Coming Soon: Affordable $50 Million Public Offerings Yearly
After the dot-com bubble burst in 2000 and the Sarbanes-Oxley Act of 2002 imposed expensive and burdensome regulations in the wake of the WorldCom and Enron scandals in 2001, regional public offerings by successful small businesses all but disappeared, and the mid-sized securities firms that underwrote them largely disbanded. After more than a decade without viable public capital markets for small businesses, the Securities and Exchange Commission has recently proposed a simplified method for small businesses to make public offerings each year of up to $50 million, $15 million of which may be made by existing stockholders. Properly structured, these offerings will not trigger the periodic reporting, proxy, tender offer or short-swing profit recovery provisions under the Securities Exchange Act of 1934, and will only require an electronically-filed simplified annual report to the SEC with audited financial statements once a year followed by a semi-annual report with unaudited financial statements six months later. Major unscheduled events are to be reported to the SEC shortly after they occur.
A $50 million simplified offering may be made every year without triggering ’34 Act registration and the burdensome regulation of Sarbanes-Oxley. Unfortunately, a NASDAQ listing requires ’34 Act registration. For reasonable aftermarket liquidity for investors, the securities would have to be traded over the OTQX or other marketplace run by the OTC Markets Group, Inc., or listed on a Canadian stock exchange. Canadian stock exchange listing requires that the financial statements be prepared in accordance with International Financial Reporting Standards (IFRS), as set by the International Accounting Standards Board, rather than Generally Accepted Accounting Principles (US GAAP), which are set by the US Financial Accounting Standards Board.
It will undoubtedly take some time for mid-sized underwriters to reorganize themselves and resume underwriting regional offerings. However, it is not too early for successful small businesses to begin the IPO planning process so that when the SEC’s final rules are promulgated (a few months from now) and the investment banks have become ready, they will be able to proceed to go public if they desire. Items they should eventually address include:
- Assessing the company’s historic and future profitability. Would the company be able to use tens of millions of dollars to scale up and replicate its historically profitable operations? Successful retail chains with recognizable brands often can do so by opening additional outlets based upon their already proven business formulas. If a technology company has little or no earnings but is nevertheless deemed “successful,” consider the parameters within the industry for demonstrating that success and how it may be portrayed credibly to underwriters and investors, as well as how proceeds from the offering would be used to expand the company’s success.
- Engaging an accounting firm that is a member of the PCAOB and has a correspondent relationship with a Canadian accounting firm, or is otherwise familiar with IFRS, to begin auditing the company’s financial statements. Two years of audited statements will be required, so that observation of opening inventories will be necessary.
- “Institutionalizing” the company’s organizational and governance structure to make it capable of being operated by persons other than its founders. Specifically:
- Install a board of directors with several independent directors, and make sure that all are knowledgeable in the business and the industry. Explore appropriate D&O insurance.
- Review the skills of management and, in particular, be sure that the chief accounting officer is well grounded in that discipline, as well as in internal financial controls. Identify and assess the potential disclosures relating to anyone in management with a regulatory history.
- Establish an audit committee of the board to serve as the primary contact with the company’s auditors.
- Remove recreational and other non-business assets from the business.
- Transfer all business assets to the company or to its wholly-owned subsidiaries.
- Wind down transactions between the business and family members, including retiring any outstanding loans.
- Adopt incentives for management, such as stock option or restricted stock plans. Use valuation experts to determine stock price.
- Having a legal audit performed – I.E., have a corporate lawyer review the company’s key documents, including articles of incorporation, by-laws, stock transfer records and major contracts, and correct any irregularities. Assess and limit, to the extent feasible, exposure from any pending or threatened lawsuits, by settlement if possible.
The final version of the SEC’s simplified public offering regulation will undoubtedly vary to some extent from the proposed one. Nevertheless, because the regulation is based upon a statute with specific standards, it is not expected to vary sufficiently to cause any great difficulties for those companies seeking to go public in a much more simple and less expensive manner than is presently required in a fully registered public offering. Hopefully, we will soon witness a new era in which local companies may go public through retail public offerings underwritten by regional investment banking firms.
When the SEC adopts its final version of this simplified public offering regulation, Karr Tuttle Campbell will hold a free in-house seminar here in our offices for our friends and clients reviewing its details and implications. Please watch for a notice from us about this seminar.
Questions or comments concerning this client alert should be directed to Mike Liles, Jr. at (206) 224-8068 [firstname.lastname@example.org] or Alan Judy at (206) 224-8067 [email@example.com]. Mr. Liles is the Chair of the Regulation A+ Working Group of the Business Law Section of the American Bar Association. He has been the principal attorney representing underwriters and issuers in over 30 major public offerings. Mr. Judy, a CPA and an attorney, oversees due diligence documentation in public and private offerings.