NEW YORK-Stock-market volatility has caused 160 companies that filed for initial public offerings this year, half of them in the third quarter, to delay or cancel those plans, according to Securities Data Corp., Newark, N.J.
That’s the good news. Now many of those same companies are finding they are barred from seeking funds in a private-equity placement for at least six months, said Marc H. Morgenstern, managing partner of Kahn, Kleinman, Yanowitz & Arnson.
The Cleveland law firm specializes in middle-market companies. Morgenstern said he represents almost exclusively entrepreneurs and emerging growth companies on issues related to venture-capital raising and public and private securities law. He also is a member of the Securities and Exchange Commission’s Small Business Capital Formation Conference.
The rules governing private placements, a logical though smaller financing alternative than IPOs, run head-on into opposing regulations governing public issuance, he said. Furthermore, this conundrum for companies needing capital is aggravated by the advent of the Internet, which disseminates at lightning speed information that was closely guarded just a few years ago.
“There is a precondition of a private placement that there [be] no general solicitation and advertising,” Morgenstern said. “Public equity sales, by contrast, are intended for widespread sale and therefore typically are broadly marketed in a general solicitation in advance of their formal offer.
“Today, because of the broadcast power of the Internet, there is no such thing as a quiet filing (for an IPO) like (in) the olden days just three years ago. It is putting many companies in the precarious position of having to wait.”
Under federal securities laws enacted in the 1930s, the SEC waives the securities offering registration requirement for “non-public distributions, narrow distributions to a limited number of people,” he said. Known colloquially as private placements, these non-public distributions tend to be for smaller aggregate amounts than public-equity sales, but are sold in comparatively large individual units of $50,000 to $250,000.
Registering with the SEC to go public is not a frivolous act that companies undertake lightly. Filing to go public is expensive, costing hundreds of thousands of dollars, and it places on display a company’s financial statements, Morgenstern said.
Until recent years, a company could change its mind after filing with the SEC to go public, opting instead for a private-equity sale, and few would know of its canceled IPO plans. Lawyers, including Morgenstern, would hand-deliver IPO registration documents to the SEC.
“If someone wanted to do a quiet filing (because) they weren’t sure they would do the deal or how large it would be, they didn’t issue a press release. Reporters wouldn’t know to look, and the lawyers, accountants and the SEC were the only ones who’d know,” Morgenstern said.
“Now, you’re not allowed to file manually but must file in EDGAR, (posted on the SEC’s Web site), and millions know five minutes after you file.”
Companies temporarily locked out of the IPO market and the option for a narrowly distributed private placement because of these conflicts might consider doing a more broadly distributed “retail private placement” of equity. However, this alternative also may run afoul of regulations.
“In a retail private placement, you’d send a memo (for example) to 300 people to try to raise money, but the odds are they’ve already been affected by the general solicitation (for the IPO),” Morgenstern said.
Typically, the SEC permits a company to seek debt financing as an alternative to equity because its “rules of solicitation don’t apply to debt … (which has) the least risk and the least reward,” he said. “Whether that’s good or bad business is a different question. Usually the reason companies go public is they need the equity.”
To a point, the ability to access capital is a priority way ahead of its cost to a company, Morgenstern said. On the other hand, “growth at any cost isn’t sensible either (because) you must make sure you’re not risking the whole mother ship.”
Conserving cash by cutting capital expenditures is another interim alternative, as is selling off non-essential assets, he said.
To some degree, the heady stock market of the recent past, with its inflated corporate valuations, encouraged at least some companies to try to go public prematurely. These companies sought public capital-market access and acceptance at a stage in their development cycle when private mezzanine financing, a midpoint between debt and equity, might have been more suitable, Morgenstern said. This option remains open.
“People hate hearing that the rules they’ve played by have changed, but no one has ever changed the laws of supply and demand,” he said.
