Rule Change to Help Smaller Companies Raise Funds
Published: January 30, 2008

Federal regulators are about to ease rules that have made it difficult for small and medium-size publicly traded companies to raise money. The changes, experts say, are well timed, given the tightening of the credit markets.

The revisions in the Securities and Exchange Commission’s Rule 144, which governs the sale of so-called restricted securities, affect companies with annual revenues of less than $700 million. The rules take effect on Feb. 15.

Restricted securities are shares or bonds sold in private placements, usually at a discount around 10 percent from the market price; the securities cannot be registered immediately with the S.E.C. Under current rules, investors must wait one year before selling them, and then usually only in stages of a specified number per quarter for the year after that.

Under the changes approved by the commission on Nov. 15, and retroactive to past transactions, the investors must wait only six months to sell the securities, and can part with them all at once.

“The changes will likely make private placements by smaller publicly traded companies much more attractive to investors,” said David Danovitch, a partner at the Manhattan law firm of Gersten Savage who specializes in securities laws. “When the credit markets tighten, people run to the equity markets, and now it should be easier for companies that are starved for cash to tap into them.”

Two years ago, Mr. Danovitch said, the S.E.C. relaxed the rules governing registration statements filed by publicly traded companies with a market capitalization of $700 million or more to give them better access to the capital markets. Now, he said, it is extending the benefits to smaller companies.

Investors will also gain a greater degree of liquidity and thus a better chance of making a good profit.

“Smaller businesses are a critical part of our nation’s economy,” the chairman of the S.E.C., Christopher Cox, said in November in announcing the unanimous vote to make the amendments. He added that the new rules would “make it more efficient for companies of all sizes to access the private markets.”

One entrepreneur who is delighted with the changes is David Warwick, chief executive of the Aftersoft Group, a $28 million maker of software for car repair shops, car parts distributors, tire makers and other car-related businesses.

Aftersoft originated in Britain but entered the American market in the early 1990s and is now seeking to expand. It is No. 1 in Britain, with 68 percent of the automotive software aftermarket, as it is called, and is hoping to achieve the same status in the United States within two years. It now holds a 12 percent share.

Mr. Warwick said his company’s software could be used in other industries as well. “We could expand to the lumber industry, the plumbing industry — the possibilities are endless,” he said. “We have a very aggressive growth plan.”

To achieve his ambitions, though, Mr. Warwick, 48, needs to raise money.

“We spent the better part of last year raising funds,” he said. “It would have been a much quicker and more efficient process if the new rules had been in effect.”

He said he expected to go back into the market late next year. Before doing a private placement, he says, he wants to get Aftersoft’s stock price up from about 30 cents a share today to $2. If he succeeds in increasing the stock price, he will seek to raise equity to do a spate of acquisitions, perhaps shooting for as much as $100 million if he decides to make a takeover bid for his major competitor, a company called Activant Solutions Inc.

The global effect of the looser S.E.C. standards is anybody’s guess at this early stage. Brian Overstreet, president of Sagient Research Systems in San Diego, said its PlacementTracker service found that the number of deals involving private investment in public equity stabilized last year at 1,378, compared with 1,343 in 2006. The funds raised, however, surged to $81.5 billion from $28.3 billion. He attributed about $40 billion of the increase to a frenzy of transactions by big investment banks in the last four months of 2007, aimed at resolving their subprime woes. Even taking that factor out the equation, though, he said, an increase to $41 billion from $28 billion was significant.

He cautioned, however, that most of those deals were made under different and more investor-friendly terms than those of Rule 144, and thus were not a barometer of future 144 activity. Still, he said, the changes approved by the S.E.C. were bound to prompt more small companies to turn to the rule.

People are just starting to price deals under the new regulations, according to Mr. Danovitch of Gersten Savage. And while the change will make it easier for small-capitalization companies to gain access to the capital markets, and do so on more favorable terms, it is not clear yet how much more money will flow to them.

“I’d say the companies that will benefit the most from the changes are those with a market cap of less than $100 million,” Mr. Danovitch said.