This is the fifth part of our Securities Law 101 series. Because capital raising is such a critical function for middle market companies, we designed this series to introduce their management teams to some of the fundamental concepts in securities law. We hope that this series will prevent some of the most common mistakes management teams make. We will periodically publish posts examining different aspects of securities law.
So your company wants to use its stock to buy another company? As we have seen, stock consideration is coming back into vogue. Issuing shares of stock for mergers and acquisitions, however, triggers the need to either register the new shares with the SEC (and possibly state securities regulators) or to find an exemption from the requirements found under Section 5 of the Securities Act of 1933. The presence of these rules can substantially increase the cost of the deal and could even make you consider going public before you thought possible.
For mergers, finding an exemption from registration is not usually an easy task unless the target company is still held largely by the founder. Usually, the target company’s shareholders in the merger are often numerous, from many different states or jurisdictions, and represent a wide range of investor qualifications (accredited, sophisticated, etc.). As such, in many cases, finding a securities exemption is all but impossible. With exemptions off the table, let’s look at how to register stock in a merger.
Stock that is registered in the context of a merger is registered on Form S-4. This form was specifically designed for business combinations and exchange offers. A transaction in which security holders are required to elect to receive new or different securities in exchange for their existing security (so called Rule 145 transactions) would qualify to use Form S-4.
Disclosure under Form S-4 can be quite complex. Generally, Form S-4 requires full disclosure regarding both the acquiring and target companies and, if the post-merger entity will differ materially from the acquiring entity, then full disclosure with respect to the post-merger entity is also required. Form S-4s also include the proxy statement for the shareholder meeting to approve the transaction and, typically, combine this proxy with the prospectus. Form S-4 mandates extensive disclosure of the transaction in the prospectus/proxy statement, including any fairness opinions and a comparison of the rights of the shareholders of the parties to the transaction. Essentially, the disclosures are tailored to the specific transaction and nuances in the deal can create the need for a lot of disclosure. Notably, for some companies, (e.g., 1st United Bancorp, Inc.) registration via Form S-4 has served as the avenue of “going public.” For companies that are already public, there is also the possibility of registering securities long before a deal or several similar deals are on the table by means of a shelf registration.
Once a registration statement is filed with respect to a security, numerous other aspects of the Securities Act apply. For example, the gun jumping and publicity rules under Section 5 of the Securities Act are now applicable. Furthermore, Sections 11 and 12(a)(2) of the Securities Act (imposing liability for statements made in the registration statement and prospectus, respectively), apply as well, both of which are more generous to plaintiffs than the Exchange Act of 1934’s Rule 10b-5 or common law fraud. You also need to consider whether the target’s shareholders will be able to resell their securities. Essentially then, the parties to a merger transaction must take into account all securities law implications associated with using stock and/or securities to effect the transaction, weighing the costs and benefits of registering the relevant securities, or seeking an exemption from registration.
On top of the federal requirements, there are also state specific requirements for registered offerings in a merger. Many states have their own registration requirements that must be considered and complied with. Thus, a registered deal has a lot more issues involved and needs more analysis and time to complete. Still, the ability to use stock that may have climbed in value and may be trading at a multiple of book value is potentially very positive for making a deal happen. Deal makers should make sure to consider the possibility of using stock as a currency.