- International Practice
- Securities Regulation
- Climate Change
- Financial Institutions
- Labor and Employment
- Strategic Communications
- Corporate and Securities
- Financial Restructuring
- Educational Institutions
- Private Funds
- Intellectual Property
- Public Finance
- White Collar Defense
- Environmental Strategies
- Internal Investigations
- Real Estate and Projects
SEC Proposes New Rules for Registered Public Offerings by Smaller Companies
June 27, 2007
As we described in a prior Update, the Securities and Exchange Commission announced in May 2007 that it intends to propose new rules to make it easier for smaller companies to raise capital. The new rules are expected to address a number of topics, including easing the eligibility requirements so companies with a public float below $75 million can take advantage of the benefits of shelf registration using Forms S-3 or F-3.
On June 20, 2007 the SEC issued the text of some of the proposed new rules to allow smaller public companies to raise funds in registered offerings using Forms S-3 or F-3 without regard to the size of their public float or the rating of the debt they are offering.
Form S-3 is the “short form” registration statement used by eligible domestic companies to register securities offerings. (Form F-3 is the equivalent for foreign companies.) Companies generally prefer to use Form S-3 when available because unlike a “long form” registration statement (Form S-1), Form S-3 allows companies to incorporate their filings under the Exchange Act by reference to satisfy the disclosure requirements.
Form S-3 eligibility is also key to a company’s ability to conduct primary “shelf” offerings. “Shelf” offerings are an attractive method of raising capital for eligible companies because the company can file its registration statement prior to planning any specific offering, then later, after the registration statement has been declared effective, offer its securities in one or more offerings without waiting for further review or action by the SEC. This provides significant flexibility to companies eligible to use Form S-3, as they can raise capital in registered offerings more quickly than would otherwise be the case.
However, to be eligible to use Form S-3, the company must meet certain requirements, and the transaction must also meet certain requirements. Under current rules, with some exceptions, the transaction requirements provide that a company may use Form
S-3 to register a primary offering (an offering for the company’s account) only if the company’s public float (its non-affiliate equity market capitalization) is at least $75 million. Thus, under current rules, companies having a market float of less than $75 million generally cannot use Form S-3 to raise equity capital.
The proposed rules would eliminate the $75 million public float requirement. A company with less than $75 million in public float would be allowed to use Form S-3 to register primary offerings, provided it:
meets the other registrant eligibility requirements of Form
S-3 (including that the company have a class of securities registered under Section 12(b) or 12(g), or is required to file reports under Section 15(d), of the Exchange Act, and has been subject to the filing requirements and has filed required reports on a timely basis for at least the prior 12 calendar months),
does not sell more than the equivalent of 20% of its public float in primary offerings in reliance on the new rules in any 12-month period, and
has not been a shell company within the prior 12 months.
Amount a Smaller Company Could Raise Using Form S-3
To determine the amount a company with a public float of less than $75 million could raise under the proposed rules:
First, the company would calculate its public float immediately prior to the proposed sale (based on the last sale price, or average of the bid and asked price, in the principal market for the company’s equity securities as of a date within 60 days prior to the date of the proposed sale); and
Second, the company would determine the amount (if any) it had sold in prior sales under the proposed rules within the preceding 12 calendar months, plus the amount of the proposed sale, to determine whether the total would be within the 20% limitation.
The amount the company would be permitted to sell under the proposed rules would be the difference between 20% of its public float, and the value of securities (equity and debt) sold by the company in primary offerings under the proposed rules in the prior 12 calendar months.
To calculate the amount of securities that are convertible into or exercisable for equity (such as convertible debt or warrants) that a company could sell, the company would use the market value of the underlying equity securities rather than the value of the convertible securities. The 20% limit would apply only to the amount the company could sell under Form S-3, and would not affect a holder’s ability to convert or exercise the convertible securities purchased from the company.
Non-Investment Grade Debt
Under current rules, companies meeting the applicable company requirements may offer non-convertible investment grade debt using Form S-3 regardless of their public float. The proposed rules would permit companies to offer non-investment grade debt using Form S-3, subject to the limitations described above.
Under the proposed rules, a former shell company that does not have $75 million in public float would become eligible to use Form S-3 to register primary offerings of its securities 12 calendar months after it ceases being a shell company, provided that it:
has filed information with the SEC that would be required in a registration statement to register a class of securities under the Exchange Act, and
has been timely reporting for 12 calendar months.
Variations in the Amount of a Company’s Public Float
Because the limit on the amount a company could offer under the proposed rules is calculated based on the company’s public float prior to a contemplated sale, the amount a company would be permitted to offer under the proposed rules could increase or decrease from time to time. However, a decrease in the company’s public float after the computation date for the determination of the amount permitted to be sold would not have any effect on a properly conducted offering.
If a company files a Form S-3 under the proposed rules, and after the effective date of the Form S-3, the company’s public float increases to $75 million or more, the 20% limitation would lifted, so that the company would be treated much like a company that had satisfied the $75 million public float requirement at the time it filed its registration statement. However, the company would be required to recompute its public float each time it amends the Form S-3 in accordance with Section 10(a)(3) of the Securities Act, typically when it files an annual report on Form 10-K.
In proposing the new rules, the SEC provided examples of how the new rules would work in different situations, which we have summarized below.
January 1, 2008 – Company A with a public float of $50 million files a shelf S-3 under the proposed rules registering up to $20 million of debt and equity securities, and the S-3 is declared effective.
March 2008 – Company A decides to sell as much common stock as it can under its shelf. It calculates its public float, as of a date within 60 days prior to the anticipated sale, as $55 million, so the total it can offer, assuming no prior sales under the new rules, is $11 million (20% of $55 million).
September 2008 - Company A determines its public float has increased to $60 million. It can offer $1 million of securities under the proposed rules (20% of $60 million = $12 million, less the $11 million previously sold.)
December 2008 – Company A determines its public float has increased to $85 million. It has now sold a total of $12 million under the S-3, leaving $8 million remaining on the S-3. Company A calculates 20% of its $85 million public float to be $17 million, and since it has already sold $12 million, under the proposed rules it would normally be able to offer only the $5 million difference. However, because its float now exceeds $75 million, it is no longer subject to the 20% limit, and thus can offer and sell the amount remaining available under its S-3, or $8 million, at any time, even if its public float falls below $75 million, until it files its next 10-K.
Company B has 12 million shares of common stock held by nonaffiliates, with a market price of $5.00, and thus a public float of $60 million. The Company has filed a Form S-3 under the proposed rules, and the S-3 has been declared effective.
The Company wants to issue $10 million of convertible debt that will be convertible into common stock at a 10% discount to the market price of the common stock. Since the amount Company B can offer under the proposed rules is measured by reference to the value of the underlying shares rather than the value of the securities to be sold, the Company calculates that at a 10% discount, the conversion price is $4.50, and thus 2,222,222 shares currently underlie the $10 million of convertible debt. Since the current market price of the common stock is $5.00, the value of the offering for purposes of the proposed rules is $11,111,110 (2,222,222 shares times $5 per share), which is less than the $12 million allowed by the 20% cap (20% of $60 million).
After these convertible securities are outstanding, Company B plans another takedown, so it must calculate its public float and the aggregate market value of all securities it has sold in the prior 12 months under the proposed rules. Since the market value of the convertible debt is calculated by reference to the underlying stock, Company B calculates the value of notes that have already been converted by using the market price of the common stock on the date(s) of conversion, and the value of the notes that have not yet been converted by multiplying the maximum number of shares into which the notes are convertible as of a date within 60 days prior to the anticipated sale by the common stock price used to determine Company B's market float.
Company C has an effective shelf Form S-3 filed pursuant to the proposed rules. At the time of the first takedown, Company C's public float is $20 million, so the maximum amount it could offer under the 20% cap is $4 million. Company C sells only $3 million in its first takedown.
Six months later, Company C's public float has decreased to $10 million. In this circumstance, Company C cannot conduct an additional takedown off its shelf, because with a public float of $10 million, the 20% cap imposes a $2 million limit during the 12 calendar months ending on the date of the proposed sale. Since Company C sold securities valued at $3 million six months earlier, it cannot sell additional securities under the S-3 until at least a full year has passed since its $3 million sale, unless its public float increases sufficiently to allow a sale.
The SEC has proposed amendments to Form F-3 that are comparable to the proposed changes to Form S-3.
Comments on the proposed rules are due 60 days after publication of the proposed rules in the Federal Register.