Going Public
Going public is a complex and challenging process and impossible to cover in just a few pages.
This section will only cover certain highlights related to public offerings.
There are a number of reasons why the management and shareholders of a company may want to become a public company. However, all options should be carefully weighed. There are so many new obligations that arise once a company becomes a public company, especially a reporting company, and the directors, officers and shareholders should understand what those obligations are.
It is vitally important that a company has advisors who can recommend the best possible course for their company to go public, including assistance in pricing the stock, structuring the underwriting, locating and negotiating with underwriters, communicating the company image, developing necessary documents, and other important areas of an effective public offering.
The first question is whether or not your company should go public. It is important to understand the advantages and disadvantages of being a public company and all should be carefully considered. Note that the following only briefly discusses the subjects. Each subject could require a comprehensive analysis.
There are several options available to companies desiring to become a public Company. Each option has its own advantages, disadvantages, state and federal requirements, time constraints, and costs involved in becoming public and remaining a public company. Very careful consideration should be given as to the method used to achieve being a public company, how it will be achieved, all of the pros and cons and which professionals will be involved, including legal, accounting, underwriters, etc.
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Methods for Becoming a Public Company
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An I.P.O. (Initial Public Offering) Through a Broker-Dealer
There are very distinct advantages with doing an I.P.O. through a broker/dealer. An I.P.O. done through a reputable brokerage firm usually allows for larger offerings and more assurance that an underwriting can get completed. A major factor in using a brokerage firm with a substantial client base for the underwriting is that the firm may get other brokerage firms involved in the underwriting (a syndicate) and they all continue to take a position in the stock long after the offering is completed, thus maintaining a market for the stock. While the sale of the securities through a broker will cost a percentage of the offering, it is usually well worth the additional costs to insure the completion of the offering and the aftermarket.
A Self-Underwriting (I.P.O.)
Company management may feel confident that they can locate investors directly and therefore do a self-underwriting, not using a broker. It is possible for a company to sell its stock directly to the public, without the use of an underwriter or professional intermediary. While this may be possible, especially if the underwriting is for a small amount, there are still inherent negatives to a self- underwriting. Especially in assurances that the deal can get completed and in the aftermarket of the stock. However, the Internet and the World Wide Web has made technology and opportunities available to companies that did not exist a few years ago. It allows for the publishing and distribution of its prospectus to solicit funds from a wide audience, without the use of a professional underwriter. A company may also use the Internet to establish their own "bulletin board" to assist potential buyers and sellers. It is very important that all state and federal laws and rules be met in any offering of a company's stock, and that professional advice be sought.
An Internet Offering (I.P.O.)
An Internet I.P.O. is simply making an offering of the company stock through the Internet. There have been few successful Internet underwritings to date, however the trend is growing and it is expected that many more offerings will be made in the future. Again, like any other offering of company stock, either public or private, all state and federal laws and rules must be met and full disclosure made. Professional legal counsel is a must in any underwriting.
Reverse Mergers (Shell)
A merger into a shell or blind pool as a means of taking a company public is totally different than a underwriting. It involves merging the private company into a public "shell", or a "blind pool", a company that is presently public but has no sales, and usually no assets or liabilities, but does have shareholders. The "shell" or "blind pool" company may or may not be a reporting company. It may have as few 20 shareholders and as many as several thousand.
A "shell" company may be one that went public years before and then later closed the business that they were in, however remaining a public company and keeping their reporting status.
When a merger takes place between the shell company or blind pool and a private company, the principal shareholders of the private company will control the reorganized public company. This type of merger can be a very effective and fast means for some companies to achieve a "public" status. This is especially effective for a company that may not be quite big enough, or have the track record of sales and earnings, or simply not have the "glamour" for a full public offering. It is also a method of becoming public usually much faster and with far less front-end cost. However, there are drawbacks to this type of merger and all pros and cons must be carefully explored.
Advantages of An Initial Public Offering (IPO)
Needed funds may be obtained from the public offering. (Providing the offering is successful)
A public offering of company stock (IPO) should improve the company's net worth, perhaps enabling the company to obtain additional capital or borrow money on more favorable terms.
A public company, with its stock quoted “over-the-counter” may be able to more easily expand through acquisitions, using it's own stock rather than depleting needed cash.
A public company may be better able to attract and retain more highly qualified personnel by offering stock options, bonuses, or other incentives involving company stock with an ascertainable market value.
With public ownership of its securities, the company may be in a position, become better known nationally, to gain prestige and improve its business operations.
With the Company stock quoted “over-the-counter, there may be an easier possibility of converting debt to equity and to strengthen the company's balance sheet.
From a lenders perspective, an equity offering of the Company’s stock, may strengthen the financial condition of the company (reduces leverage).
If the price of the stock remains favorable, it may be possible to obtaine future financing more easily since the company can offer investors a security that is liquid, more freely tradable, with an ascertainable market value.
With the company being trading over-the-counter, it may mean more liquidity for the owners of the company, including founders, venture capital and other professional investors..
An IPO for the Company may enable the company to eliminate existing personal guarantees to lenders and others and, if sufficient capital is raised, allow the company to avoid future personal guarantees.
By establishing a public market for the stock of the Company, it may allow the founders and major shareholders to achieve a psychological sense of financial success and self-fulfillment.
Disadvantages of being a Public Company Public
There is a very significant cost involved in going public. There will be substantial accounting, legal, printing, travel and man hours devoted to preparing for a public offering.
In becoming a public company, significant information must be disclosed in great detail about the Company, and all of this information becomes public information, including sales and profits, executive salaries, transactions with management, competitive position, mode of operation and other material information.
Becoming a public company usually means that there are many shareholders of the Company. These means that management of the company may lose some flexibility in managing the company's affairs, particularly actions which require shareholder approval. As a public company, there may be practical, if not legal, limitations on salaries and fringe benefits, relatives on the payroll and certain other operating procedures. As a public company, the Board of Directors and officers of the company may not have the ability to act quickly if approval is required by shareholders or outside directors.
Under numerous state and federal laws, the officers and directors of the company assume serious additional responsibilities to its shareholders and the general public. The company must report any material change in the company through filings with the SEC, which are posted on EDGAR. The Company must inform shareholders and the public of business operations, financial condition, changes in management, and any other event which may materially affect the company or the public's investment decision relative to the company's stock, through it regular filings with the SEC and news releases. Founders and other insiders may lose control of the company if a sufficiently large proportion of the shares are sold to the public.
In a public company, officers and directors may become subject to a class action or derivative lawsuit alleging violations of corporate and securities laws, causing time-consuming, distracting and an expensive defense, even if the claim has no merit.
While the owners of a privately held company may, for whatever reason, not want the company to pay dividends, the underwriters for an IPO may require dividends to be paid.
By taking their company public there may be a negative effect on an estate tax of the founders.
Being a public company and reporting to the SEC, there are numerous additional expenses annually, including legal expenses in preparing the required reports, audited financial statements, preparation and distribution of proxy material, quarterly and annual reports to shareholders, fees for transfer agents, public relations, as well as other costs, including the time required by company officers devoted to these matters.
The value of a public company will fluctuate with the buying and selling of stock by the public investors. This can be dramatically influenced by a number of factors, including how well the company is doing, the changes in market conditions and the ability of the company to maintain an effective public relations program to communicate its worth to its shareholders and to new investors.
Decisions About Taking Your Company Public
There are numerous considerations which must be addressed in the decision to go public. Many of the considerations and decisions are very technical and could have both a short term and a long term impact on the company. Such decisions should be made with the help and advice of professionals who have extensive experience in I.P.O. underwritings, shells, mergers and public companies.
While it is impossible to cover all subjects involved, and the depth in which they should be discussed, the information contained in this material is simply present some subjects which should be addressed. The information contained here assumes that the company is intending to become a public company, either through an IPO or a reverse merger, and therefore does not attempt to address private placements of corporate stock or other means of financing. None of this material is intended to be legal advice. A competent attorney with extensive SEC experience should be consulted for advice on going public.
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Eligibility for Public Offering
The underwriters usually determine eligibility for a company going public through an IPO, (Unless a self-underwriting or a reverse merger is done). The underwriter is the sales agent for the company's stock to the public and must feel comfortable that the public will have an interest in making an investment in the company. They will look at the industry the company is in, the amount and trend of the company's sales and earnings and compare it with the industry trend, working capital and cash flow needs, use of proceeds of the offering, the experience and integrity and quality of the company management, growth potential of the company and other factors that could influence the decision of investors. The underwriter, along with management, will determine the percentage of the company to be offered to the public and the price of the stock. If the company intends to do a "self underwriting" the officers of the company must make the same type of evaluations, but may not be able to maintain the same objective outlook as a broker-dealer.
Audited Financial Statements (I.P.O.)
Audited financial statements will be required, usually for three years. Preparing audited financials, if the company has not had audited statements in the previous year, can be costly and time consuming. This can be especially difficult if information is missing or audit procedures were not performed at the appropriate time. It is best to start the audit with qualified auditors as soon as going public appears likely.
Management Team (I.P.O.)
Your company should have a strong management team that will appeal to the investing public. Registration statements will require the identity of senior executives, including a five-year work history for each individual. The management team should have individuals with experience in your industry.
Executive Compensation
Your company will need a sensible executive compensation program, designed to attract and retain executives while not showing overcompensation or favoritism.
Public Relations
A public relations program for your company should begin long before a public offering is under way. A public relations program should be designed to give your company a positive image with the financial community, business press and to the public. A good PR program takes time and effort and professional PR people should be used for maximum effectiveness.
Capital Structure
A capital structure for the company should be set up with the long term goals of the company in mind. Capital structures designed to meet the needs of a closely-held business and its owners may not be right for a public company. Major and far reaching decisions must be made in the structuring of the offering. This decision usually encompasses company management, underwriters, legal counsel and even the accountants. Should the offering be just common stock - what percentage of the company should be offered - at what price - should the offering include warrants - should there be preferred stock - all are just a few of the decisions to be made.
Related Party Transactions
Usually in private companies, there are a number of related party transactions. This could include loans, special stock arrangements, agreements with other companies owned by management, etc. All such arrangements and transactions must be disclosed, and if such transactions appear to be unfavorable to new investors, may have to be changed or done away with. Your corporate attorney and the lead underwriter should review all such transactions, in order to anticipate problems that could be detrimental to the offering or cause a delay with the SEC registration process.
Advance Preparation
Consult with corporate accountants and attorneys to determine any information that will need to be disclosed. This may involve audited financial statements of any predecessor or acquired companies, any legal problems involving the company, etc.. If the management of the company assembles all of the appropriate information needed for audited statements and in an offering circular, cost of the audit and the legal expenses could be reduced and much time saved.
Assembly of Your Team
During the IPO process, an enormous amount of management's time will be spent more with the group of people involved in the underwriting. It is essential for your team to be qualified from a professional standpoint and there needs to be a high level of trust and communication among the team to accomplish the objectives. It is especially important that you use accountants, attorneys and advisors who have SEC and underwriting experience. Your independent accounting firm and legal counsel should have the ability to provide a broad array of services. In addition to being experienced in SEC matters and public offerings you may want them to advise on corporate and personal taxes, enhancing shareholder value, management of employment contracts, corporate agreements, etc.
Selection of an Underwriter
Choosing the appropriate lead underwriter can be extremely important to both the success of the offering and to the "aftermarket". Investment banking firms vary widely in client base, financial strength, prestige, and their ability to provide necessary services for the company. Underwriters sometimes specialize in certain types of offerings. Some may not do first offerings while others specialize in them. Some specialize in certain industries and particular sizes of underwritings. While the larger brokerage houses will refuse to do an offering for under $20 million, smaller firms simply do not have the ability to do offerings of that size. There are local brokerage firms (have offices in only one town), regional firms (office in several regional states) and national firms (offices throughout the U.S.). The customer base of the underwriter should play a role in the selection process. Some firms have a strong retail base, (individual investors) while others deal primarily to institutional clients. There are advantages and disadvantages to both and these pros and cons should be understood and considered in choosing an underwriter. As with other decisions, proper due-diligence on investment firms should be done with the advice of professionals.
The Underwriting Agreement
Once an underwriter is chosen, you will ordinarily sign a Letter of Intent which will outline the terms of the Underwriting Agreement. The Underwriting agreement will detail such items as compensation to the underwriter, estimated price of the stock, how the underwriting is to structured, what will be required by the independent accountants for the benefit of the underwriter, and many other details. The corporate accountants and attorneys should review any underwriting agreement. The final underwriting agreement will usually not be signed until just before the underwriting is to take place and the stock sold to the public. Clauses in both the letter of intent and the underwriting agreement will allow the underwriter to change its mind if the stock market declines or the company's fortunes change.
The two basic types of underwriting arrangements are the firm commitment and the best efforts agreement. The firm agreement means that the underwriter agrees to buy all of the stock being offered and resell it to the public at the underwriter's own risk. The best efforts agreement means that the underwriter has no obligation to purchase any shares that the public does not buy. In a best efforts offering, the underwriter may agree that if all of a minimum offering number of shares are not sold to the public, the offering will be canceled. Obviously, to a company, a firm commitment is far more desirable than a best efforts offering. Best efforts offerings are usually used in smaller underwritings.
The Registration Process/Statement
A registration statement consists of a prospectus, which is going to be distributed to potential investors, and supplemental information. Supplemental information may consist of documents and information which is submitted to the SEC, and is available to the investor by request to the SEC's main office in Washington D.C., but is not distributed to potential investors.
The registration process actually begins with the first meeting of all participants, including company officials, the chief executive officer, the chief financial officer, independent accountants, corporate attorneys and the lead underwriter and its attorneys. An IPO must reach the market under favorable market conditions, therefore time is of the essence in completing the process.
The drafting of the Registration statement is a combined effort of company management, independent accountants, corporate attorneys and the underwriter and its attorneys. The prospectus is the document that potential investors will receive from the broker describing your company and why they should invest. The document is a "selling" document, and therefore, every one involved will want to show the company in its best possible light. However, the document is also a legal document, and must contain full disclosure of the company as described in the Securities Act of 1934, as amended. It simply means that anything that might have any influence on the decision of the potential investor or might have any significant impact on the company, must be fully disclosed. An experienced SEC attorney will know these rules and regulations and exactly what must be fully disclosed.
The "Red Herring"
After the draft of the registration statement is finished and the team is fully satisfied with it, it is printed and filed with the SEC. At this time, the lead underwriter begins to develop an underwriting syndicate, which is a group of other underwriters who will assist in selling the stock of the company. The number in the syndicate depends on the size of the offering and the size of the lead underwriter which can vary in size from a few to over one hundred. The prospectus is distributed to the members of the syndicate as a preliminary prospectus and then distributed to interested potential investors. At this time, the SEC has not yet declared the prospectus effective, and the securities cannot be sold to the public. A warning statement to that effect is printed on the prospectus.
The Quiet Period: Starting when an understanding is reached with an underwriter, a "quiet period" starts. The SEC strictly regulates any selling activities of company stock and company public relations activities. This period extends through the SEC review and ends 90 days after the effective date of the registration statement. Offering securities to the public before the registration statement is filed with the SEC is prohibited and after filing only oral selling efforts are allowed. No printed sales materials about the securities can be distributed to the public, other than the red herring or a simple announcement of the offering. While public statements about normal business operations, such as new product announcements, are permitted during the quiet period, however, legal counsel should review even these communications.
SEC Review
The SEC's Division of Corporate Finance generally reviews the registration statements, and the initial review usually takes approximately 30 days. The review will focus on whether the registration statement contains adequate disclosures and complies with the SEC rules. After the review is completed, the company will receive a comment letter from the SEC requesting changes in, or explanations of, certain items in the registration statement. Extensive changes can seriously delay the offering. It is important that any potential problems be anticipated and dealt with prior to the filing of the statement with the SEC. Competent and experienced legal counsel and accountants can usually dramatically reduce problems, time and costs of the filing process.
State "Blue Sky" Laws
A public offering must not only qualify under The SEC regulations, but each state has so called "Blue Sky" laws governing the sale of securities in every state in which the securities are to be sold. Qualifying under a states blue sky laws is usually handled by the underwriters attorneys.
The Road Show
During the period of time that the registration statement is under review by the SEC, the underwriter may request that the company go on a "road show", promoting the company to the participating underwriting syndicate, financial analysts, major investors, and others, allowing them to question management. This road show is critical in generating interest in your company and it's stock, and the presentation should be developed with the help of the accountants, attorneys, the lead underwriter, and perhaps a good public relations firm.
Becoming Public
The underwriting agreement is signed just before the registration becomes effective. After the effective date, the final prospectus which indicates the actual offering price of the securities is printed and then distributed to the members of the underwriting syndicate for further distribution to prospective investors who had received a copy of the red herring. A "tombstone" ad is published, usually in The Wall Street Journal and other newspapers and financial publications to targeted markets, letting investors know where they can get a copy of the prospectus.
The closing usually takes place a week or so after the effective date. At the closing the underwriters receive the funds from their customers, and the company then receives the net proceeds after the underwriter's compensation. If the underwriting agreement required a minimum number of shares to be sold and that minimum was not reached in this time frame, the offering period may be extended or even withdrawn.
Listing Your Company's Securities
The ideal situation for a company is to have their stock listed on an exchange, like the New York Stock Exchange (NYSE), the American Stock Exchange (ASE) or the NASDAQ National Market operated by the National Association of Securities Dealers (NASD). The decision for listing should have been made back when the underwriting deal was structured, as each of the exchanges have qualifications which must be met and the decisions as to the price of the shares, number to be sold, the amount of the total underwriting, all would have a baring on the possible listing of the stock. Most smaller underwritings usually attempt to qualify for NASD, which has fewer requirements than the larger exchanges. However, the NASD requirements are now such that they eliminate many good companies from being listed. The ASE and NASD both operate separate trading markets for smaller companies, called the ASE Emerging Companies Marketplace (EMC) and the NASDAQ SmallCap Marketplace.
Requirement for NASDAQ Listing
It is often the goal of young public companies to be listed on a stock exchange, usually NASDAQ. Listing on NASDAQ allows for more trading of a company's stock. A company has to meet certain requirements for listing on the NASDAQ reporting system.
The present requirements are as follows:
- Total Assets: $4 million
- Total Stockholders Equity: $2 million
- Registration under Section 12 (g) of the Securities Exchange Act of 1934 or equivalent
- Public Float (shares): 100,000
- Market Value of Public Float: $1 million
- Shareholders: 300
- Minimum Bid Price of Stock: $3
- Number of Marketmakers: 2
Federal Securities Laws
There are two primary sets of federal laws that govern the offering of securities to the public. These two are the Securities Act of 1933 (Securities Act) and the Securities Exchange Act of 1934 (Exchange Act).
Securities Act
The Securities Act, among other things, requires companies to give investors “full disclosure” of all “material facts” of the company. The “material facts” include any facts about the company that any investor may consider to be important in making an investment decision. To do this, a “Offering Memorandum” or “Registration Statement” is prepared by the corporate legal counsel and submitted to the SEC for their review. There are very specific guidelines that are required in a Registration Statement. It is very important that the company has very experienced legal counsel to prepare the registration statement. An experienced attorney can reduce the comments that will returned by the SEC and therefore also reduce some cost. Keep in mind that the SEC does not evaluate the merits of the business of the company or attempt to determine whether the securities being offered by the Company is a “good” investment. The purpose of the review by the SEC staff is to determine whether “full disclosure” is made. Once they determine that full disclosure has been made, the staff of the SEC can declare the registration to be “effective” and the Comp-any can then proceed to sell their securities.
Exchange Act
The Exchange Act is the part of the federal laws that requires publicly held companies to disclose information continually about their business operations, financial conditions, and managements. A public company, and in many cases their officers, directors and significant shareholders, must file periodic reports or other disclosure documents with the SEC. This is usually done in the form of a Form 10K which is filed at end of the company’ year end and audited financial statements are required. Quarterly reports are filed in a From 10Q which updates any important information of the company and is filed with unaudited financial statements. While the Form 10K and 10Q is filed with the SEC and is thereafter available on EDGAR, additional material changes in the company must be filed on a Form 8K. In addition,there may be some information that the company must deliver the information directly to shareholders.
Exemptions
Under some circumstances, your company may be exempt from these registration and reporting requirements.
There are also state rules and regulations to which a company must comply.
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