Registration Statements (#93)
/In this podcast episode, we discuss the various types of registration statements required by the SEC. Key points made are noted below.
The Need for a Registration Statement
A company can only sell shares, and its investors can only sell their shares, if the stock is registered. This means that you have to write up a looong registration document, and submit it to the SEC. And then – most of the time – they take a month to review it, and then they send it back with comments – possibly dozens of comments – and then you respond, and then they take another month to review it, and so on. Once they finally declare it effective, which can easily take a half a year, then the stock is registered. And then you or the existing investors can sell stock. And by the way, only the investors whose shares are listed in the registration statement can sell. Everyone else is out of luck.
This is annoying in two ways. First, you spend an amazing amount of time writing the registration statement, which also calls for a lot of expensive input from your auditors and attorneys. And second, you absolutely want to throttle the SEC by the time they’ve picked through the statement multiple times – and in excruciating detail. More about that later.
Registration Statement Exemptions
Now, you can avoid a registration statement with exemptions. I already covered Regulation A stock sales in episode 90, and Regulation D stock sales in episode 89. And I still haven’t talked about one more variation, which is Rule 144. But if you can’t do any of those, and you’re stuck with doing a stock registration, then what’s that all about?
First of all, you may be forced to register your stock. If a big investor puts in money, it may be on the condition that you register their stock within a certain period of time. And if you can’t register it by the deadline, then they may impose penalties. Or, you may get verbal pressure from existing shareholders, who want to sell their shares. So there may be reasons why you just have to do this.
Types of Stock Registrations
Well, there are several types of stock registration. The biggest, baddest, and basically the worst one is called the Form S-1. This one requires an amazing amount of information, with the worst of it under a category called “Information with Respect to the Registrant.” The company is the registrant. You have to describe the entire business in nauseating detail, and that includes any legal proceedings, financial statements, and management’s discussion of the financial results. The result really will be the size of a small book.
A key issue in preparing an S-1 is whether you can incorporate a bunch of information by reference, which means that you can describe something elsewhere, like in your annual 10-K report, and then just refer to the 10-K in your S-1. This would be way more efficient, but of course, the SEC doesn’t allow this for newer companies. You cannot incorporate by reference if the company has been a blank check company or a shell company, or if you’re offering penny stock. And you have to be current with your public filings. If you went public by buying a public shell, then you have to wait three years before you can incorporate information by reference.
So, are there alternatives to an S-1? Luckily, yes. There’s the S-3 and the S-8. The S-3 allows for the incorporation by reference of a lot of information; you can refer to the latest Forms 10-K, 10-Q, and 8-K, which address nearly everything in that section called “Information with Respect to the Registrant.” This saves a pile of time, but of course, the S-3 can only be used by some public companies.
To use it, you have to have your principal business operations within the United States, and you already have to have a class of registered securities (that’s a big one), and you can’t have defaulted on any debt or lease payments recently, and the market value of the common equity held by non-affiliates has to be at least $75 million. If that bit about the market value is less than $75 million, you can still use an S-3 if you’re listed on a national stock exchange, and haven’t been a shell company for the past year.
So, the S-3 is really designed for larger public companies. If you’re running a micro-cap company, then you’ll be stuck with the S-1.
Now, there is a registration variation called the Form S-8, which is pretty nice. But it’s also extremely restrictive. The S-8 allows you to register securities that you’re offering to your employees under an employee benefit plan. This can include things like an employee stock purchase plan, or stock options, or restricted stock units. Stock recipients covered by an S-8 are employees, officers, directors, general partners, and consultants. And even family members, if they received the securities through an employee gift.
The inclusion of consultants in this list is a little odd, since everybody else is clearly some variation on an employee. So, the SEC makes it a little more difficult for consultants to be included. Any securities issued to consultants can only be registered under an S-8 if they provide bona fide services to the company, and those services cannot be related to the sale of the company’s securities.
The S-8 – obviously – is restricted to what is normally a tiny subset of all the securities that a company has outstanding. Nonetheless, it’s really useful for the group that it applies to, and I absolutely recommend that you use it. And for two good reasons. First, it’s effective as soon as you file it, so there’s none of that incredibly annoying back and forth with the SEC’s comment letters. And second, it is really easy to complete. All you have to do is state that the company’s regular filings are incorporated by reference, and describe how the company indemnifies its officers and directors. And attach the employee benefit plan. There are a few other minor requirements, but that’s really about it.
The S-8 is only available if the company has been current with its filing requirements for the last 12 months, and it hasn’t been a shell company for at least the preceding 60 days.
One other point with an S-8 is that you can’t keep issuing securities under it if you stop being current with your SEC filings. That means anything previously issued under it can still be traded, but you can’t keep issuing more securities.
There’s also something called a shelf registration. This is the registration of a new issue of securities, and it can be filed up to three years in advance of actually distributing the securities. This allows you to obtain funds really fast when you need them. This is really useful for debt offerings, because a company can do the shelf registration and then wait for interest rates to decline before issuing any debt.
You usually do a shelf registration with an S-3 filing, which still requires it to be declared effective by the SEC, which can take some time. However, it can be effective immediately upon the date of filing. This automatic shelf registration is only available to what are known as “well-known seasoned issuers”. Which sounds a bit like they’ve been marinated for a while.
Anyways, these companies must have common stock belonging to non-affiliates that has a market value of at least $700 million, or they must have issued at least $1 billion of non-convertible securities within the past three years. So, this is essentially only available to mid-cap and large-cap companies. Everyone else is just too small.
When a Registration Statement is Effective
One last item. Let’s get back to that bit about the SEC declaring a registration statement effective. What’s that all about? It means that the SEC staff finds that your registration statement conforms to their regulations, and it includes key information about the company. So all the SEC is doing is making sure that the document is complete – they can’t pass judgment on whether it’s completely idiotic for anyone to invest in your company – only that the information is listed in the registration statement that tells investors that an investment is a really bad idea.
The SEC staff has one month in which to review a registration statement. And they use the entire period. And on the last possible day, they send you a comment letter. I’m going to read part of their standard boilerplate, because it tells you what they’re up to. It says, and I’m starting partway into a sentence:
“We think you should revise your document in response to these comments. If you disagree, we will consider your explanation as to why our comment is inapplicable or a revision is unnecessary. After reviewing this information, we may raise additional questions. Please understand that the purpose of our review process is to assist you in your compliance with the applicable disclosure requirements, and to enhance the overall disclosure of your filing.”
The comments they attach may include a couple of significant items, and then there’ll be a whole pile of items so nit-picky that you really start wondering about the SEC staff time that goes into these reviews. I cannot possibly say that the SEC is being effective in how they review a document. They really should just zip through a registration document, and comment on the big stuff, but that is absolutely not the case. If anything, this looks like the worst possible case of make-work that I’ve ever seen. But, that is the system.