Access to Public
Liquidity and Senior Secured Financing
Public liquidity can have many advantages for corporations
seeking to access the capital markets.
Access can come in several forms, however for the purpose of this memo,
we will focus on three forms:
1.
Reverse Merger – A “reverse merger” is a
transaction where by a private company becomes a public company by merging with
(or otherwise being acquired by, for example via share exchange) a public
company. Very often, the public company vehicle is (although it does not have
to be) a “shell” company. According to the rules of the U.S. Securities and
Exchange Commission (“SEC”), a shell company is a company that has: (a) no or
nominal operations; and (b) either: (1) no or nominal assets; (2) assets
consisting solely of cash and cash equivalents; or (3) assets consisting of any
amount of cash and cash equivalents and nominal other assets. A company can
become a shell company through various means, including a sale or liquidation
of its business or by agreeing to spin off its current assets and liabilities
at the time of the reverse merger.
2.
Self-Registration – The self-filing approach is
a way to take a company public without wither an initial public offering or a
reverse merger. By self-filing, an operating company can go public without the
use of a shell. A self-filing is the choice by a private company to begin the
process of voluntarily becoming a reporting company under SEC rules. By so doing,
a company assumes the obligation of filing quarterly and annual reports, and
becomes subject to proxy and other rules. “Self-filing” or a “direct public
offering”, when filed directly with the SEC (either on Form 10 or Form S-1) a
company becomes a fully-reporting public company. In the case of a Form S-1
filing, shares of the company and its shareholders can be registered for
resale. In contrast, a Form 10 filing subjects the company to the SEC’s public
information reporting requirements only, without any registration of shares. A
Form S-1 would have to be filed following a Form 10 if the company wishes for
the registered shares to be made available to investors and others for trading in
markets beyond any non-restricted shares held by shareholders at the time.
3.
Initial Public Offering – An IPO is a
transaction with the public capital markets, usually the equities market, in
which a company sells its unissued securities and receives all the proceeds in
the form of additional capital. This is called a primary offering. A securities
sale in which securities held by the owners of the company are sold, and from
which the owners receive the proceeds, is called a secondary offering. IPOs are
almost always primary offerings, but may include the sale of shares held by the
present owners. A company usually begins to think about going public when the
funding required to meet the demands of its business begins to exceed the
company’s ability to raise additional capital through other channels at
attractive terms. An initial public offering is no small obligation, and comes
with significant costs; ongoing expenses, loss of control, loss of privacy,
pressure for performance, and restrictions on insider sales to name a few.
However if the company is well positioned for this decision, an initial public
offering can an attractive decision; increased cash and long-term capital,
increased market value, mergers/acquisitions, growth strategies, ability to
attract and keep key personnel, increased prestige/reputation are just a few of
the benefits of the initial public offering.
More About Reverse
Mergers
The goal of the reverse merger is simple – to turn the
private company into a public company in a more efficient and cost effective
way than a traditional initial public offering (IPO). Another key goal, that is
often overlooked, is that once the reverse merger is completed, the conditions
should be set for the private company to operate as a public company. In our
experience, there are certain key conditions that a private company should be
looking for in a public shell vehicle to ensure an optimal outcome for either a
reverse merger or an alternative public offering. Among these are:
1.
The public vehicle should have a meaningful
number of shareholders (over 50), each holding at least 100 shares (so called
“round lot” shareholders). This allows for at least the beginnings of a
shareholder base, which is necessary if the goal is establish a liquid market
for the company’s shares (a key reason for going public in the first place).
2.
The shares of stock that these shareholders hold
must be “freely trading.” This is known as the “float” – how many shares are
not held by insiders (which is typically a large percentage post-reverse merger
due to the reverse merger structure described above). This is also key to
helping establish a liquid market.
3.
The public vehicle should be an SEC reporting
company (meaning subject to the requirements of the Securities Exchange Act of
1934) and should be current with its filing requirements. Non-reporting (or
tardy filing) shells are typically more trouble than they are worth given the
time and effort it takes to get them into compliance.
4.
The public vehicle should be listed for
quotation on a trading market such as the OTC Bulletin Board. Ideally, there
should be an active market for the public vehicle’s stock (although this is
typically not the case for shell companies).
5.
The public vehicle should be “clean” – the shell
should be owned/managed by reputable people, and there ideally should be no
liabilities in the company (including pending litigation) and no other matters
which would impair the operation of the private company’s business going
forward.
Roadmap to the
Reverse Mergers
1.
Identify
a suitable shell company. Public shell companies come in all shapes and
sizes. As previously stated, some shell companies have met the key criteria
stated above; while others have not. Some are quoted or listed on the OTC
Bulletin Board (or OTCQB Market) (“OTCBB”) or NASDAQ, while others may be
listed on the Pink Sheets (a lesser market). An even more important distinction
is whether the shell company is “clean” or not. Although the price may be
attractive, troubled shells should be avoided at all cost.
2.
Prepare
an Audit. If the private company is being acquired by a legal “shell”
company, within 4 business days following the transaction, the combined company
will be required to file audited financial statement of the private company
prepared in accordance with US GAAP standards. This is a very important lead
time item as it can take a reputable auditor 6-8 weeks or more (depending on
the subject company) to complete the audit.
3.
Conduct
due diligence. Once a suitable shell company is found, due diligence must
be conducted. The history of the shell company, its shareholders, and its
officers/directors must be documented and reviewed to ensure a smooth
transaction and help safeguard against problems post-acquisition.
4.
Negotiate
an agreement. The private company and the shell company must negotiate and
finalize a deal. This is often a more time-consuming process than expected, so
budget your time accordingly.
5.
Effect
the Transaction. All of the transactions associated with a merger or share
exchange must be completed by shareholders on both sides of the deal. It may
sound obvious, but don’t settle for signatures to be delivered later and
otherwise missing key elements at the closing table.
6.
Post-Acquisition
Filing Requirements. Once the acquisition is completed, the former private
company principals now find themselves running a public company. The public
company obligations start right away, within four business days, and preferably
as early as possible, after the closing of the acquisition, the newly-merged
company must file a Current Report on Form 8-K with the SEC, along with audited
financials of the private company (note: if the public vehicle is not legally a
“shell”, the time requirement is much longer). The 8-K will describe the newly
combined company, stock issued, information on the new officers and directors,
a full description of the business, and (if applicable) the terms of any
financing undertaken. The 8-K must disclose substantially similar type of
information that it would be required to provide in registering a class of
securities under the Securities Exchange Act of 1934. Thereafter, the company
will need to continue its reporting requirements with the SEC.
More about
Self-Registration
Self Registration is an alternative method to raise funds
and become a public company without the services of an investment banking firm.
In this method, the private company raises money in a private placement by
selling unregistered shares to “accredited investors” and at the same time
agreeing to register such shares with the SEC by filing a Registration
Statement on Form S-1 (or, for foreign companies, a Form F-1) with the SEC.
First, the company raises money through the private placement. Subsequently, a
registration statement is prepared, filed with the SEC and ultimately (after
the SEC review and comment process described blow) declared effective. At this
time, the holders of the shares purchased in the private placement may sell the
shares publicly. As described further below, prior to going effective, the
company must arrange for a listing or quotation of its shares on an exchange
like Nasdaq (which is very rare in these situations) or more likely the OTCBB.
The Registration Statement is a comprehensive disclosure
document consisting of a narrative description of the company, its business,
management, risk factors, a description its securities and audited financial
statements for the past 2 years (or inception, whichever is less) and interim
quarterly periods. After the Registration Statement is first filed with the
SEC, the SEC will generally review the Registration Statement and provide
comments within 30 days. The company will then address the SEC’s comments to
the filing issued by the SEC and amend the filing in response thereto. After
the comments are responded to and the SEC has no further comments, the SEC will
declare the registration statement effective.
The Registration Statement serves multiple purposes. First,
it allows the holders of the company’s securities which are registered via the
registration statement to sell their shares without further restrictions and
second, by filing a Form 8-A (a very short form) at the time the Registration
Statement is declared effective, the company makes itself subject to the
reporting requirements of the Securities Exchange Act of 1934. This means that,
among other things, the company is required the filing of quarterly reports,
annual reports, makes the company subject to the SEC’s proxy rules, and makes
the company’s senior management team subject to Section 16 filings whereby they
publicly report their ownership in the company.
Roadmap to the
Self-Registration
Before any stock exchange or quotation service will list or
quote the company’s common stock for trading, the company must meet the key
requirements stated above. As a result, it may be necessary for your company to
conduct a private placement to raise money, and issue stock to increase its
number of shareholders. The filing of the Registration Statement allows the
registered shares to be freely tradable. The filing of the Form 8-A then makes
the company subject to the Securities Exchange Act.
In order for a company to be listed on the OTCBB, a market
maker must file a Form 211 and act as a market maker for the stock. The market
maker will provide the bid and ask prices for an orderly market. Once the
shares are trading, it will be easier for the company to raise additional money
by selling additional shares of through an underwritten offering or a
self-directed offering by the company by filing another Registration Statement
covering such new shares. Subsequent Registration Statements are easier since
the SEC already commented on the first one. Furthermore, the company should be
able to raise more money this way since investors would more likely want to
invest in a company that already has a liquid market for its stock so that they
could have an exit strategy for this investment.
Differences between
a Reverse Merger and Self-Registration
1.
Advantages of Reverse Merger versus
Self-Registration
a.
The reverse merger process generally takes about
one month less than self-registration.
b.
The company will be a publicly-traded company
immediately after merger if the shell was previously trading and will not have
to wait until SEC clearance
c.
A
suitable shell company will already have the adequate number of shareholders
and freely trading shares
2.
Disadvantages of Reverse Merger versus
Self-Registration
The
costs of buying a shell (up to $500,000 and up to 10% of the combined company)
and conducting due diligence can be costly. Furthermore, it is our experience
that in many instances the shell company may have problems that do not become
evident until the due diligence process is completed, at which point a lot of
time was wasted or worse, if the transaction is completed, the new public
company has problems that it must deal with.
to learn more send me an email at : adi@otccapitalpartners,.net
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