Steve Cartisano .com

Market Information From Steve Cartisano

In the United States, the principal public markets are the New York Stock Exchange and the American Stock Exchange. Regional stock exchanges are the Pacific Stock Exchange in San Francisco, the NASDAQ National Market and Small Cap Market, and the Over-the-Counter markets which include the NASDAQ-administered Over-the-Counter Bulletin Board and the independent “Pink Sheets.”

Some of the benefits of being a publicly-traded company include:

While it is not necessary to have a public offering of a company’s stock in order for the company to be publicly traded, a public offering of a company’s stock normally results in its stock being publicly traded after the offering is completed. While the traditional method of becoming a “public” company is to do a registered public offering, it is quite feasible to become a publicly-traded company without doing a public stock offering. 

All that is necessary is to meet the listing requirements of the trading market in which the security is to be traded and to obtain regulatory approval of trading. In the case of NASDAQ and over-the-counter markets it is also necessary to persuade one or more licensed broker-dealer firms to act as “market-makers,” who have agreed to “make a market” in the stock by continually quoting the bid and ask prices at which that market maker is willing to purchase and sell the stock of a given company.

Each of the markets has its own requirements for listing a company for trading.  The qualification requirements are highest for the national stock exchanges and the NASDAQ National Market, lower for the NASDAQ market and the over-the-counter bulletin board, which is referred to as the OTCBB and the lowest for the Pink Sheets.

The qualification requirements involve the amount of stockholder equity, the market value of the publicly-tradable shares, the number of public stockholders, the number of publicly-tradable shares outstanding, the value of the publicly-tradable shares, and company financial issues such as total assets or total revenue.

Companies traded in these markets are required to be “reporting companies” under the Securities Exchange act of 1934 and must have audited financial statements.

The methods of becoming a publicly-traded company include:

• Registered public offering of company stock followed by public trading as a reporting company

• Exempt, unregistered offering(s) of company stock (in order to capitalize the company, but not necessarily contemporaneous with becoming publicly-traded) followed by either:

• the filing of a registration statement under the Exchange Act or,

• in the case of Pink Sheet trading, preparing and filing a Form 211 and its attachments, including the 15c2-11 disclosure statement and financial statements

• merger of the company with an inactive but publicly-traded company, called a “shell company”

The traditional method of making a registered public offering of stock can be somewhat time-consuming and expensive, but if successful it can produce excellent results. It requires engaging one or more broker-dealers to act as the underwriters of the offering.  Then the company will need to prepare a Securities Act registration statement, which includes the offering prospectus, to be filed with the Securities and Exchange Commission. This document will be examined carefully by the SEC, and will need to be revised by the company as necessary to satisfy the SEC. Then the company will assist the underwriters in marketing the stock.  Upon completion of the offering, the stock will be publicly traded.  The main advantage of this method is that it produces both a public market for the stock as well as the capital resulting from the offering. This process typically takes six to nine months to complete and will likely involve substantial cash outlays to cover the expenses of preparation of the registration statement and offering expenses, which may be problematic for some companies.

If a small company would like to become publicly-traded with a minimum of expense and delay, in most instances, the best method probably is to get the company quoted in the Pink Sheets and, as the company’s circumstances improve, consider moving the company to the OTC BB (which requires that it be an Exchange Act “reporting company”).  The basic steps involved in becoming a publicly-traded company by this method in include:
• Find an NASD-licensed broker-dealer firm willing to act as a market maker for the company
• Prepare the requisite financial statements (audited financials not required)
• Prepare 15c2-11 disclosure statement ; this includes basic information about the company
• Prepare a Form 211; this is an application by the market maker to NASDAQ for permission to make a public market for the stock
• The market maker files of the Form 211 together with the 15c2-11 disclosure statement (which includes the financial statements) and other required documents, such as a certified stockholder list and a legal opinion as to the stock being eligible for lawful public trading
• The company engages a transfer agent for the company stock
• Upon NASDAQ approval, which is discretionary, a market trading symbol is assigned and trading can commence.

NASDAQ is not required to approve the trading of any stock and may refuse to permit any stock to trade in its discretion.  In general, NASDAQ will not approve trading of any stock of a “blank check” or shell company (available trading shell companies usually were trading before becoming a shell). The principal factors NASDAQ considers in determining whether to allow trading include:

     • Whether the company has a real business (not a shell or just a business plan)

     • Company revenues (not absolutely mandatory, but virtually so)

     • Company profits (not mandatory, but very helpful)

     • Sufficient number of stockholders (discretionary, but probably 50 or more non-affiliate stockholders are typically needed)

     • Acceptable stock distribution among the stockholders (they don’t like to see most of the stock held by a very few stockholders and the rest of the stockholders having only very small amounts of stock)

     • Reasonable capitalization (money raised).  They don’t like companies with little capital or assets.

     • Issuance of all stock pursuant to legally-qualified sales and by appropriate means

     • Proof of free tradability of the stock (may require legal opinion)

• Proper disclosures made in 15c2-11 disclosure statement
• the financial statements need not be audited, but must conform to U.S. Generally Accepted Accounting Principles (GAAP).

The procedures for becoming publicly-traded in one of the NASDAQ markets is very similar to those for Pink Sheet trading.  The major difference is that the company must be a reporting company under the Exchange Act and meet the listing requirements.  To become a reporting company, the company files with the SEC an Exchange Act registration statement, which contains extensive information about the company and its business and includes audited financial statements?  Thereafter the company will be subject to the SEC reporting requirements, such as the Form 10-K or Form 10-KSB annual reports, quarterly reports, etc. and will be subject to the corporate governance standards imposed by Sarbanes-Oxley. The company also will need to satisfy the listing standards applicable to the market in which it wishes to be traded. Consequently, it is substantially more difficult and expensive to become traded on the NASDAQ markets than the Pink Sheets, but is still much easier than conducting a public offering of the company’s stock.

An alternative to the traditional methods of becoming a publicly-traded company is to merge the private operating company into a company that is already publicly-traded. If the company were merged into a publicly-traded company with substantial operations, it would be real merger, not just a method of making the private company publicly-traded, so the publicly-traded company needs to be one which has no business operations and thus is referred to as a “shell company.”  

Although the transaction is often referred to as a merger, the operative transaction usually isn’t a merger, but rather a “takeover” via a stock exchange transaction.  The stockholders of the privately-held company trade their stock in the private company for a large block of new stock issued by the public company; thus they become controlling stockholders of the public company and the private company becomes a wholly-owned subsidiary of the public company.  The new subsidiary may or may not be actually merged with the public company.

Note that this method doesn’t involve the sale of any stock to new investors and doesn’t raise any capital for the private company unless the shell has substantial assets; usually it doesn’t. If there is no offering of stock involved in the transaction, then what merger accomplishes is to make the private company into one which is publicly-traded. 

     • If the merger is with a “reporting company,” the merger bypasses the preparation and filing of an Exchange Act registration statement, provides enough stockholders to support public trading, and avoids the listing application process.  For this reason, the transaction is often referred to as a “back door listing.”

     • If the merger is with a Pink Sheet traded company, then the merger doesn’t avoid the Exchange Act registration statement because Pink Sheet companies do not have to file registration statements.  In this case the benefit is limited to obtaining stockholders and avoiding the listing application process; since the Pink Sheet listing process is simple, there is little benefit in avoiding it. 

     • In the case of mergers with companies which are not being currently traded, the only benefit to the private company is obtaining a number of stockholders sufficient to establish a public market, which is a somewhat questionable benefit.

The cost to the private company is that it acquires a lot of stockholders who have contributed no capital to the company; in fact, the private company usually has to pay a cash premium to the controlling stockholders of the shell, sometimes as much as $500,000 or more.

The Securities and Exchange Commission and other securities regulators have always viewed this method as an attempt to circumvent the securities laws and frowned upon it even though everything was accomplished within the letter of the law.  Furthermore, there has been a lot of fraud in some of the transactions. In July, 2005, The SEC took actions which have made mergers with shell companies much less attractive as an alternative to other methods of making a company publicly-traded. The new regulations, now in effect, made the following changes:

● Define the term "shell company" to mean a registrant, other than an asset-backed issuer, that has no or nominal operations, and either:
                    ○  no or nominal assets;
                    ○  assets consisting solely of cash and cash equivalents; or
                    ○  assets consisting of any amount of cash and cash equivalents and nominal other assets;
 
● Prohibit the use of Form S-8 by shell companies but permit former shell companies to use Form S-8 once they become operating companies and 60 days have passed since they filed with the Commission the information about the operating company that they will be required to provide if they were filing a registration statement under the Exchange Act; and
 
● Add new Form 8-K Item 5.06 to require disclosure when companies cease to be shell companies (which occurs when they “merge” with a private, operating company) and  revise the existing Form 8-K items relating to acquisition or disposition of assets and changes in control to require companies that cease being shell companies, within four business days of the transaction, to disclose information comparable to the information that they will be required to provide if they were filing an Exchange Act registration statement.

In essence, the last of these items requires that within four days after merger of the shell company and the private operating company, the merged company must file the equivalent of an Exchange Act registration statement. One of the principal benefits of the shell merger was avoidance of the filing such a registration statement, so the principal incentive for shell mergers has been eliminated. Other restrictions on shell companies also make the process more difficult and expensive.  Consequently, in most circumstances shell mergers are of doubtful value.  The other methods previously described will probably prove to be more attractive.

The term “PIPE” is an acronym for “Private Investment in Public Entity” In a PIPE transaction, the issuer sells its stock to a group of accredited investors in a private, exempt (usually Regulation D, Rule 506) transaction, rather than to the public through an offering registered with the Securities and Exchange Commission.  The stock is a “restricted security” and as part of the transaction, the issuer agrees to use its best efforts to file a Securities Act registration statement which will permit the purchasers to resell their stock into the public market. Since completion of the transaction requires that a public market exist for the resale of the stock, only publicly-traded companies can undertake a PIPE transaction, although a privately-traded company could also make itself publicly-traded before, or simultaneously with, the PIPE transaction.

PIPE transactions are typically undertaken by smaller public companies. Shares are sold at a slight discount to the public market price. The benefit of these transactions for smaller issuers is that they provide quick access to capital at a reasonable transaction cost. Some investors find these attractive because they get shares at a discount to the public market price, and because it provides an opportunity to acquire a sizeable position without having to chase a rising stock price caused by their own purchases. Depending upon the terms of the transaction, a PIPE may dilute existing shareholders' equity, particularly if the seller has agreed to provide the investors with protection against market price declines (a common practice), which can lead to issuance of considerably more shares to the investors for no more money.

The benefits of a PIPE transaction include:

• Does not require SEC registration prior to offering

• Allows for a more flexible transaction size than traditional public alternatives

• Improves balance sheet strength and financial flexibility
 
• Offers greater confidentiality and eliminates typical price declines on filing of traditional public offering (“announcement effect”)

• Requires minimal preparation before launch

• Increases issuer’s trading liquidity levels and diversifies shareholder base

• Allows for a targeted marketing process, reducing management’s time contribution
 

Dominion Worldwide Capital Investment Group, Ltd.
10421 S. Jordan Gateway
Suite 600
South Jordan, UT 84095
801.495.7099 phone
801.495.4071 fax