Which came first? Going public or financing?

Many companies seek to go public in order to obtain needed capital for the growth of their business. Some companies, seeking that capital, meet a potential source who suggests that going public will make it easier for them to raise this particular round of financing, even though they may not have been considering going public. And of course in many cases the companies comply in order to get the funding they need. This is particularly true in stages of development where venture capital money is no longer available, but the company also may not be ready for later stage private equity.

One way to tell if a company really should be public is asking which came first? If a company, otherwise not interested in going public, does so at the request of a financing source, careful analysis should be undertaken. If a company has worked with its advisors to determine that it can benefit long-term from being publicly held, and can bear the costs of doing so, then seeks to raise money as part of that process, it has a much greater likelihood of succeeding in its plan to aid its growth through a publicly-traded stock. Too often companies go public simply to raise one round of financing, and find that there are no other advantages to being public, yet significant additional costs end up burdening them.

That said, if you have done the right analysis, are clear that going public makes sense, and are seeking financing, what are some of the trends in the marketplace for raising that money? Good news: the trends mostly favor companies going public. Here are some highlights..

1. Everyone's doing it. Investment banking firms from Goldman Sachs, Lehman Brothers and all the way down are involved in financings related to or closely following reverse mergers. It now appears that throughout Wall Street, any old "taint" associated with RM's shady past has been eliminated.

2. PIPE funds are proliferating and focusing on RM. More and more PIPE investors, forced in the last few years to change some of their questionable, but very profitable, practices, have looked to the greater risk but much greater potential upside of APOs and the like to enhance their returns. More and more funds are being created in the industry that did $36 billion in investments last year and going at a pace to well exceed $40 billion this year.

3. The regulatory environment is about to improve significantly. The SEC is expected in the next few months to pass the proposals announced back in May to implement some of the key recommendations of an SEC advisory committee on smaller public companies. Most importantly, (a) the holding period for unregistered securities (such as PIPE securities) is being reduced in most cases to six months and (b) shell shareholders, previously prohibited from selling under the exemption from registration in Rule 144, now will be able to sell under 144, probably six months after completion of a reverse merger and release of information. This will help companies to argue for improving the cost of obtaining financing, because investors have a quicker path to liquidity than in the past. It will also cause more and more investors to be interested in this space. It will also draw more players to create shells, knowing that they will have a path to liquidity even without registration following a merger.

4. It's happening more and more. About 50% of reverse merger deals include a contemporaneous financing. It has not always been thus. In my shop, frankly, more like 90% of the deals we work on are financing-driven. Why do an IPO when you can complete an "APO" (alternative public offering) characterized by a simultaneous reverse merger and PIPE.

5. More financings come with a shell. Many PIPE investors and investment banks have created "virgin shells" through Form 10-SB for use in their own deals. As a result, finding a shell becomes a non-issue when choosing the right financing source. These totally clean, fully SEC reporting, inexpensive but non-trading shells are becoming more and more popular as problems with trading shells have persisted.

6. More self-filings are possible. The main disadvantage of doing a self-filing to go public rather than complete a reverse merger is the time it takes to complete, delaying the needed financing. However, more and more PIPE investors are willing to invest directly into the private company, so along as the next thing it does is a self-filing to go public. This avoids the dilution of leaving an interest behind for the shell. A number of other conditions should be present for a self-filing to make sense, as outlined in my book.

7. The "yuan rush" continues. More and more Chinese deals seem to be heading to our shores, and more and more include contemporaneous financings. The valuations continue to rise, many deals are indeed high quality, but we can only hope values remain realistic so as to avoid this bubble getting too close to bursting. The recent scare caused by China's foreign exchange regulator, SAFE, issuing its circular 106, has led many to find legitimate ways to go forward with deals efficiently while still complying with 106.

8. New structures are bringing new creativity. Rodman & Renshaw has the CAP structure, Westpark Capital the WRAPPS approach. In both cases they are innovative approaches to raise money and go public at the same time through a reverse merger. As with SPACs five years ago, some or all of these may begin to really take off.

9. With experience comes confidence. Several years ago a number of PIPEs players began to finance reverse merger deals. In some cases there was early frustration with deals that take months (PIPEs usually take a few weeks), problems with shells and the like. But as the players have completed more deals, their savvy has improved. Some have brought in outside experts to oversee the deals. Others have set up inhouse teams to pursue the area. Thus the desire to do more and more deals has grown.

10. Bottom line: good stuff. Some have begun describing this as the "heyday" of reverse mergers and APOs. We have never been busier for sure, and it is indeed, for the moment, the perfect storm for the attractiveness of these efficient and straightforward methods to help a company achieve greater liquidity, have greater ease of capital formation and provide growth to some of the world's great entrepreneurial ventures.

By the way, this is a message from my 5-year old son, whom I blogged about last week and who typed this: we want for THOUSANDS! of people to read the reverse merger blog. The End. And make sure you read the PANDA POOP! part. and the part when like SEAWEED! is a problem and be careful with KEIKIS! when you are in your car! [referring to my entry on August 1]

Coming Home

A busy week for those of us in smallcap, PIPEs, reverse mergers and APOs as the annual PIPEs Conference convened in NY, so not much else new to write, the SEC has not yet announced anything (although they have declared this Disability Employment Awareness Month), so a moment off to write about, as they say in the Lion King, the circle of life.


My wife and I both attended the same school on Long Island which goes from pre-kindergarten to 12th grade (http://www.lawrencewoodmere.org/). My son is now attending there in kindergarten, his first year. Friday night we attended our first official function as parents, the annual Faculty Show. Yesterday was the school's Homecoming. Though we have attended before as alumni, this was the first year we truly feel as if we are coming home. When my son refers to places in the school that he had music class or an assembly, memories wash over us that are both strange and exhilirating.


Most of us remember our high school years fondly. My wife and I had that rare experience of truly loving school. Great kids, great teachers, great opportunities, great fun. We are so excited that our son has the chance to be just as lucky as we were and so far (well admittedly it is Kindergarten), he is loving school. At the same time, there is a sadness yet serenity that overcomes us as we pass the torch to the next generation. Indeed, in our day there was a ceremony at the end of the school year where a physical "lamp of learning" was symbolically passed from grade to grade; maybe we should do that at home too.

Our older daughter is fabulous but for various reasons did not attend the same school. While we have such pride for her achievements as we slog through the extraordinary fun of the college application process, and have been very active in her school, it simply was not the same as the experience we are having now.

We are very glad to be coming home.

Next, back to RM!

Tip of the Week: So Many Issues in Buying a Shell

One topic we simply didn't have much room for in the book was the mechanics of "purchasing" a shell. Many shell players find shells and acquire a controlling interest prior to identifying a transaction to put in. This is true for both trading and non-trading virgin shells, as both types are flipped, typically for a cash payment in what is often called a "cash and carry" transaction.


Here are just a few issues to be careful about in buying a shell.


1. Are you starting a tender offer? If you are not careful your offer to acquire shares from shareholders to obtain control might constitute a tender offer under SEC rules, which could trigger the requirement to put together a time-consuming and costly SEC filing which obviously should be avoided. There is no bright line test of what constitutes a tender offer, only a number of factors to be considered on a case by case basis. Make sure you consult with counsel to analyze whether your offer might inadvertently cross the line.


2. Watch out for Worm/Wulff. If the people you are buying shares from acquired them at a time when the company was a shell company, they may be subject to the so-called "Worm/Wulff letters." Among other things, these letters between the SEC and the NASD make clear that an affiliate or promoter of a shell cannot transfer his shares to a third party in a private transaction. Period. Further, the SEC staff expands that and has the view that all shell shareholders are subject to this, not just affiliates and promoters. Make sure to look for ways to avoid purchasing shares from current shareholders if possible (for example purchasing shares directly from the company), and if not possible, conduct an analysis as to whether the shares are or are not subject to Worm/Wulff.


3. Don't forget due diligence! Do thorough due diligence on the shell the same as if you were a private company merging in. If that takes weeks of review, so be it. If there are undisclosed problems in the shell, your entire purchase could become worthless. In particular, try to trace all stock issuances since inception to ensure that they match the company's claimed capitalization.


4. Watch timing of deals. It is generally recommended that shells be purchased and put on the shelf for a period of time before entering into a deal. There are a number of reasons for this that should be discussed with your counsel.


5. Can you get indemnities? What if the person controlling the shell misrepresents something, for example about how many shares or warrants are outstanding? Can you go after him afterward? Usually not. Sometimes sellers are willing to put some shares in escrow for a period to be used to help compensate for any misrepresentations or breaches of the purchase agreement. It depends on the transaction and the leverage of the parties.


6. Watch out for footnote 32! I think I've said this enough times, and you can go back to prior posts and my book to see the telltale signs of a tainted shell pretending to be or have been a real company. Make sure counsel experienced in this issue looks at it on every shell.

7. Watch out for short swing profits. If the seller purchased any shares (or anyone whose shares he beneficially owns did so) less than six months prior to the intended sale, the profit the seller earns in the sale may have to be disgorged back to the company. This is only true if the seller is an officer, director or 10% shareholder.


8. Surprise - filings required!


(a) Schedule 14f-1. If the purchase of shares of more than 5% of a public reporting company includes a requirement that a majority of the Board change hands, a Schedule 14f-1 has to be prepared, filed with the SEC and mailed to all shareholders of the shell at least 10 days prior to the purchase.


(b) Super 8-K. Wait, don't we only have to file the "super 8-K" imposed by the SEC since 2005 when the company ceases to be a shell? That filing includes all the information that would be in a Form 10 for the company, essentially the equivalent of a public offering prospectus, including audited financials and so on. A little known part of the changes the SEC adopted to Form 8-K included a requirement to file a super 8-K upon any change in control of a shell company.

(c) Insider Filings. If the seller is an officer, director or 5% shareholder, he will have to file Schedule 13D and possibly Form 4. If the buyer is going to become an officer, director or 5% shareholder, he also may have to file Schedule 13D and possibly Form 3.

Enjoy Indian summer!

Waiting on the Sunshine Notice from the SEC

If the full 5-member Securities and Exchange Commission is holding a public hearing, they are required to give 10 days' public notice, which is typically listed in the SEC's website under "upcoming events." Given John White's statement last week that they are planning for the new small business proposals to be adopted before the end of the year, I am watching (well not every minute, gotta practice law after all) to see when we will have that 10 day notice with an agenda.

John had indicated that he wanted to underpromise and overdeliver, which leads me to believe that it is very possible the announcement is imminent. They may decide to approve all six proposals in one hearing, or it's possible they will split them up to two different hearings. And given how positive the comments have been overall, it is very likely the proposals will be approved without significant changes (though many of us wish certain changes will get a serious look as indicated in prior posts).

In every deal we are working on now, clients ask, "If they approve the Rule 144 shorter holding period, will it be retroactive?" Answer: I don't know, and I have asked multiple senior SEC staffers that question and they have not, shall we say, provided meaningful guidance on the issue. But it would seem logical that it should be retroactive. Fingers crossed on that, and on timing hopefully soon!