How to Go Public
How does my small business go public?
Section 5 of the Securities Act requires that a registration statement be filed with the SEC before securities are offered for sale to the public. It also prohibits the sale of those securities until the registration statement becomes "effective." (Although registration statements become public immediately upon filing with the Commission, it is illegal to sell the securities until the effective date.) The basic registration statement consists of two principal parts:
Is the prospectus (the legal offering or "selling" document), which must be furnished to all purchasers of the securities. Your company - the "issuer" of the securities - is required to put in the printed prospectus the essential facts regarding its business operations, financial condition, and management. The prospectus must be made available to everyone who buys the new issue, and also to anyone who is made an offer to purchase the securities.
Contains additional information available at the SEC for inspection by the public. (Copies of all disclosure documents filed with the SEC may be obtained by mail, for a nominal copying charge.)
Basic Registration of Securities
The basic registration form is Form SB-2. It requires companies to disclose, among other things:
It is not prepared as a fill-in-the-blank form like a tax return but is similar to a brochure, with information provided in a narrative format. There are also detailed requirements concerning financial statements, including the requirement that such statements be audited by an independent certified public accountant.
In addition to the information expressly required by the form, the company must also provide any other information necessary to make the statements complete and not misleading. If sufficient adverse or risk factors exist concerning the offering and the issuer, they must also be set forth prominently in the prospectus, usually in the beginning. Examples of these factors are:
Lack of business operating history; Adverse economic conditions in a particular industry; Lack of market for the securities offered; and Dependence upon key personnel.
Alternative Registration Forms for Small Business Issuers
Recently, the SEC adopted simplified forms (Forms SB- 1 and SB-2) for use by small business issuers. A small business issuer is a United States or Canadian issuer that had less than $25 million in revenues in its last fiscal year, provided that the value of its outstanding securities in the hands of the public is no more than $25 million.
These formats are alternatives to Form S-1. Form SB-1 for small business issuers offering up to $10 million worth of securities in a fiscal year, permits the use of disclosure similar to that required in a Regulation A offering, including the use of the question and answer format. It requires, however, audited financial statements,
Form SB-2 permits the offering of an unlimited dollar amount of securities by any small business issuer. The form may be used again and again as long as the issuer meets the definition of small business issuer. Form SB-2 offers certain advantages, including the location of all disclosure requirements in a central repository, Regulation S-B. These disclosure requirements are presented in simple, non-legalistic technology.
Form SB-2 also permits the issuer to:
Registration statements are examined for compliance with disclosure requirements. If a statement appears to be materially incomplete or inaccurate, the registrant usually is informed by letter and given an opportunity to file correcting or clarifying amendments. The Commission can refuse or suspend the effectiveness of any registration statement if it finds that material representations are misleading, inaccurate, or incomplete.
If my company becomes "public," what are its disclosure obligations?
The Exchange Act requires a company to file certain periodic reports once its registration statement has been declared effective. This obligation continues indefinitely unless:
In these cases, the reporting obligation is suspended. Otherwise, a company must continuously disclose certain information about:
All companies with total assets exceeding $5 million and a class of equity securities held by 500 or more persons are required by the Exchange Act to file the same supplementary, periodic, and current reports as noted above. Companies with these characteristics must also comply with the Commission's proxy rules if proxies are solicited from holders of its securities. In such a case, the company must furnish all shareholders proxy statements disclosing all material facts concerning matters on which they are being asked to vote. If the proxy solicitation by management relates to an annual meeting at which directors are to be elected, the Commission's proxy rules also require the company to furnish each shareholder an annual report disclosing certain information about the company, including audited financial statements for its latest fiscal year.
Small business issuers are offered an alternative in the Commission's continuous reporting system. This alternative permits them to use Regulation S-B as the appropriate disclosure requirements for registration under the Securities Act, as well as registration and reporting under the Exchange Act.
Are there legal ways to sell securities without registering with the SEC?
Yes! The Securities Act provides several exemptions from the registration requirements; the most common are discussed below. Nonetheless, purchases or sales of securities (even in exempt transactions) are subject to the antifraud provisions of the federal securities laws. This means that issuers are responsible for false or misleading statements (whether oral or written) which may be redressed through private or government legal action, including criminal sanctions. Also, if all conditions of the exemptions discussed below are not met, purchasers may seek to have their purchase price refunded. In addition, the fact that an offending may be exempt from certain provisions of the federal securities laws does not necessarily mean that it is exempt from the notice and filing obligations of various state laws. Issuers are cautioned to check with the appropriate state authority before proceeding with an offering relying on any of the exemptions discussed below.
Intrastate Offering Exemption
Section 3(a)(I 1) of the Securities Act is generally known as the "intrastate offering exemption." It exempts from registration any security which is part of an issue offered and sold only to residents of a single state or territory and the issuer is both a resident of and doing business within that state or territory, This exemption is intended to facilitate the local financing of local business operations. In order to quality for the intrastate offering exemption, your company must:
Although there is no fixed limit on the size of the offering or the number of purchasers, your company has the obligation to determine the residence of each purchaser. If any of the securities are offered or sold to one out-of-state purchaser, the exemption may be lost. In addition, if any of the securities are resold by an original resident purchaser to a person resident outside the state within nine months after the offering by the issuer is completed, the entire transaction may be in violation of the Securities Act. Therefore, there is usually no significant after-market for any securities issued in an intrastate offering during the nine-month period following the initial sale. Consequently, they must normally be sold at a discount.
It is difficult for you as an issuer to rely on the intrastate exemption unless your company knows the purchasers and the sale is directly negotiated with them. A company with some of its assets outside the state, or deriving a substantial portion of its revenues outside the state where it proposes to offer its securities, will probably have a difficult time justifying the exemption.
The SEC has adopted Rule 147, a "safe harbor" rule, which may be followed by companies to be certain they meet the requirements for this exemption. It is possible, however, that transactions not meeting all requirements of Rule 147 may still quality for the exemption.
Private Offering Exemption
Section 4(2) of the Securities Act provides exemption from registration for "transactions by an issuer not involving any public offering." There has been much uncertainty as to the precise limits of this private offering exemption. Generally, sales to persons who have access to information about the company and are able to fend for themselves (such as those directly managing the business) fall within the intended scope of the exemption. These are known as "sophisticated investors." As the number of purchasers increase and their relationship to the company and its management becomes more remote, however, it becomes more difficult for an issuer to demonstrate that the transaction does, in fact, qualify for the exemption.
To quality the offering under this exemption, it is necessary that the persons to whom your company sells the security:
In addition, your offering may not be made by any form of public solicitation or general advertising. You should be aware that if the security is offered for sale to even one person who does not meet the necessary conditions, the entire offering may be in violation of the Securities Act. The SEC has adopted Rule 506, another "safe harbor" rule, which provides objective standards upon which business people may rely in order to be certain they meet the requirements of this exemption. Rule 506 is a part of Regulation D, which is described more fully later.
Section 3(b) of the Securities Act gives the SEC authority to exempt from registration certain offerings where the securities to be offered involve relatively small dollar amounts. Under this provision, the SEC has adopted Regulation A, a conditional exemption for certain public offerings not exceeding $5 million in any 12-month period. An offering statement (consisting of a notification, offering circular, and exhibits) must be filed with the SEC Regional Office in the region where the company's principal business activities are conducted (the Atlanta District Office for issuers located in the Southeast Region). Although Regulation A is technically an exemption from the registration requirements of the Securities Act, it is often referred to as a "short form" of registration since the offering circular (similar in content to a prospectus) must be supplied to each purchaser and the securities issued are freely tradeable in an aftermarket.
The principal advantages of Regulation A offerings, as opposed to full registration on Form S- 1, SB- I or SB-2, are:
There are three permitted offering circular formats under Regulation A, one of which is a simplified question-and answer document. This style of disclosure is useful to potential investors and may offer significant benefits to the issuer in the time expended and the costs of preparation.
All types of companies which are not reporting under the Exchange Act may use Regulation A, except "blank check" companies (i.e., those with the business of seeking an unspecified business) and investment companies registered or required to be registered under the Investment Company Act of 1940.
In most cases, Regulation A may also be used by shareholders for the resale of up to $1.5 million of securities.
Regulation A includes a provision which allows an issuer to "test the waters" to determine whether or not there is any investor interest in its securities before the filing of a complete offering document. Thus, an issuer may publish factual information about its business or proposed business before incurring a full range of legal, accounting and other costs, in order to gauge potential investor interest in a possible securities offering; however, the provision specifically provides that no money may be solicited or accepted until an offering statement has been qualified by the Commission, and prescribed offering materials have been delivered to potential investors.
Under Sections 4(2) and 3(b) of the Securities Act, the SEC in March, 1982, adopted Regulation D to coordinate the various limited offering exemptions and to streamline the existing requirements applicable to private offers and sales of securities. The Regulation establishes three exemptions from registration in Rules 504, 505, and 506.
Rule 504, which provides an exemption for non-reporting companies unless they are "blank check" issuers, stipulates that:
The sale of up to $1,000,000 of securities in a 12-month period is permitted; No limitation is placed on the number of persons purchasing securities; The offering may be made with general solicitation or general advertising; The securities received in the offering are not "restricted securities"; and A Form D notice be filed with SEC headquarters within 15 days after the first sale of securities under the Rule.
Unlike Rules 505 and 506, Rule 504 does not mandate that specified disclosure be provided to purchasers. Nonetheless, the businessperson should take care that sufficient information is provided to meet the full disclosure obligations which exist under the antifraud provisions of the securities laws.
Rule 505 was adopted by the SEC to provide small businesses more flexibility in raising capital than under Rule 504 - but without the uncertainty of determining the quality of the purchasers that generally is involved in using Rule 506. Rule 505 provides issuers a limited offering exemption for sales of securities totaling up to $5 million in any 12-month period.
Rule 505 contains certain restrictions regarding "accredited investors" and non-accredited persons. The-term "accredited investor" includes:
There is no specific information the issuer must furnish to accredited investors. However, non accredited investors must be advised of and furnished, upon request, all material information furnished to accredited investors, as well as certain specified information. Financial statement requirements include:
Further restrictions under Rule 505 include:
Offers and sales of securities by an issuer that satisfy the conditions stated below are deemed transactions not involving any public offering within the meaning of Section 4(2) of the Securities Act. For an offering to be considered exempt from the registration requirements, Rule 506 stipulates:
The information requirements are generally the same as those on the registration form the issuer would be entitled to use. If the issuer cannot obtain audited financial statements without unreasonable effort or expense, then financial statements may be provided in accordance with the special treatment described under Rule 505 above.
The securities sold are "restricted" under the same stipulations in Rule 505.
A company is required to file a notice of the offering on Form D at SEC headquarters within 15 days after the first sale in the offering. There is no requirement to file the offering memorandum with the Commission.
Accredited Investor Exemption: Section 4(6)
The Small Business Investment Incentive Act of 1980 created a new statutory exemption from registration under the Securities Act for transactions involving offers and sales of securities by any issuer solely to one or more "accredited investors." Under Section 4(6):
The total offering price of each issue of securities under the exemption may not exceed the limit on small offerings set by Section 3(b) the Securities Act, which currently is $5 million per issue.
The offering may not be made by means of any form of advertising or public solicitation.
The term "accredited investor" is defined to include the same individuals and entities as included for purposes of Rules 505 and 506.
The issuer is required to file a notice of sales on Form D with the Commission 15 days after the initial sale is made in reliance on the exemption.
Private Placement Shares Tradeability Issues
Private placements are sales of restricted common stock, typically under Regulation D, Rule 505 or 506. For a company with no trading symbol and no market for its stock, a private placement is a non-liquid investment. For companies with trading symbols, however, securities sold in a private placement may become freely trade-able under Rule 144. Rule 144 allows affiliated and non-affiliated investors to sell a limited amount of their securities after one year, if certain requirements are met. After two years, non-affiliates can have the legends removed from their stock, which is then freely trade-able under Rule 144k.
Reverse mergers are typically involved when a company wishes to go public "instantly." First, it must obtain a "shell company", or company which is reporting and trading, but with no longer an operating business, or a candidate for merger with a compatible business or one that wants to "spin out" its business and go private.
The cost for obtaining such a vehicle is typically anywhere from $300,000 to $500,000. Some of the many risks are liabilities (known or unknown), less of a percentage available to the merging company's group of investors, and issues regarding reporting and auditing. New SEC policy mandates that the SEC requires the 8-K filed in a reverse merger to have all the requisite detail of a form 10 filing, and it may, at its option, review the 8-K using its form 10 review process.
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