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The SEC's Small-Cap Acquisition Anomaly

Smaller publicly-traded companies that do not meet the public float requirements for Form S-4 incorporation by reference face an expensive and time-consuming public M&A process; the SEC’s focus on capital formation by smaller public companies should not overshadow efforts to aid in their future growth through acquisitions.

A significant issue for smaller publicly-traded companies is growth, particularly via acquisitions of other companies. With more than an estimated 3,500 smaller public companies classified by the SEC as “smaller reporting companies,” public mergers and acquisitions among these similarly-sized companies would seem to be the perfect path to gain the critical mass to effectively compete against larger companies in their industry. Smaller public companies, however, generally need to structure their acquisitions as stock-for-stock statutory mergers because buyers are typically not in a financial position to effect all-cash acquisitions of another public company by means of a tender offer or other hybrid structure and sellers often wish to participate in any potential future growth of the combined company.

As a result of this transaction structure, stock-for-stock mergers require two shareholders’ meetings to be typically held, a joint shareholder proxy statement-prospectus to be prepared, and extensive SEC review in pre-clearing the materials to be distributed to shareholders, all of which amounts to substantial expense and delay. The costs of counsel to prepare a 150+ page registration statement on Form S-4, including joint proxy statement-prospectus, together with related fees for accountants, financial advisors and other professionals, plus a timetable from preliminary negotiations and agreement in principle through the proxy solicitation period and merger closing of four months or more, make these acquisitions prohibitive.

One approach to mitigate this expensive and time-consuming process may be to amend the aggregate public float requirement for incorporation by reference in Form S-4 to ease the paperwork by smaller reporting companies. In a somewhat complicated puzzle, as set forth in General Instruction B.1a(i) and (ii) of Form S-4, many smaller reporting companies do not meet the aggregate public float requirement of Form S-3 for S-4 incorporation by reference unless they meet the aggregate market value requirement of General Instruction 1.B.1 of Form S-3, which requires that they have common equity held by non-affiliates of $75 million or more.

But why should SEC rules restrict Form S-4 incorporation by reference for companies that fall below General Instruction 1.B.1’s public float requirements if the companies, for example, have timely filed all of their required periodic reports during the preceding 12 months. If eliminating these public float requirements to allow incorporation by reference by public companies of all sizes is not practicable to the SEC staff, looking to the “baby shelf” rules under General Instruction I.B.6 (rather than I.B.1) may be an alternative reference point for accommodating the interests of smaller reporting companies. By this analogy, the SEC could consider the scale of the proposed business acquisition to determine whether the parties must include all required disclosure within the Form S-4 or they can incorporate by reference information previously filed. 

Interestingly, smaller reporting companies can file a capital-raising “shelf” registration statement on Form S-3 subject to a limitation on sales of one-third of the aggregate market value of its non-affiliate held common equity. But, an acquisition “shelf” registration statement on Form S-4 cannot be used by smaller reporting companies with common equity held by non-affiliates of less than $75 million.

It seems that the baby shelf compromise and the public float provisions of the incorporation by reference rules, which were aimed to facilitate growth through capital investment, were never replicated in the SEC rules to similarly support growth through acquisitions by smaller publicly-traded companies.

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