By Greg Kramer, Rick Werner, and Jayun Koo
On July 5, 2019, the Securities and Exchange Commission approved certain changes to Nasdaq’s initial listing standards in an attempt to increase liquidity in shares of listed companies. While the new rules are unlikely to have a significant impact on most private companies that seek Nasdaq listings in connection with a traditional initial public offering, these new rules do have the potential to place substantial additional burdens on smaller companies seeking to list through reverse listings.
Brief Overview Of Reverse Listings
In the past 5 years, we have witnessed many companies focused on emerging technologies, such as life sciences companies, seek to go public through reverse listing transactions, given the lower cost and expedited timeline such transactions offer in comparison to an initial public offering. A reverse listing transaction also provides investors with an accelerated path to liquidity and exposes a private company to a new universe of investors.
In a reverse listing, also called a reverse merger, a private company is “acquired” by a Nasdaq listed company through either a merger, share exchange or other type of business combination. However, unlike in a traditional acquisition, at the close of a reverse listing transaction, the private company’s shareholders own the majority of the listed company’s outstanding stock, the private company’s board of directors replaces a majority of the listed company’s board of directors and the private company’s business becomes the primary business of the listed company. In addition, in many reverse mergers, shareholders of the private company are required to sign lock-up agreements with respect to the shares they receive of the Nasdaq listed company. Reverse listing companies often also undergo reverse stock splits in order to meet Nasdaq’s minimum bid price, which can reduce the number of shareholders below Nasdaq’s minimums prior to completion of the reverse listing transaction.
For a Nasdaq company to retain its listing following a reverse listing transaction, the combined entity must meet all of Nasdaq’s initial listing criteria. Specifically, under Section 5110(a) of the Nasdaq rules, “[a] Company must apply for initial listing in connection with a transaction whereby the Company combines with a non-Nasdaq entity, resulting in a change of control of the Company and potentially allowing the non-Nasdaq entity to obtain a Nasdaq Listing.” Accordingly, any modifications to Nasdaq’s initial listing standards can have a meaningful impact on companies considering reverse mergers.
Overview Of The New Nasdaq Listing Requirements
Although the changes to the listing criteria affect all tiers of the Nasdaq Stock Market, this article will primarily focus on the Nasdaq Capital Market (the “Nasdaq CM”). The Nasdaq CM is the market where private companies contemplating a reverse merger are most likely to seek a listing. Below is a summary of the most significant modifications:
- “Restricted securities” will be excluded from the calculations of a company’s publicly held shares, market value of publicly held shares and round lot holders. “Restricted securities” are defined as securities that are subject to resale restrictions for any reason, including, but not limited to, securities: (1) acquired directly or indirectly from the issuer or an affiliate of the issuer in unregistered offerings such as private placements or Regulation D offerings; (2) acquired through an employee stock benefit plan or as compensation for professional services; (3) acquired in reliance on Regulation S, which cannot be resold within the United States; (4) subject to a lockup agreement or a similar contractual restriction; or (5) considered “restricted securities” under Rule 144.
- The definition of “round lot holder” now refers to a holder of a normal unit of trading (generally, 100 shares) of “unrestricted securities.” “Unrestricted securities” means any securities that are not restricted securities.
- Now at least 50 percent of a company’s round lot holders must each hold unrestricted securities with a market value of at least $2,500.
As a result of these modifications, for a reverse merger company to qualify for listing on Nasdaq under the “Equity Standard” or the “Market Value of Listed Securities Standard” (the two most common standards of qualification for reverse merger companies), the market value of their unrestricted publicly held shares will need to equal $15 million, they will need at least 1 million unrestricted publicly held shares and at least 300 round lot shareholders.
A few key takeaways:
- Nasdaq’s new liquidity requirements, by excluding restricted securities from the calculations of a company’s publicly held shares, market value of publicly held shares and round lot holders, will likely result in parties to a reverse merger registering the stock issued to the private company shareholders on an S-4 registration statement to increase the number of unrestricted securities even though such a registration statement may not be required under the Securities Act of 1933, as amended. In our experience, an S-4 can be subject to a lengthier review by the SEC than a simple merger proxy, which can extend transaction timelines and increase costs.
- The ability to use lock-up agreements to limit selling by large shareholders following a reverse merger transaction, because the definition of restricted securities includes shares subject to lock-ups, may be unavailable or limited and the trading price of reverse merger companies following a transaction may be more volatile.
- In light of these facts, we believe that fewer private companies may choose to pursue reverse listing transactions unless the target Nasdaq companies have sufficient cash on hand to avoid the need to file an S-4 registration statement or the private company has sufficient resources to complete a lengthier transaction.
Greg Kramer practices in the areas of securities law, M&A and alternative lending and serves as co-chair of Haynes and Boone, LLP’s New York Capital Markets and Securities Practice Group.
Rick Werner is a partner, co-chair of the Capital Markets and Securities Practice Group, and a member of Haynes and Boone’s Board of Directors.
Jayun Koo is a Haynes and Boone associate in the Capital Markets and Securities Practice Group.