A provision of the recently enacted legislation, known as the FAST Act, makes it easier for smaller public companies to conduct registered offerings.
The reason why this is significant is that smaller public companies face a very unreceptive market when raising capital via private placements, known as PIPE offerings.
Burden to Qualify to Invest in Private Placement
In general, the requirements to qualify as an investor in a private placement leave only a small universe available to consider a private placement offering.
A private placement investor must undergo the paperwork burden to prove the investor qualifies as an accredited investor, with
- the capability to evaluate the risks of the offering;
- the willingness to forego immediate liquidity of the securities purchased in the offering; and
- the ability to sustain the total loss of the investment.
Given the limited universe of investors for private placement offerings, in today’s capital markets, smaller public companies, especially OTC listed companies, typically find only toxic financing available from PIPE investors. That is, the issuing public company may be able to raise capital but the form of the securities demanded by investors has features which are extremely expensive to the issuer and may, in certain circumstances, result in severe negative impact on the issuer’s stock price, perhaps due to substantial dilution of shares.
In contrast with the limitations of a private placement, an investor in a registered offering:
- has no paperwork burden to prove eligibility to purchase the securities; and
- has immediately tradable securities, subject only to the liquidity of the company’s stock.
Given these features of a registered offering, issuers can tap a much broader universe of potential investors for a registered offering which should enable an issuer to obtain better terms than for a private placement.
Why then don’t smaller companies issue shares through registered offerings?
The reasons typically given include:
- raising capital via a registered offering involves upfront and ongoing costs for legal and accounting work to file an S-1 registration statement without certainty of success in actually raising capital,
- offering size may be small in relation to the fixed upfront costs noted above; and
- filing a registered offering is public and would enable a stock short seller to short the issuer’s stock depressing its price then cover the short at a profit with stock purchased on the offering.
The new rules enabled by the FAST Act don’t eliminate all these impediments but eliminate one of the costs and risks, which is the requirement to file additional S-1 supplements once the S-1 is declared effective.
Final rules issued by the SEC on January 13th, implementing the FAST Act, enables companies using the S-1 form of registration statement to incorporate by reference required SEC filings after the S-1 is declared effective.
Up until now, S-1 registration statements could only incorporate by reference prior SEC filings. Larger companies, able to use S-3 registrations could incorporate future SEC filings.
Now a smaller company using an S-1 registration statement, which makes the election to incorporate future SEC filings by reference, need not file an update to its S-1 registration when a new SEC filing is required, such as an 8-K or 10-Q, and risk SEC review and comments.
This is a substantial cost and time saving benefit of this provision of the FAST Act.
Interestingly, this is not the feature which got the attention when the FAST Act was passed or the final rules issued.
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For background reading on this and other capital market provisions in the FAST Act, please click on the following:
The amendment to Form S-1 requires smaller reporting companies that make this election to state in the prospectus contained in the registration statement that all documents subsequently filed by the smaller reporting company pursuant to Sections 13(a), 13(c), 14 or 15(d) of the Exchange Act before the termination of the offering shall be deemed to be incorporated by reference into the prospectus.
This amendment will permit smaller reporting companies to eliminate the additional costs and delays of manual updates to “shelf” registration statements on Form S-1 for resale transactions and continuous offerings that commence promptly after effectiveness and continue for a period in excess of 30 days after effectiveness. This amendment does not change the current requirement that companies must conduct delayed offerings under Rule 415(a)(1)(x) under the Securities Act of 1933 using Form S-3 or Form F-3.
In addition, this amendment does not change the eligibility requirements for companies that wish to incorporate documents filed after the effective date of the registration statement under General Instruction VII to Form S-1. The principal eligibility requirements include the following: (1) the company is required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act, (2) the company has filed all reports and other materials required by Sections 13(a), 14 or 15(d) of the Exchange Act during the preceding 12 months or such shorter period as the company was required to file such reports and materials, (3) the company has filed an annual report required under Section 13(a) or Section 15(d) of the Exchange Act for its most recently completed fiscal year, (4) the company is not a blank check company, a shell company or a registrant for a penny stock offering and (5) the company is not registering an offering that effectuates a business combination transaction).