disclosure contained in a Form 10 registration statement including audited financial statements, must be filed with the SEC. The preparation and filing of the Super 8-K can be complicated and time-consuming and experienced legal counsel should be engaged.