By Laura Anthony, Esq.
One of the methods of going public is directly through a public offering.
Initial and Direct Public Offerings
One of the methods of going public is directly through a public offering. In today’s financial environment, many issuers are choosing to self-underwrite their public offerings, commonly referred to as a Direct Public Offering (DPO). An IPO, on the other hand, is the term of art generally used to refer to a public offering underwritten by a broker-dealer (underwriter). As a very first step, an issuer and their counsel will need to complete a legal audit and any necessary corporate cleanup to prepare the company for a going public transaction. This step includes, but is not limited to, a review of all articles and amendments, the current capitalization and share structure and all outstanding securities; a review of all convertible instruments including options, warrants and debt; and the completion of any necessary amendments or changes to the current structure and instruments. All past issuances will need to be reviewed to ensure prior compliance with securities laws. Moreover, all existing contracts and obligations will need to be reviewed, including employment agreements, internal structure agreements, and all third-party agreements.
Once the due diligence and corporate cleanup are complete, the issuer is ready to move forward with an offering. Companies desiring to offer and sell securities to the public with the intention of creating a public market or going public must file with the SEC and provide prospective investors with a registration statement containing all material information concerning the company and the securities offered. Such registration statement is generally on Form S-1. For a detailed discussion of the S-1 contents, please see my article HERE. The average time to complete, file and clear comments on an S-1 registration statement is 90-120 days. Upon clearing comments, the S-1 will be declared effective by the SEC.
Following the effectiveness of the S-1, the issuer is free to sell securities to the public. The method of completing a transaction is generally the same as in a private offering. That is: (i) the issuer delivers a copy of the effective S-1 to a potential investor, which delivery can be accomplished via a link to the effective registration statement on the SEC EDGAR website together with a subscription agreement; (ii) the investor completes the subscription agreement and returns it to the issuer with the funds to purchase the securities; and (iii) the issuer orders the shares from the transfer agent to be delivered directly to the investor. If the issuer arranges in advance, shares can be delivered to the investors via electronic transfer or DWAC directly to the investor’s brokerage account.
Once the issuer has completed the sale process under the S-1 – either because all registered shares have been sold, the time of effectiveness of the S-1 has elapsed, or the issuer decides to close out the offering – a market maker files a 15c2-11 application on behalf of the issuer to obtain a trading symbol and begin trading either on the over-the-counter market (such as OTCQB) or on an exchange. The market maker will also assist the issuer in applying for DTC eligibility.
A DPO can also be completed by completing a private offering prior to the filing of the S-1 registration statement and then filing the S-1 registration statement to register those shares for resale. In such case, the steps remain primarily the same except that the sales by the company are completed prior to the S-1 and a the 15c2-11 can be filed immediately following effectiveness of the S-1 registration statement.
Basic Differences in DPO vs. Reverse Merger Process
As opposed to a reverse merger, a company completing a DPO does not have to worry about potential carry-forward liability issues from the public shell.
A company completing a DPO does not have to wait 12 months to apply to the NASDAQ, NYSE MKT or other exchange and if qualified, may go public directly onto an exchange.
A DPO is a money-raising transaction (either pre S-1 in a private offering or as part of the S-1 process). A reverse merger does not raise money for the going public entity unless a separate money-raising transaction is concurrently completed.
As long as the company completing the DPO has more than nominal operations (i.e., it is not a very early-stage startup with little more than a business plan), it will not be considered a shell company and will not be subject to the various rules affecting entities that are or ever have been a shell company. To the contrary, many public entities completing a reverse merger are or were shells.
A DPO is less expensive than a reverse merger. The total cost of a DPO is approximately and generally $100,000-$150,000 all in. The cost of a reverse merger includes the price of the public vehicle, which can range from $250,000-$500,000. Accordingly, the total cost of a reverse merger is approximately and generally $350,000-$650,000 all in. Deals can be made where the cost of the public shell is paid in equity in the post-reverse merger entity instead of or in addition to cash, but either way, the public vehicle is being paid for. NOTE: These are approximate costs. Many factors can change the cost of the transactions.
Why Reverse Merger:
Raising money is difficult, and much more so in the pre-public stages. In a reverse merger, the public company shareholders become shareholders of the operating business and no capital raising transaction needs to be completed to complete the process.
A reverse merger can be much quicker than a DPO.
Raising money in a public company is much easier than in a private company pre going public. A reverse merger can be completed quickly, and thereafter the now public company can raise money.
Reverse Mergers and DPO’s Are Both Excellent Methods for Going Public
As I see it, the evolution in the markets and regulations have created new opportunities, including the opportunity for a revived, better reverse merger market and a revived, better DPO market. A reverse merger remains the quickest way for a company to go public, and a DPO remains the cleanest way for a company to go public. Both have advantages and disadvantages, and either may be the right choice for a going public transaction depending on the facts, circumstances and business needs of the company.
The increased difficulties in general and scrutiny by regulators may be just what the industry needed to weed out the unscrupulous players and invigorate this business model. Shell companies necessarily require greater due diligence up front, if for no other reasons than to ensure DTC eligibility and broker-dealer tradability, prevent future regulatory issues, and ensure that no “bad boys” are part of the deal or were ever involved in the shell. Increased due diligence will result in fewer post-merger issues.
The over-the-counter market has regained credibility and supports higher stock prices, especially since exchanges are forcing companies to trade there for a longer period of time before becoming eligible to move up. Resale registration statements, and thus disclosure, may increase to combat the Rule 144 prohibitions. We have already seen greater disclosure by non-reporting entities trading on otcmarkets.com. Also, venture exchanges designed specifically for and that support trading in smaller public companies appear to be on the horizon.
Click Here to Print Going Public Transactions For Smaller Companies: Direct Public Offering And Reverse Merger- LC PDF Printout- Going Public Transactions
Note 1: Read Part I of this Article. Click HERE
Note 2: Original appeared on Legal & Compliance, LLC on 30 June 2015. Click HERE
Securities attorney Laura Anthony is the founding partner of Legal & Compliance, LLC, a corporate, securities and business transactions law firm. The firm’s experienced legal team provides ongoing corporate counsel to small and mid-size private companies, OTC and exchange traded issuers as well as private companies going public on the NASDAQ, NYSE MKT or over-the-counter market, such as the OTCQB and OTCQX. For nearly two decades Legal & Compliance, LLC has served clients providing fast, personalized, cutting-edge legal service. The firm’s reputation and relationships provide invaluable resources to clients including introductions to investment bankers, broker-dealers, institutional investors and other strategic alliances.