By John Lowy
It’s well-documented that publicly-held companies are worth considerably more than similar private companies. There are good reasons for the disparity--liquidity, of course, is paramount. There are other advantages to becoming public: it’s much easier to raise capital, because investors see the exit strategy; and, public companies can use stock options to hire more qualified employees, whose talent enables public companies to increase revenues, profits and value.
So, how can a privately-owned company become publicly-held in the United States? This article is a brief overview of those ways to become public, and some of the pluses and minuses of each.
First, in the traditional Initial Public Offering (“IPO”), the private company retains an underwriter for the S-1 offering, which will agree, subject to certain conditions, to raise an agreed-upon amount of money in exchange for an agreed-upon percentage of the company’s shares. The most desirable type of S-1 is a firm commitment offering, in which the underwriter agrees to purchase the shares being offered, and then resell them to investors. Thus, when the offering is declared effective, the company is assured of receiving the offering proceeds—unless a negative event occurs in the few days between the effective date and the closing.
The advantage of a firm commitment IPO is clear: assuming it is successful, the company will be publicly-traded, and is often immediately listed on an exchange—NASDAQ, AMEX or even NYSE, depending upon the size of the company and the offering.
The principal disadvantage of a firm commitment IPO is that the large majority of firm commitment IPOs are for companies which raise $40,000,000 or more, which significantly limits the number of companies that can even contemplate such an IPO. Another important disadvantage of a possible IPO is that it is subject to market conditions—if the stock market is declining, the underwriter can either delay or even cancel the offering. Or, if the company’s business softens, or its business sector suddenly goes from hot to cold, e.g., biotech deals recently, the underwriter may cancel the deal.
Not discussed here: either a self-underwritten IPO, in which the company attempts to go public by selling its shares without an underwriter, or the new so-called “Regulation A+,” which allows companies to raise up to $50,000,000 without using Form S-1. In my opinion, unless the company has access to a large base of potential investors, self-underwritings usually result in the company raising only a small amount of money, with no liquidity. And given its brief existence, it’s too early to determine if Reg A+ offerings will be successful, either with or without an underwriter.
A new term, “Slow PO,” is being used to describe an old method by which private companies become publicly-traded: a private company can raise money from investors over the years, building its shareholder base, and then make those shares publicly tradable.
In a Slow PO, after a company has established a shareholder base, an attorney issues a legal opinion that those shareholders may publicly resell their shares without registration, pursuant to the exemption provided by Section 4(a)(1) of the Securities Act of 1933. The company also engages a broker-dealer to file an application with FINRA to obtain a trading symbol for the company’s shares. In this scenario, the company is not necessarily required to become a reporting issuer; instead, it could trade as a non-reporting issuer. Candidly, I do not advise using this Slow PO route to become a non-reporting public company, because with such minimal public information, trading will probably be sporadic.
In another “Slow PO” scenario, a private company with an aged shareholder base files a Form 10 with the SEC to become a reporting issuer, which, as a matter of law, becomes effective 60 days after it is filed. The company and its principals are then required to file periodic reports with the SEC—Forms 10-K, 13d, etc. The advantage to this type of “Slow PO” is that when FINRA authorizes the broker-dealer to publish quotations for the shares, the company will be a publicly-listed (OTC) reporting issuer.
There are many disadvantages to the second type of Slow PO: first, it obviously takes a long time, even years, before the private company has enough shareholders with the required holding period. Second, there are significant legal and accounting costs in filing the Form 10, plus company officers being diverted from company business to ensure the accuracy of the FINRA and SEC documents. Moreover, it is common that there is a lapse of time between when the Form 10 becomes effective and the company’s stock is cleared for trading, during which period the company must continue to file reports with the SEC, but with no trading market for its shares—the worst of both worlds.
Which brings me to reverse mergers:
Starting with the negative, the principal disadvantage of a reverse merger is that, unless it is coupled with a simultaneous PIPE [Private Investment in Public Equity] the reverse merger itself does not raise capital for the company, and in fact costs money—to purchase the shares from the principals of the public company, plus legal and accounting fees, etc.
But, in my opinion, the advantages of a reverse merger significantly outweigh the negatives: (1) a reverse merger is faster than an IPO, and significantly faster than a Slow PO; (2) it is far less expensive than an IPO, even including purchasing the shares of the public company’s principals, because of the substantial legal, accounting, underwriting, road show, etc. expenses of an IPO; and, (3) perhaps most important, a reverse merger is far more certain to be successfully completed than an IPO.
As noted above, the underwriter of an IPO can “pull” the deal at any time before the offering closes, for many reasons. By contrast, in a reverse merger, the private company is the master of its destiny: as long as it abides by the terms of the merger agreement with the public company, the deal will close and the private company will then be publicly-held.
So, on balance, if a private company intends to become publicly-held quickly, I recommend doing so by reverse merging with a publicly-held issuer.
John Lowy is the founder (in 1993) and CEO of Olympic Capital Group, Inc. (www.ocgfinance.com), and is the principal of his law firm John B. Lowy PC, both based in New York City. John is a highly-respected and acknowledged expert in reverse mergers, capital formation, financial consulting and initial public listings. He is also a licensed FINRA-registered representative with Transnational Capital Corporation, a New York-based broker-dealer.
As an attorney, an advisor or as a principal, John has led or participated in more than 200 such transactions, creating market value in excess of $5 billion. He has been instrumental in leading the process by which many companies have reverse merged and achieved listings on the NASDAQ or the AMEX.
In addition to the U.S., John has completed transactions for clients based in Australia, Brazil, Canada, the Caribbean, China, Hong Kong, India, Korea, Philippines, Singapore, South Africa, Turkey, UK, Vietnam and other nations. The sectors in which these clients are engaged range from high tech to low tech, real estate, pharmaceuticals, medical devices, oil and gas, mining, solar power and other renewable energy, entertainment, food, forestry, agriculture, education and retail, among others.
John received his B.A. from Tufts University and began practicing law after graduating from the University of Pennsylvania Law School.
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