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purchased from the company (after a registration Rule 144 would not be needed), and at least they know that one year after closing the PIPE trans- action they will be able to sell some of their warrants as long as they are in the money and there is a liquid market.
This same analysis applies to preferred stock or convertible debt. In both cases, the security usually can be exchanged for common stock on some basis, without payment of additional cash. Under Rule 144, because one security is exchanged for another, the holding period relates back to the date of acquisition of the preferred stock or convertible debt. Again, in PIPE transactions involving these securities, an investor utilizing this cash- less feature has some protection if the resale registration is not completed.
Self-Filing Through Form SB-2
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vately held operating business “goes public” by effecting a resale registra- tion of shares that have been distributed but, under Rule 144, cannot yet be sold. Assuming the company qualifi es under the SEC’s small-business disclosure system, it will fi le Form SB-2, which includes two years of au- dited fi nancial statements.
The SEC Advisory Committee on Smaller Public Companies has pro- posed expanding the availability of the S-B system to larger companies, but combining it with the preexisting S-K system and simply providing for relief under that system for certain fi lers.
Private Offerings During Registration
One of the basic no-no’s of a primary offering or resale registration is that, with narrow exceptions, one cannot pursue a private offering of company securities when a registration is pending with the SEC. In a famous no-action letter, the SEC ruled that the only private placement one can pursue during a registration is an offering to qualifi ed institu- tional buyers or QIBs, as defi ned in SEC Rule 144A.
Technically, this no-action letter, known as “Black Box,” only applies to company registrations. It does not address resale registrations; however, over the last year the SEC staff has been applying the Black Box analysis to pending resale registrations anyway. This means that one may not pursue a private placement other than to QIBs while either a company or a resale registration is pending; those who do will incur SEC ire.
QIBs are entities that, acting for their own account or others, own or invest on a discretionary basis at least $100 million in securities of issuers not affi liated with the company selling securities to the QIB. So basically, if an entity does not regularly invest over $100 million, it is not a QIB. Also, securities dealers who own and invest at least $10 million in securities not affi liated with the company are QIBs. Securities dealers are presumed to be more sophisticated than others who may invest larger amounts and, therefore, are permitted the lower threshold. Individuals cannot be QIBs.
Therefore, many usual sources of fi nancing—angels, venture fi rms, and accredited investors—are unavailable while a registration statement is pending. This blackout period while pursuing a self-fi ling can last between fi ve and eight months—sometimes longer. Occasionally, depending on circumstances, the SEC will allow an exception.
This rule, prohibiting most private placements during a pending of- fering or resale registration, exists to make sure that one of the provisions of Regulation D is not violated. The provision says that when a company wishes to complete a private placement, it may not engage in a “general solicitation” of investors. The offering documents fi led pursuant to the
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registration are publicly available during the SEC review process. The SEC’s position is that this very public availability of information in con- nection with an offering (even if a different offering from the proposed private placement), whether fi led by shareholders seeking a resale or a company seeking an initial registration, constitutes a general solicitation of a non-QIB private placement. As a result, the two offerings are “inte- grated” or joined together. The determination that the two offerings are integrated results in the company’s failure to meet the requirements for a valid private placement and would cause the company to be required to register the securities offered in the private placement as well.
The SEC will make other exceptions, however, besides offerings to QIBs. In one case we worked on, the staff allowed a small private place- ment to a principal of a brokerage fi rm while the company in question was in registration for an IPO. The reasons this was permitted included the fact that the investor, though not a QIB, was an experienced Wall Street veteran; the security he was purchasing (debt with warrants) was very different from the IPO security, thereby increasing the argument that the IPO prospectus does not constitute general solicitation for the private placement; and the fact that the offering of $500,000 was relatively small compared to the much larger IPO.
Companies that pursue an SB-2 resale strategy must ensure that either (a) they obtain any fi nancing they need for the duration prior to the fi ling of the SB-2, (b) they have connections to obtain fi nancing from QIBs or some other possible exemption under which they can obtain fi nancing, or (c) they do not need fi nancing until the SB-2 is effective.
PRACTICE TIP
If fi nancing is necessary while a registration is pending, consider going public through Form 10-SB, which is discussed in detail in the following chapter. Most practitioners believe that the restric- tion on private placements during registration does not apply to a Form 10-SB fi ling, since no public offering is taking place to be integrated with the private offering.
One major benefi t of the SB-2, however, is that if the company has many shareholders whose shares would not become publicly tradable un- der Rule 144 if it goes public through Form 10-SB (which does not reg- ister individual shares and relies on enough shareholders being able to sell under Rule 144 without registration), the SB-2 effects the removal of all trading restrictions on the shares being registered.
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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.