As reported in the Wall Street Journal, Facebook, Inc. filed a registration statement with the SEC late Wednesday to register to go public.  This continues the recent trend of established technology companies going public since the beginning of last year.  Whether the stock price ultimately supports its expected lofty valuation remains to be seen.

While the IPO has been long-expected, it is important to remember the reason why Facebook decided to go public: it was required.  Section 12(g) of the Securities Exchange Act of 1934 requires companies that have at least $10,000,000 in assets and at least 500 shareholders as of the end of its fiscal year to register with the SEC.  This shareholder limit has not been adjusted since its adoption in 1964, and causes companies that need to raise capital to face two equally unappealing choices: limit the number of investors to ensure the 500 limit is not breached or register with the SEC regardless of whether being a public company is in the company’s best interests once the limit is met.  While a recent proposed bill in the House has attempted to lessen the burden on private companies looking to raise capital by increasing the shareholder limit from 500 to 1000, to date no legislation has been enacted into law.  The SEC is also reviewing the shareholder limit.

Until Congress or the SEC acts, private companies should consider taking a few safeguards to avoid the requirement to register with the SEC.  First, adopt a shareholders’ agreement that restricts the transferability of the shares.  The transfer restriction will prevent shareholders from subsequently transferring their shares to multiple new shareholders which could cause the company to exceed the limit.  Second, issue stock options to employees rather than shares of stock.  Stock options are considered a separate class of equity security, and since 2007, the SEC has exempted companies from having to register under Section 12(g) because there were more than 500 option holders.  Third, private companies can adopt an insider trading policy that prohibits any employee from reselling their shares.  Facebook adopted such a policy, which effectively eliminated the secondary distribution of its shares.  Fourth, companies can implement high transfer fees to restrict the distribution of its shares similar to the fees Facebook and Zynga implemented in 2011.  Fifth, if employees are eager to sell their shares, a company can coordinate a secondary sale to one investor, which would have the effect of reducing the total number of shareholders.  Lastly, if all else fails, a company can attempt a reverse stock split, which would force the smallest shareholders to cash out their shares.  Reverse stock splits are not viewed favorably by shareholders, particularly those who are being cashed out.  In addition, using a company’s cash to fund a reverse stock split is likely not the best use of its cash, especially for a growth company.