Goldwyn Capital
You took your company public by merging it into a public shell, and most of what you own is now its stock. When you asked what a lender would advance against the position, the first question back was whether your shares are free trading.
For founders who went public this way, the answer is often “not yet.” The reason is one paragraph of the SEC’s Rule 144, written for companies that were once shells.
Restricted and control securities
The SEC describes restricted securities as those “acquired in unregistered, private sales from the issuing company or from an affiliate of the issuer.” They usually carry a legend saying they may not be resold in the marketplace unless they are registered with the SEC or exempt from registration.
Control securities are shares held by an affiliate: a person in a relationship of control with the company, such as an executive officer, a director or a large shareholder. Their certificates usually have no legend, but an affiliate selling under Rule 144 still has to meet the rule’s conditions.
A reverse merger tends to produce both. In the SEC’s description, the private company’s shareholders typically swap their shares for a large majority of the shell’s shares, and the private company’s management takes over the shell’s board. Unlike an IPO, the deal carries no Securities Act registration requirement. If your shares were issued in a private, unregistered transaction, they are restricted. If you run the company or sit on its board, expect to be treated as an affiliate too.
Rule 144(i): the shell company rule
Rule 144 is the SEC’s safe harbor for reselling restricted and control securities. When a company has been subject to SEC reporting for at least 90 days, restricted shares can normally be resold under it after six months, subject to the rule’s other conditions.
Paragraph (i) makes Rule 144 unavailable for securities “initially issued” by a shell, or by an issuer that “has been at any time previously” a shell. In the rule’s terms, a shell has no or nominal operations, and assets that are nominal, cash, or cash plus nominal other assets. (There is a narrow carve-out for a “business combination related shell company,” which your counsel can check.)
Because your company was a shell before the merger, this covers the shares it issued afterward. SEC staff guidance says the safe harbor stays closed for them until every condition in paragraph (i)(2) is met at the time of the sale:
- the company has ceased to be a shell;
- it is subject to SEC reporting under section 13 or 15(d) of the Exchange Act;
- it has filed all reports and other materials required in the preceding 12 months, other than Form 8-K reports;
- it has filed current “Form 10 information” showing it is no longer a shell, and one year has passed since that filing.
Form 10 information is what a company would provide to register its shares under the Exchange Act. It can sit in any SEC filing, and Form 8-K requires a company that stops being a shell to file one containing it or naming the filing that does. Start with the 8-K that reported your merger.
Because the test applies at each sale, the filing record keeps mattering after the year is up: a missed 10-K or 10-Q can close the safe harbor again.
Paragraph (i) took effect on February 15, 2008. The SEC called the one-year wait “necessary for investor protection,” citing comments about abuse and microcap fraud involving shell company securities, and its staff has said the paragraph also covers securities issued before that date.
Even when the conditions are met, the legend has to come off before restricted shares can be sold publicly. Only a transfer agent can remove it, and the SEC says the agent will want the company’s consent, usually an opinion letter from the company’s counsel.
Registering the shares for resale
Outside Rule 144, the route that matters here is registration. The company files a registration statement covering resales by shareholders. SEC rules require it to name each selling shareholder, describe any position or relationship with the company in the past three years, and state how many shares each owns and is offering.
The shell company paragraph governs Rule 144 only, so it does not decide this route. Registration is the company’s filing, though, so it needs the company’s cooperation. If you are still an officer or director, it is the route that matters for a loan.
What the lender needs to see
The lender Goldwyn Capital works with, an independent US family office making non-recourse stock loans since 2006, accepts shares that are free trading, eligible for resale under Rule 144, or registered. Officers and directors need their shares registered for resale. Section 16 filers should expect to report the loan on Form 4 (confirm this with your company’s counsel), and some insider trading policies restrict pledging.
The stock typically needs to trade around 100,000 shares a day or more; under about 10,000 a day usually doesn’t qualify. The lender can take up to 4.99% of a company’s outstanding shares, which limits how much of a large founder stake it can accept.
What to gather before you ask
| What to gather | Where to find it |
|---|---|
| How you hold the shares, and in whose name | Certificate, transfer agent or brokerage statement, trust or holding company papers |
| Whether they carry a restrictive legend | The certificate, or the company’s transfer agent |
| Your role at the company | Officer, director or large holder, confirmed with counsel |
| Any resale registration covering your shares | The company’s registration statements on EDGAR |
| When Form 10 information was filed | The 8-K that reported the merger |
| Whether the company is current | Its 10-K and 10-Q filings for the past 12 months |
Your securities counsel confirms whether your shares are eligible. Goldwyn Capital does not give legal advice.
How the non-recourse loan works
Loans run from $50,000 to $5,000,000, depending on the size of the position, and pay 30 to 50% of the shares’ market value, more for heavily traded stocks. Interest is 5 to 7% a year, simple, fixed for the term and paid quarterly, with any fees listed on the term sheet. The term is three years; you can repay from month 24, with a penalty before that.
Your shares move to the lender’s custody account for the life of the loan and are returned when you repay. If the stock has risen by then, you benefit on the terms written into your term sheet. The loan is non-recourse: no credit check, no personal guarantee, and the shares are the only thing securing it.
Say your company has 40,000,000 shares outstanding at $2.00, trading well above 100,000 shares a day, and you hold 12,000,000 registered shares. The lender can take up to 4.99% of the outstanding shares, about 1,996,000 shares worth roughly $4,000,000, so you could receive about $1,200,000 to $2,000,000. On $1,600,000, simple interest at 5 to 7% is $80,000 to $112,000 a year.
If the stock fell 25% below the level the loan closed at, to $1.50, you would get 5 to 10 business days to top up with cash, stock or other securities. If you chose not to, the loan would close: you keep the cash, the lender keeps the shares, and you owe nothing further.
Depending on how the loan is structured and where you live, transferring shares to a lender can be a reportable tax event, so talk to a tax adviser before signing. Indicative terms come back within one business day of a request, and loans fund in 7 to 10 business days.
