A Primer on Going Public - Part I

Date: 2009-06-21 20:17:29

By Brian A. Lebrecht

This is not another article on why you should go public, nor is it another briefing on all the disclosure and costs brought about by the Sarbanes-Oxley Act. For this article, I have assumed that the benefits and burdens of operating as a public company have been considered, and the decision to go public has already been made. The next question that business owners, investors, key employees and other stakeholders ask is, "how do we go about becoming publicly traded?"

The Lebrecht Group, APLC has developed a specialized practice in taking private companies public through a variety of alternative methods. When we undertake representation of a new client interested in becoming publicly traded, the first thing we do is educate them on the different methods that can be used to achieve their goal. This article is intended to be an overview of three common methods used by our clients. Subsequent articles will detail the benefits and drawbacks of each method.

The Yellow Brick Road

This is the term I use for the traditional method we all learned about in business school and read about in magazines and newspapers. Start your company; go to friends and family for your first round of financing, followed by rounds of financing by angels and venture capitalists; and finally conduct a multi-million dollar IPO underwritten by a major investment banking firm and a simultaneous listing on a national stock exchange.

If you want to be public, and you can go down the Yellow Brick Road, my advice is generally "Do It." However, a very small percentage of the good companies out there are able to utilize this method, primarily because venture capitalists and major investment banking firms only fund companies that can show extraordinary potential growth, and other factors such as the overall economic climate have a material impact on the number of deals they will do in any given year.

The Self-Underwritten IPO

The first alternative method is to conduct an initial public offering without the services of a major investment banking firm. Here, the issuer files a registration statement on Form S-1 with the Securities and Exchange Commission, addresses comments to the filing issued by the Commission and amends the filing in response thereto, and eventually the Commission declares the registration statement effective.

The registration statement serves multiple purposes. First, by filing a Form 8-A towards the end of the comment process, the issuer makes itself subject to the reporting requirements of the Securities Exchange Act of 1934 (the "'34 Act"). The '34 Act requires the filing of quarterly reports, annual reports, makes an issuer subject to the proxy rules, and makes the issuers management team subject to Section 16 filings, among other things. Before any stock exchange will list an issuer's common stock (other than the Pink Sheets), the issuer must be subject to the reporting requirements of the '34 Act.

The second purpose of the registration statement is to register the resale of stock that was previously sold to investors in a private placement, or issued in exchange for services. Under most private placement exemptions, the stock issued in these transactions is restricted in accordance with Rule 144 and thus can't be sold into an open marketplace should trading develop in the issuer's stock. Before any stock exchange will list an issuer's common stock for trading, the issuer must be able to demonstrate that it has a sufficient number of people, with a sufficient number of shares of common stock, so that it is reasonably likely that a public trading market will develop. Because of this requirement, it may be necessary for the issuer to conduct a private placement before filing the registration statement, not only to raise the necessary funds, but also to increase its number of shareholders.

The third purpose of the registration statement is to raise money for the issuer. Like any IPO, a self-underwritten IPO can register stock for sale to the public, and unlike a private placement, a registered public offering generally allows the issuer to solicit investors, advertise, and pay sales commissions. And, since the issuer anticipates that it will have its stock publicly traded in a short period of time, it should be able to attract a larger group of potential investors, including hedge funds and institutional investors. Note, however, that an issuer cannot apply to have its stock traded on any exchange until the offering is finished, so unlike an underwritten IPO where the investment banking firm buys the entire offering immediately upon effectiveness of the registration statement, a self-underwritten IPO may take days, weeks, or months to complete.

The Reverse Merger into a Public Shell

A very common alternative method of going public is to merge a private company into a public shell. A public shell is a company that is available for public trading (although often it has very little recent trading activity), but has no operational business of its own. There are a number of ways that a public shell could find itself in this position, including a failed prior business, or it was formed for the express purpose of being a public shell.

Regardless of its past, public shells all have a few common characteristics. The most prominent is that its stock is already listed for trading on some exchange. This is most commonly the Over the Counter Bulletin Board, but could be the Pink Sheets or NASDAQ as well. If the issuer's stock is traded on any exchange except for the Pink Sheets, it is also already subject to the reporting requirements of the '34 Act (see above.)

The second common characteristic is that the public shell is controlled by one or a small group of shareholders who, for a negotiated price, are willing to transfer control to the private company shareholders, or agree to vote in favor of the issuance of a control block of stock to the private company shareholders.

Once the private company is acquired by, or merged into, the public shell, and the shareholders of the private company own a controlling interest in the public shell, in effect the private company has "gone public" via a reverse merger.

The Spin Out

A less-often used alternative technique for taking a private company public is the spinout. In a spinout, a "host" company, usually a publicly traded company, acquires an interest in a private company, the "target." The host then declares a dividend of its ownership interest in the target, distributing that interest to the host company's shareholders pro-rata. Now, all of the public company's shareholders own a small interest in the target, giving it the necessary number of shareholders so that there is a reasonable chance that a public market might develop. Once the target makes itself subject to the reporting requirements of the '34 Act, it is eligible to apply to have its stock traded on an exchange.

Generally, there is a requirement that there be some kind of business purpose for the transaction (other than to take a company public) and that there be some business synergy between the host and the target.

Moving to a National Exchange

In most cases, no matter what strategy is used, the issuer will initially list its stock for trading on the Over the Counter Bulletin Board. Once an issuer can demonstrate the minimum stock price and/or capitalization requirements of another exchange, such as the AMEX or NASDAQ, the issuer can apply to move to that exchange.

Summary

I have provided a very brief overview of three alternative methods of going public. There are many advantages and disadvantages of each, including the cost, the time it takes to complete a strategy, and the potential liabilities of each strategy. Before undertaking any of these strategies, consult with a securities lawyer who is experienced in this type of transaction, and educate yourself on the characteristics of each strategy.


Author

Brian A. Lebrecht is an attorney with and the founder of The Lebrecht Group, APLC, located in Irvine, California and Salt Lake City, Utah. http://www.thelebrechtgroup.com.. This articles came from MoreArticles.net.


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