Seven Tips for Companies Going Public Through a Management-Underwritten Initial Public Offering

by Edward Weaver on May 14, 2009

For our clients with a reasonable time horizon for going public – approximately nine months – we often recommend a management-underwritten initial public offering, which is an offering whereby the company’s shares of stock are sold directly to investors by management, rather than through an investment bank or any other underwriter.  This offeringeliminates the substantial costs associated with using an underwriter or acquiring control of a public shell corporation.  If the management-underwritten IPO is a going public strategy that interests you, we offer the following seven tips to help expedite the process and eliminate unwanted delays and expenses: 

1.         Hire an Experienced Securities Attorney.  The registration process entails drafting and filing a registration statement, responding to SEC comments until the registration statement is declared effective, and drafting and filing post-effective amendments as necessary.  Hire a competent, experienced securities attorney who can take care of every aspect of the registration process so you can focus on running your business.  Moreover, hire a law firm that is the right size for your business and your offering.  Once your company becomes fully reporting, you will be required to continuously file various reports with the SEC, including Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and more.

2.         Create the Proper Shareholder Base.  The Financial Industry Regulatory Authority (“FINRA”) will not allow a market maker to initiate quotations of your company’s securities in the OTC Bulletin Board if it does not believe an orderly and liquid market in your company’s securities can develop.  Accordingly, you must build a fairly large shareholder base.  A good rule of thumb is to have at least 100 shareholders, each of whom owns at least 100 shares of your public stock.  In addition, avoid a highly concentrated ownership structure.  For example, if 95% of your company’s common stock is owned by two or three shareholders, FINRA will likely argue that an orderly and liquid market in your common stock cannot develop because these few shareholders will have too much power to manipulate that market or will be unable to freely trade their stock due to their affiliate status.

3.         Make Sure Your Business Can Pass the “Shell” Test.  Ever since the SEC amended Rule 144 of the Securities Act of 1933 (“Rule 144”), we have noticed that during the comment phase of the Form 211 application process, FINRA has been more liberal in issuing the “shell” comment to small startup companies, especially companies without revenues.  Because there is a market for shell corporations that are quoted on the OTC Bulletin Board, some individuals attempt to get companies without legitimate operations quoted on the OTC Bulletin Board.  Subsequently, they use the shell as a vehicle for effecting a reverse merger.  If FINRA suspects your company has “shell” characteristics, it will likely make the comment phase of the Form 211 application process very long and difficult.  Prior to allowing a market maker to submit a Form 211 application to initiate quotations of your company’s securities in the OTC Bulletin Board, you should make sure you can provide sufficient evidence to FINRA to prove that your company is not a shell. For more information on how to build a strong case that your startup company is not a shell, please see the following article: FINRA Comments Are Leaving Many Startup Companies “Shell” Shocked.

4.         Start Preparing Your Financial Statements Now.  Your registration statement must include audited financial statements for such part of the two preceding fiscal years that your company has been in existence. First, your accountant should prepare GAAP-compliant financial statements and the footnotes to those financial statements.  Next, you must hire an independent registered public accounting firm to audit those financial statements and prepare an independent opinion on whether or not those financial statements are relevant, accurate, complete, and fairly presented.  Your auditor is prohibited from preparing your financial statements for you, so the financial statements prepared by your accountant should be complete.  Independent registered public accounting firms are busy, especially when annual and quarterly reports are due during the year, and the preparation of audited financials is the primary cause of delay in filing a registration statement.  Accordingly, the moment you decide to pursue a management-underwritten public offering, get working on your financial statements.

5.         Stop Using Potentially Misleading Disclosure. Most entrepreneurs are blessed with an unlimited supply of optimism.  This trait, while desirable in many business situations, can be problematic during the funding and promoting stages of a company’s development.  These entrepreneurs often prepare business plans that use excessive puffery to describe the business and the investing opportunity.  Occasionally, they prepare overly optimistic financial forecasts that suggest unreasonably high returns. Sometimes, they even place this information on their websites or in press releases for the entire world to see.  There is a fine line between puffery and misrepresentation and companies desiring to go public must be especially careful not to cross that line.  Sophisticated investors may expect and tolerate a certain amount of enthusiasm and know what questions to ask if a company’s disclosure appears to be misleading.  However, when you place this kind of disclosure on a website or in a press release, you no longer control who views and acts upon the disclosure.  The unsophisticated widow who invests her small nest egg in your business based on arguably misleading statements on your website and loses everything makes a very sympathetic plaintiff.

Moreover, FINRA will search your website, press releases and other publicly available disclosure about your company for potentially misleading statements and will issue comments asking you to explain them.  If FINRA suspects you are using misleading and/or fraudulent statements to condition the market for your securities, it will not approve your application to initiate quotations in the OTC Bulletin Board.  Consequently, review your website content and previously issued press releases for potentially misleading statements.  Remove such statements from your website, and, if previously issued press releases contain arguably misleading statements, consider issuing a new press release to address and correct such statements.

6.         Hire a Good Transfer Agent.  A transfer agent is an outside organization retained by a corporation to maintain shareholder records, including purchases, sales, and account balances and process transfers and registration of stock certificates.  As you increase your shareholder base, it becomes increasingly important to devote more resources to maintaining your shareholder records.  Hire a good transfer agent to manage your shareholder records so you can focus on running your business.  There are many transfer agents out there but some provide better service than others.

7.         Find the Right Market Maker.  To initiate quotations of your company’s securities in the OTC Bulletin Board, a market maker must submit a Form 211 application to FINRA.  Market makers cannot receive remuneration in exchange for submitting a Form 211 application.  Consequently, most market makers will not waste their time submitting Form 211 applications for small companies.  You must find the right market maker for your particular company.  Before filing the Form 211 application, market makers are required to perform due diligence on your company in compliance with Rule 15c2-11(a)(5) of the Securities Exchange Act of 1934, as amended.  The market maker will require a 15c2-11 Disclosure Statement from your company, a copy of which must be maintained at the market maker’s office and submitted to FINRA with the Form 211 application.

There are many potential pitfalls when going public, and I have addressed only a few of them that we see regularly in our practice.  There is no way to plan for all contingencies, but by planning ahead, you can eliminate many of the unwanted delays and costs.

This article is intended only as a general discussion of the foregoing issues and should not be regarded as legal advice.

Edward H. Weaver is an attorney with The Lebrecht Group, APLC, located in Irvine, California and Salt Lake City, Utah.  He can be reached at (801) 983-4948 .  Please visit our website at for further information.

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