Navigating a Tough Market: Insights and Strategies for Emerging Public Companies Raising Capital and Avoiding Delisting
After a market flush with cash and deal flow from 2020 through the first half of 2022, in the last six to twelve months the markets have been particularly tight. Particularly impacted in this turbulent market have been small and micro-cap public companies, which often bear the brunt of the volatility and price depreciation more acutely than other market participants.
These companies often are newly public (whether via traditional IPO or via SPAC merger), emerging growth companies in need of ongoing operating capital to sustain their operations. They are typically not cash flow positive and, in the case of emerging biotech and life sciences companies, may be entirely dependent on outside capital to sustain their cash burn if they are pre-revenue.
The result of this influx of small, newly public issuers presents a few unique problems.
One of the most immediate concerns a small public company faces in response to a declining stock price is whether such price decline puts it in jeopardy of being delisted from a national exchange. Both NYSE and Nasdaq require a $1.00 minimum trading price for continued listing. See Section 802.01C of the NYSE Listed Company Manual and Nasdaq Rule 5550(a)(2) (for Nasdaq Capital Market).
Using Nasdaq rules as an example, if a company’s bid price falls below that $1.00 threshold for 30 consecutive business days, the exchange will issue a deficiency notice. That will need to be disclosed under Item 3.01 of Form 8-K, which states that said company has 180 calendar days to cure the deficiency. To regain compliance, the closing bid price of the company’s stock must meet or exceed $1.00 per share for at least ten consecutive business days during this 180 calendar-day period. In the event the company does not regain compliance by such date, the company may be eligible for an additional 180 calendar-day grace period if it meets the other continued listing requirements of its exchange and provides written notice to Nasdaq of its intention to cure the deficiency during the second compliance period by effecting a reverse stock split, if necessary.
Generally, this means either (i) a company organically regains compliance by trading back above $1.00 or, more likely, (ii) they must implement a reverse stock split to regain minimum price compliance.
Under Delaware law, a reverse stock split requires approval of a majority of the outstanding shares and the company’s board of directors and would require the company to hold a stockholder meeting. That can take a few months.
Nevada public companies may be able to fast-track this process in reliance on Nevada Revised Statutes (NRS) Section 78.207, which provides that a board of directors may effect a reverse split without stockholder approval if (i) both the number of authorized shares of the common stock and the number of issued and outstanding shares of the common stock are proportionally reduced as a result of the reverse split; (ii) the reverse split does not adversely affect any other class of stock of the company; and, (iii) the company does not pay money or issue scrip to stockholders who would otherwise be entitled to receive a fractional share as a result of the reverse split.
In any event, the board of directors will need to approve a stock split ratio. A board may be tempted to split the stock too much to make absolutely sure the stock price stays well above $1.00. However, in our experience, splitting the stock too much, which correspondingly reduces the number of shares in the public float, could actually increase volatility in the stock price.
We suggest a balance between splitting the stock too much and too little (which could risk a repeat delisting concern if the stock price depreciates following announcement of the reverse split). We also advise issuers that are close to the minimum bid price to plan ahead and understand their corporate governing documents, internal policies and their compliance with continued exchange listing requirements so that a plan can be implemented in the event a deficiency notice is issued.
Lastly, it is also important for issuers to monitor compliance with other continued listing requirements. For example, for Nasdaq Capital Market issuers that comply with the Equity Standard, they must continue to meet stockholders’ equity of at least $2.5 million. Rapid stock price depreciation, reverse stock splits and dwindling cash reserves all could impact a company’s stockholders’ equity calculation which may present separate grounds for delisting.
Raising Capital in a Volatile Public Market
Whether or not a small public company is navigating delisting issues, certain SEC restrictions on smaller public companies’ ability to raise capital could hinder capital raising efforts in a down market.
First, a company’s stock exchange may limit the amount of securities it can issue in an equity financing. Nasdaq Rule 5635(d) requires stockholder approval for any transaction that may result in the issuance or sale of 20% or more of a listed company’s outstanding common stock or voting power (the “20% Rule”) at a price that is less than the “Minimum Price.” Minimum Price is defined as the lower of:
- The Nasdaq Official Closing Price as reflected on Nasdaq.com immediately preceding the signing of the binding agreement.
- The average Nasdaq Official Closing Price of the common stock as reflected on Nasdaq.com for the five trading days immediately preceding the signing of the binding agreement.
The NYSE has a similar requirement. See Section 312.03 of the NYSE Listed Company Manual.
Stockholder approval for issuances of 20% or more of a company’s common stock or voting power required by Nasdaq Rule 5635 is not required for “public offerings” but would limit certain private investment into public entity (PIPE) transactions unless they were at or above the Minimum Price.
Second, a company needs to determine whether it is subject to the so-called “baby shelf” rules implemented by the SEC. Instruction I.B.6. to Form S-3 limits the use of a company’s shelf registration statement to no more than one-third of the aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant (also known as the non-affiliate public float) during the period of 12 calendar months immediately prior to, and including, the sale if such company’s non-affiliate public float is $75 million or less (the “Baby Shelf Rule”).
As such, a small public company that is facing rapid depreciation in its stock price may fall below the $75 million non-affiliate public float which limits the amount and speed in which that company can raise capital. And, in our experience, public companies that routinely traded at market caps well above $75 million are unfamiliar with the additional restrictions presented by the 20% Rule and the Baby Shelf Rule.
In certain extreme situations, a company facing delisting concerns due to a stock price below $1.00 or failure to comply with minimum stockholder equity requirements has their situation compounded by their limited methods to raise capital via a PIPE (limited by the 20% Rule) or a registered direct shelf offering (one-third Baby Shelf Rule). Debt financings could also compound such stockholder equity issues in much the same manner. As such, those companies may be left only with a basic Form S-1 follow-on offering which has its own limitations as (i) it is subject to potential SEC review, (ii) requires a two business day period before pricing after filing a request for acceleration (see Rule 461 under the Securities Act of 1933, as amended), (iii) can be viewed negatively by the investing public due to potential dilution, and (iv) is more expensive to bring to market.
Small public companies face unique issues relative to the broader public company landscape. It serves company executives and board members well to think ahead and plan for the potential pitfalls of a downside scenario if at all possible. Consider increasing the detail and frequency of management and finance team cash flow updates to the board, right sizing the company and finding an investment banking partner that specializes in companies of your size and in your industry. Our Capital Markets and Securities attorneys are uniquely positioned to address the volatile nature of these issues as you navigate this difficult market.