Source: TKTK
PRACTICE TIP
If many holders have held stock for less than a year or are consid- ered affi liates of the company, don’t run too fast from an SB-2.
Or, consider my strategy below of a Form 10-SB with contem- poraneous fi nancing, followed immediately by an SB-2 resale registration.
Source: TKTK
Equally, the company or its investors may wish to restrict which share- holders will have the right to have their shares registered. For example, a key member of management who may have held shares for a short time may wish to have his shares registered, but investors may feel it is not de- sirable for a member of management to have the ability to cash out of his company ownership.
At this time, an analysis of the timing of fi nancing makes sense. If the company is considering a PIPE or other fi nancing before it goes public, that would have to be completed either prior to fi ling the SB-2 or after the SB-2 has gone into effect. (See above for the reasons for this.) If the fi nancing is completed before the fi ling, then the investors’ shares can be included in the SB-2 registration and will be tradable as soon as the regis- tration becomes effective. Those who invest early, however, take a risk that the SB-2 or other going public event will never occur and they will be left with illiquid securities.
In fact, in a number of recent transactions handled by our offi ce, PIPE investors have been willing to invest in a private company, as long as its very next step is to go public through an SB-2 resale registration that reg- isters their shares and allows them to trade upon effectiveness. This is a departure for PIPE investors, who previously had only been willing to invest in private companies as part of a reverse merger.
In many cases, though, companies and their investors wait until after the company is public to conduct a fi nancing. By waiting to complete the PIPE until after the company is public, the investor assumes less risk but must then wait for an additional registration to be fi led to include their shares after going public (or await an applicable exemption). Nevertheless, if the SB-2 registration takes the company public and shortly thereafter a PIPE is closed, and then an additional SB-2 is fi led almost immediately to register the PIPE investor’s shares, this second SB-2 fi ling is likely to get a much quicker review by the SEC.
The fl ip side of limiting who gets to register has to do with the fl oat.
The larger the number of both shares and shareholders available to resell in the public market, the stronger the potential that a robust and liquid trading market will develop, thereby creating a reasonable fl oat in the outstanding shares of the company. Unlike an IPO, where lockups are common to restrict insiders from unloading their shares, in alternatives to IPOs such as a self-fi ling, the only people who can create the fl oat are those very insiders. Some companies limit how many shares key insiders may sell over certain periods of time (through what is known as a “lock- up” or “leakout” arrangement), but still allow the shares to be registered.
This is generally a more logical approach than excluding people from the registration.
Source: TKTK
Preparing and Filing the Document
The preparation of the contents of the document is similar to the prepara- tion of the new super Form 8-K, which is required after a reverse merger with a shell company. Usually, the attorneys, with help from management, take the lead in putting the document together. The basis of the fi ling is a well-written business plan prepared by management that is transformed into a prospectus. Before writing the registration statement, my associates and I typically spend most of a full day with management, understanding their business, its opportunities and challenges. Then we research similar companies and develop risk factors (a key section of the prospectus that outlines specifi c risks to the company and its business) from that and from information we receive from management.
The auditors must complete their two-year audit, as well as assist man- agement in preparing a section of the document known as “management’s discussion and analysis.” In this section, they must describe, line item by line item, what changed from year to year and quarter to quarter (if in the middle of a year), and why it changed. They also must review the company’s liquidity situation as well as its capital resources. The auditors also fully review the SB-2 fi ling and must sign off on all its contents before providing their consent for the audit to be included in the document.
Once the fi ling is ready, it is sent for what is now known in the trade as “edgarization” under the SEC’s Electronic Data Gathering, Analysis, and Retrieval system (EDGAR). EDGAR is the electronic fi ling system fully implemented by the SEC in 1996. EDGAR allows review of any SEC fi ling by anyone with an Internet connection and access to the SEC’s website at www.sec.gov.
EDGAR was set up pursuant to a complex SEC rule known as “Regu- lation S-T.” Specialized fi rms, including most fi nancial printers, will con- vert a document for SEC fi ling. They will then return it for proofreading and fi nal approval. Since the fi ling is electronic, yet includes a signature line, the fi ling must include a “conformed” company executive’s signature (in other words his or her name is simply typed in above the signature line) and the actual original signature must be kept in the company’s records. At one time, some larger law fi rms were offering an edgarizing service to their clients, but most abandoned it as either unprofi table or ineffi cient.
PRACTICE TIP
Leave extra time to obtain EDGAR codes—the IDs and pass- words needed to fi le with EDGAR. A fi ling service typically can obtain them, but it can take one to two days, and occasionally more, for the EDGAR fi ling support people at the SEC to issue the codes.
Source: TKTK
Once all the approvals are obtained, a company authorizes the EDGAR service to push the button and fi le. The fi ling date is the same as the day the fi les were sent, as long as this was before 5:30 p.m. Eastern time. The fi ling date can be important, as the fi nancial information in the fi ling must be current. If the fi nancials go “stale,” it may be necessary to input updated information and then fi le.
SEC (and NASD) Comments and Revisions
After fi ling comes waiting. Sometimes the response arrives in fewer than thirty days, but not usually. The company typically receives a formal comment letter from the SEC examiner who reviewed the fi ling. This letter states who at the SEC is in charge of the fi ling and gives the com- pany and its registration an SEC fi le number. If the fi ling includes selling shareholders who are affi liated with brokerage fi rms, the NASD may need to review the document as well, to determine if any interest held by those individuals or entities violates their limits on underwriting com- pensation. The NASD’s review has no specifi c time frame and can take quite a bit of time.
Most professionals rank SEC comment letters by the number of com- ments received. “We only got forty comments” is not an unusual happy response on a fi rst fi ling. I think, though, that quality of comments is more important than quantity. I once received seventy-two comments on an initial fi ling, and felt very unhappy. But as I went through the comments, it was clear that very few of them were substantive, the great majority cosmetic or minor. That, to me, is better than receiving forty diffi cult comments to address.
An SB-2 allows a reasonable and fl exible amount of response time (unlike a Form 10-SB fi ling which, as will be discussed in the next chap- ter, comes with a ticking sixty-day clock); however, a response to the SEC is mandatory. If no response is received, the SEC will eventually decide that the registration has been withdrawn and abandoned (although it will usually warn you before doing this).
The SEC reviews an SB-2 fi ling thoroughly because it involves a public offering by the selling shareholders, whereas Form 10-SB simply requests that the company voluntarily subject itself to the SEC report- ing requirements. Therefore, an SB-2 fi ling can take longer than a Form 10-SB fi ling.
Comments tend to be divided between fi nancial and nonfi nancial and, therefore, must be reviewed with auditors as well as company of- fi cials. The team then responds to the comments. In some cases, agreeing with a comment is no problem (such as when they suggest that a risk factor is too “generic” and must be removed). In some cases, agreeing
Source: TKTK
with a comment is a project (such as changes to the fi nancial statements or altering a business description). In some cases, the company simply disagrees with a comment and wishes to express its view (occasionally the examiner misunderstands a disclosure of some kind or the SEC is requesting disclosure that is not required and which the company prefers not to make).
At this point, a decision is made whether to simply fi le an amendment with such changes as the company wishes to make, along with a letter responding point by point to the SEC’s comments (even if the response is “see our change on page x”), or to contact the examiner with regard to any larger issues. Comments for which the company and its advisers be- lieve its response may cause a problem with the examiner might be better discussed before fi ling an amendment. Professionals help companies make these judgments based on their experience.
Ultimately, an amendment is fi led, along with responses to the com- ments, and then the SEC takes another round to review and provide another comment letter, ideally with fewer comments than the previous letter. This continues, essentially, until they are out of comments. The number of rounds of fi lings this takes is a function of the company’s will- ingness to play ball with every SEC comment, the capability of the SEC examiner, and, frankly, the SEC’s apparent comfort level with the fi ling or transaction in question.
If the SEC staff is concerned about players involved in a transaction, they can delay and add more comments, not offi cially stopping the process but certainly slowing it down. Heel-dragging may not be offi cial policy, or offi cially condoned, but any fair-minded practitioner would admit it does occur from time to time.
Once the SEC has completed its comments, it declares the registration statement “effective” and it can be used to resell the securities that were registered through that process. Typically, effectiveness is accelerated by a formal request asking for a certain effective date.
The NASD can be more diffi cult, and some fi lings can’t go ahead with- out their approval. And in general, there is simply no way to predict how long it will take. Comments in the third round of communications can be brand new and of the type that should have been raised in the fi rst round.
It can take forty-fi ve or sixty days to get one round of comments.
PRACTICE TIP
Wherever possible, try to avoid NASD review. (The Form 10-SB fi lings do not involve NASD review, but the SB-2 might, if a broker-dealer or affi liate is registering its own shares for resale.)
Source: TKTK
Establishing a Trading Market
Once the SB-2 is effective, the company is public. No IPO. No reverse merger with a shell. Financing has been obtained either before or right af- ter the fi ling becomes effective. There are now enough shares in the public fl oat to qualify for, say, the OTC Bulletin Board, which unoffi cially re- quires at least thirty-fi ve to forty nonaffi liate shareholders with at least one hundred tradable shares (Note: This requirement is not on any offi cial list of rules, but as a practical matter the regulators will bury your application to trade if you do not meet this criterion.)
All that’s missing is a listing on an exchange or market, without which the shares may not be traded through brokers. On the Pink Sheets and OTC Bulletin Board, the company cannot apply for a listing; the market maker must do so. On the Nasdaq, American Stock Exchange, and New York Stock Exchange companies apply for listing, not market makers.
Most companies going through a self-fi ling do not yet qualify for the higher exchanges, so market makers will be needed to get trading going.
I generally recommend that a company encourage market makers to start the application process while the SB-2 or other fi ling is pending so as not to waste time. The process of getting approved can take a few months, so the sooner the process starts the better.
In general, the OTC Bulletin Board will begin reviewing an applica- tion for a company that is not yet public, as long as the company has initiated the process. Running these two processes in parallel gives the best chance the company will have a listing by the time the SEC clears the registration statement so that the shares can begin trading.