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Financing Alternatives in Today's Capital Market Environment

January 21, 2015

Raising capital in today's uncertain economic environment requires public companies to look beyond the methods used in the past.  Private investment in public equity (PIPE) transactions or fully underwritten offerings can be expensive and time consuming in the best of times. 

Because shares placed in a PIPE transaction are not registered, a resale registration statement must be filed with the SEC and declared effective for the shares to be freely tradable in open market transactions.  Investors in PIPE transactions typically request a heavy discount to the issuer's current share price and possibly warrant coverage to compensate for the risks related to this illiquidity.  Additionally, the terms of the PIPE transaction may include penalties or liquidated damages provisions in the event the issuer fails to obtain an effective registration statement within a prescribed timeframe. 

An underwritten or secondary offering of shares can be time consuming and expensive, given the need to file a registration statement and accompanying prospectus with the SEC and the associated legal and underwriting fees.  The shares cannot be priced or placed until the SEC declares the registration statement effective which, depending on the SEC review process and any related follow on comments that need to be addressed, can take time, a commodity that many smaller public companies cannot afford.

A registered direct offering provides an alternative to public companies seeking capital and provides a number of benefits to the above alternatives; however, an RDO is not without its downsides.

What is a Registered Direct Offering? 

RDO's are not a financing cure-all and there are some disadvantages to RDO's over other methods of financing.

1.      Distribution -   Because an RDO is marketed to a select number of investors, shares are not as widely distributed as would typically be the case in a secondary offering.  As a consequence, the issuer's shareholder base is not necessarily broadened as a result of an RDO transaction.

2.      Exchange Rules -  If an RDO cannot be structured to meet an exchange's definition of a public offering, and the proposed transaction is greater than 20% of the issuer's outstanding capital stock, shareholder approval may be required, which would erode the advantages of timeliness and cost effectiveness of an RDO transaction.

3.      Form S-3 -  An issuer must be Form S-3 eligible to complete an RDO.  While Form S-3 eligibility requirements have been relaxed, not all issuers will qualify.  

4.      Best efforts basis -  A 'best efforts' basis means no firm commitment to the issuer regarding the number of shares to be sold.   If the market fails to materialize for the issuer's securities, the placement agent has no obligation to purchase any shares.

How do I start the process?   

If an issuer does not already have an effective shelf registration statement on file, the first step in the process is to determine, together with legal counsel, the issuer's Form S-3 eligibility.  The next step is to assess any exchange rules that might apply regarding the determination of whether a proposed RDO is a 'public offering.'  If the issuer is eligible for an RDO transaction, identification of the appropriate placement agent is the next critical hurdle.  For a successful RDO, the placement agent should have longstanding relationships with a number of institutional.

The Bottom Line  

RDO's are quicker to close than either a PIPE transaction or a secondary offering, which allows the issuer to quickly take advantage of favorable capital market conditions.  The securities offered in an RDO are priced similar to a secondary offering, but without the related hurdles, and an RDO transaction can be marketed confidentially, which will reduce selling pressure on the issuer's stock prior to completion of the transaction.  Additionally, RDO transactions are typically cheaper to complete, in terms of discount, fees and related warrant coverage. 

With the loosening of Form S-3 eligibility requirements in 2008, RDOs are an effective alternative for smaller public companies to raise capital in today's capital market environment.

David Grossman

Written by David Grossman

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