Fall 2022 Final Test on Getting a Listing Using Shell Companies- Finance, University of South Florida
Here is the final finance test completed in fall 2022 at the University of South Florida. The test included questions on getting listings using shell companies and we have provided some solutions to help you revise on the topic. By following this blog, you will find answers to help you do your finance exams excellently in future. You can also contact us with your test requirements and we will take your test on getting listings using shell companies for you.Exam Question:
Discuss how a company can obtain a listing using shell companies?
Exam Solution: The process of obtaining a listing through a full-scale flotation or initial public offering is subject to the moods of the market and the uncertainty of success up to the moment of announcement and underwriting. Alternative methods of achieving a listing that avoids some of the uncertainties are therefore worth considering.
A listing may be obtained by means of gaining control of an already listed company, usually small and inactive. Control is secured either by the purchase of a major block of existing shares or by an agreement for the issue of substantial numbers of new shares. A majority of representatives of the new shareholders are appointed to the board. The assets or business for which the listing is desired are then sold into the company for cash or shares.
This procedure is sometimes referred to as a 'reverse' takeover or a 'back-door listing. The company used is referred to as a 'shell' company. Depending on circumstances, the stock exchange in question may require a suspension of trading in the shares until full details of the reorganization proposed have been published.
What is the procedure of gaining a listing through shell companies?
Exam Solution: The steps to follow when gaining a listing through shell companies are:
- General offer
- Assets to be injected
- Marketing of shares
Control of a public company is defined differently in different markets. If control of a company is obtained, or if a substantial block of shares is purchased and a subsequent issue of shares gives one party a controlling position, a general offer may be required to be made to the remaining shareholders. The offer, if required, will be in cash or with a cash alternative at the highest price paid for the shares. The offer documentation is likely to emphasize information on the new controlling shareholder and his intentions for the future direction of the company.
On the face of it, the offer may be attractive to minority shareholders. They may be influenced by the decision of the major shareholder to sell and follow his example. In the past, they may have been locked in by a lack of trading and wish to take the opportunity to dispose of their investment. To obtain control of the shell company, the purchaser is likely to have paid a premium over net assets. The offer price will therefore be at a premium to the net asset value.
The new shareholder must guard against possible delisting (and therefore total frustration with his plans) if the offer is overwhelmingly accepted. Careful attention to the assets to be injected and to marketing plans for the shares is therefore needed.
The existing controlling shareholder of a shell company may agree not to sell any of his shares and allow control to pass by way of injection of assets for the issue of new shares. In this case, the requirement for a general offer (if any) may be waived by the relevant authorities provided that the issue of new shares has been approved by the shareholders of the shell company in a general meeting. Any shareholders with a conflict of interest must not vote.
The assets to be injected should be identified by the new controlling shareholder before he acquires control of a shell. The practice of acquiring a shell and then thinking of what to put in it frequently has unfortunate results.
The suitability of the assets or business to be injected should be assessed against the desired position of the company after it has made the acquisitions. The factors to be considered include asset backing, earnings, and dividend-paying ability. The fundamentals of the enlarged group should be attractive to the investing public. An accountant's report will be required on any active businesses being injected and an independent professional valuation will be needed of any major assets.
If assets are purchased from the new controlling shareholders by the company at around this time, particularly for cash, care must be taken not to infringe regulations preventing the company from assisting in the purchase of its shares. Ideally, the party taking control should be able to demonstrate that they could finance the acquisition without any subsequent transaction with the company.
Purchasing control of a shell company achieves a listing but does nothing of itself to improve marketability or raise funds. Improvements in marketability and fund-raising must be undertaken as a separate exercise by the new controlling shareholders. The methods used are as follows:
Placing through brokers. The new controlling shareholders may seek to develop their links with the broking community. They may provide background information for circulars on the new group and its prospects. It is in a broker's interest to circulate clients if the circular provoke sufficient market interest to generate commission on purchases and sales of the shares. Sometimes the new controlling shareholders will undertake to make lines of shares available to the market to ensure that the interest aroused can be satisfied in reasonable size without an immediate price rise and tightening of the market.
Rights issue. After obtaining control, a rights issue may be announced on relatively attractive terms. To facilitate a broadening of the shareholder base, the new controlling shareholder may elect not to take up some or all of his rights. Shares will be available for placing in the market or for other shareholders through excess application forms (if permitted by stock exchange rules) or they may be taken up by underwriting institutions. If the company's plans are favorably received by the market, new shareholders can be expected to buy to be eligible for the rights issue.
Further acquisitions. The shareholding base may be widened by the acquisition of further assets or companies from third parties for new shares. If the vendors do not wish to retain the shares it may be possible to arrange a vendor placing through a merchant bank or stockbroker.
In general, terms, whether these measures will succeed will be heavily dependent on the quality of assets injected into the shell company and the reputation of the new shareholders.
Discuss the various advantages of using a shell company to gain a listing.
The advantages of using a shell company are as follows:
- Size/type of assets to be injected
- Control of circumstances
It has, on occasion, proved possible to obtain listings via a shell company for assets or businesses which would not meet all the criteria for a full-scale flotation or which might not for the moment prove attractive to investors. For example, a business that has only been in existence for a relatively short time might not have a sufficient track record to form the basis of a standard flotation. A property development might take some years to come to fruition and until it did there would be no prospects of dividends. A special situation might be too speculative for investors in general.
There would appear to be some inconsistency in this experience. The attitude of the regulatory authorities in different jurisdictions varies and, within markets, has changed from time to time and case to case. One view might be that anything done to improve the prospects of dormant listed companies is good and should be encouraged. If the company remains inactive and is eventually delisted, the public shareholders will be penalized. A contrary view holds that such benefits are outweighed by the potential dangers of allowing a listing for businesses that might not otherwise be able to achieve this status. If a business is not suitable for listing on its own, what is the logic for allowing it to be listed via a shell? This view holds that the acid test should be what is acceptable to underwriters and the market when their own money and reputation are at stake.
The procedure for a full-scale flotation is relatively rigid and lengthy. Because of rules calling for audited accounts not more than a certain number of months old (often six months) and documentary and regulatory requirements, there may only be a limited number of months in a year when it is practicable for a company to go public. If a company is not able to obtain a place in the queue from the stock exchange during these months, plans for a flotation may have to be postponed.
A bunching of issues is likely as a consensus emerges on favorable conditions and timing. An issue can easily be crowded out. Market conditions that are beyond the control of the company may delay the launch. Complications in the legal or accounting work may also force a delay. Once a delay has occurred it may be several months before the procedure can be completed or even restarted. If the mood breaks, the new issue market can be virtually closed and the chance lost.
With a shell company, the timetable and feasibility are much less subject to the requirements of third parties. Once control of the shell has been obtained, the question of injection of assets can usually be decided without significant permissions needed from outside authorities although the proposals will normally be put to a vote of independent shareholders. The timetable is also more flexible. There is no deadline for accounts. No flotation price has to be set and sometimes no funds are raised. There is no highly publicized under or over-subscription. The market will react to the proposals after they are announced and the price will adjust to them.
Although the procedures for a shell company operation take several months to complete, the impact on the market is felt as soon as a full announcement of the terms of the proposals can be made, providing no suspension of trading is necessary.
Practice varies in different markets as to the length of time it may be necessary (if at all) to suspend trading in the shares of a shell company at the time proposals are announced. However, provided that the intentions of the parties can be clearly and fully stated at the outset, any suspension in the trading of the shares may be a brief one. The effect is therefore that the shares of the shell company are likely to be re-rated in the market almost immediately, on the basis that the transaction will proceed.
Although the transaction may not in fact be completed for a number of months, the controlling shareholders already have a vehicle that reflects what is intended. This is not the case with a full-scale flotation where trading in the shares cannot begin until the end of the whole operation. The months of planning before trading begins can be a frustrating experience and opportunities may be missed in the interim.
Depending on the circumstances, it may be possible to achieve a listing at a lower cost by using a shell company. However, although many of the costs associated with the production of a full-scale prospectus will be avoided or reduced, a premium over the net asset value will normally be required by the shareholders relinquishing control, reflecting among other factors the convenience of a shell company and the amounts of costs saved. A premium at the upper end of the market range is likely to render a shell company operation more expensive than a flotation.
Explain some of the disadvantages of obtaining a listing using a shell company
The main disadvantages are likely to be:
- Difficulty in obtaining control of a suitable shell
- History of the company
- No funds are raised
- Lack of marketability
Negotiating for control of a shell company can tax the patience of the most persistent suitor. Although there may be existing major shareholders with whom negotiations can be conducted, they are often unable or unwilling to make final decisions on the sale of a controlling stake. The fact that someone wishes to buy their dormant company may be the very factor that convinces them to keep it.
The reason that a shell company has become a shell may be traced to something that has gone badly wrong in the past. Large losses may have been incurred, the aftermath of which may include lawsuits, receivership, or other events which serve to taint the name of the company. As accounts may have not always been efficiently kept, there is the danger of unrecorded or undisclosed liabilities and other claims and contingencies. These are all the more likely to surface once it is realized that a new party has made a financial commitment to the company or injected new assets or capital, which it will wish to preserve.
A purchaser may to some extent be able to protect himself through the terms of a sale-and-purchase contract if one is signed. The vendors are likely to argue that, as the company is public, the basis of the transaction is the same as any market purchase of listed shares and resist further documentation, particularly giving warranties. Although this argument has some theoretical merit, a shell company is by definition a 'failed' public company and retains some of the characteristics of a private company, despite its listing. Its major shareholders will certainly know more about its affairs than the average shareholder of a public company. Some additional documentation including limited warranties is a fair compromise.
An important result of a flotation, once it is underwritten, is the guarantee of funds to the company or its existing shareholders. No funds are raised through the simple purchase of a shell company or by the injection of assets. The raising of new equity must be tackled separately.
A full-scale prospectus achieves a very high degree of visibility and if successful, a large shareholding base for the newly floated group. A shell company is not likely to have many shareholders (perhaps a few hundred) and almost no marketability. If a general offer is required to all shareholders after the acquisition of control, the position may be worsened in the first instance owing to acceptance of the offer. Any improvement of marketability and widening of shareholding which is required by the authorities or desired by the new controlling shareholders must be undertaken as a separate exercise. This can prove a difficult and tedious process.
Explain the important characteristics to consider when identifying a suitable shell company.
Exam Solution: A suitable shell company will have the following characteristics:
The company is being sought for its listing and not for its existing business or assets. It should ideally have a low level of issued share capital and assets. If the company has a large authorized share capital, this may save capital duty at a later stage (depending on local taxation rules) when further issues of shares are made.
An investigation will be simplified if the company has no or few subsidiaries. The assets of the group should be as straightforward as possible, for example, holdings of cash, marketable securities, or investment properties. If the company or any of its subsidiaries operate active businesses, it may be preferable for them to be sold out of the group to the previous controlling shareholders as part of the transaction. The shareholders will be able to fund these purchases from the cash they receive from the sale of their shares.
There should be one existing controlling shareholder who can be approached as regards a possible transaction and who can give a commitment before any public announcement is needed. It is also an advantage if this controlling shareholder is a substantial party whose integrity can be relied upon and from whom, subject to negotiation, worthwhile warranties about the financial position of the shell company can be obtained.