The stock market has been on a tear, to say the least. In the last six months, the Dow Jones Industrial Average is up about thirteen percent. More to the point, the ABA NASDAQ Community Bank Index is up over twenty-seven percent during that same period. Numbers like that are eye-catching.

To be ready for any opportunities the capital markets may provide your bank or bank holding company, we recommend re-visiting a few basic questions to which directors and senior management should know the answers when thinking about capital needs and opportunities.

What is your authorized capital structure?

With respect to equity capital, a Virginia bank is only permitted to issue the types and number of shares authorized in its articles of incorporation. All Virginia banks will be authorized to issue "standard" voting common stock. If expressly provided for in its articles, a bank may also be able to issue non-voting common stock or preferred stock. If the articles authorize preferred stock, specific series with particular preferences, rights and limitations may be designated or the articles may provide for "blank check" preferred stock, which is discussed below.

Virginia law does not require articles of incorporation to address the issuance of debt securities, and articles are generally silent on the point.

Can you issue "blank check" preferred stock?

Blank check preferred stock refers to authorized shares of preferred stock from which a board of directors has been granted authority to create, without further shareholder approval, different series of preferred stock with such voting rights, preferences, limitations and other terms and conditions that the board may determine. Blank check preferred stock can provide a company greater flexibility in raising capital because it permits a company to tailor the terms of an equity security for a specific market opportunity. This flexibility is of particular value to bank holding companies and banks because it permits the voting rights, conversion rights and other terms of an equity security to be crafted in order to avoid regulatory hurdles related to, among other things, a shareholder being deemed to have "control" of the bank holding company or bank.

Do your articles of incorporation grant preemptive rights to existing shareholders?

Preemptive rights protect a company's existing shareholders against dilution of their holdings by giving those shareholders the first chance to purchase shares in any future stock issuances. Preemptive rights can significantly complicate and delay stock offerings. For this reason, it is extremely rare for publicly traded companies to have preemptive rights, although it is more common with privately held companies.

Somewhat confusingly, Virginia law governing preemptive rights varies depending on when a company was incorporated. For companies incorporated before January 1, 2006, shareholders will have preemptive rights unless the articles of incorporation expressly deny such rights. For companies incorporated on or after January 1, 2006, shareholders will not have preemptive rights unless the articles of incorporation expressly grant such rights.

Are you subject to contractual provisions of relevance?

In addition to your articles of incorporation, contracts may contain provisions of relevance to future securities offerings. For example, existing securities purchase agreements, shareholder agreements and similar contracts may contain provisions granting rights of first refusal, "piggyback" registration rights, "most favored nation" status and similar rights. A right of first refusal requires a company to offer securities to a particular party before offering the securities to third parties. "Piggyback" registration rights require a company that is filing a securities registration statement with the SEC to also register securities owned by the holder of the rights. A "most favored nation" provision entitles a first party to at least as favorable terms as a second party in circumstances specified in the provision (e.g., granting board observer rights to a first investor if those rights are given to a second investor).

Financing documents, like credit facilities, can also contain provisions relevant to future capital raising activity, such as negative covenants against the incurrence of future indebtedness and the like.

The existence of contractual provisions like those discussed above generally will not preclude a capital raise, but do need to be identified and addressed in both the planning and execution phases of a capital raise.

If a public reporting company, are you eligible to use a Form S-3 registration statement for capital raises?

Eligibility to use a Form S-3 registration statement to register securities with the Securities and Exchange Commission permits public reporting companies to access the capital markets more quickly and with lower initial and ongoing transactions costs. Unlike the much longer default Form S-1 registration statement, Form S-3 is a "short form" registration statement that permits an eligible company to provide the majority of disclosure by incorporating the required information by reference to periodic and current reports previously filed with the SEC. This significantly reduces the time and cost involved in preparing the registration statement.

To be eligible to use Form S-3, a company must meet all of the following requirements:

  • be a U.S. corporation,
  • have been a public reporting company registered under the Securities Exchange Act of 1934 for the past 12 months,
  • have timely filed all Exchange Act reports required to be filed during the past 12 months,
  • not have failed to pay any dividend or sinking fund installment on preferred stock since the end of the most recent fiscal year (including any deferral of a dividend permitted by the terms of the stock),
  • not have defaulted on any material debt or long-term lease since the end of the most recent fiscal year and
  • be in compliance with SEC rules regarding posting of interactive data files on a corporate website.

If at the time of sale of the securities a Form S-3 eligible company has a public float of $75 million or more, the company may use Form S-3 for any offering of debt or equity for cash. If the company has a public float of less than $75 million, the use of Form S-3 is more constrained, including a restriction on selling securities valued at more than one-third of its public float in any rolling twelve-month period.

If eligible to use Form S-3, should you file a "shelf registration statement"?

We generally recommend that issuers eligible to use Form S-3 file a shelf registration statement, as a shelf registration statement provides a tremendous amount of flexibility for future capital raises.

A shelf registration statement permits an issuer to complete the registration process with the SEC and, metaphorically, have pre-registered securities "on the shelf," ready for quick issuance when need or opportunity arises. A company can shelf register a single type of securities or several different types of securities on a single Form S-3. Any of these securities may be sold in a single offering or multiple offerings based on the single registration statement until the registration statement expires after three years.

Having a shelf registration on file offers the following advantages:

  • Quick access to the capital markets: The original shelf registration statement is subject to SEC review and must be declared effective by the SEC. Once the shelf registration statement is declared effective by the SEC, however, the securities can be issued and sold quickly without delay or undergoing further SEC review. This allows for the filing of a preliminary prospectus supplement, marketing and pricing of an offering on a single day if the company desires. Having "pre-registered" securities with the SEC eliminates the uncertainty of a potentially lengthy delay of an SEC review and ensures a company that it can act quickly in response to market opportunity.
  • Flexibility: In addition to the flexibility as to the timing of accessing the capital markets, a shelf registration statement provides flexibility as to the amount and variety of securities, distribution methods and pricing models. A variety of securities may be registered and issued under a single registration statement and then sold in multiple offerings. Offerings can be underwritten, made direct to purchasers in negotiated sales or conducted as competitively bid transactions or through agents or dealers.
  • Simplified disclosure: A shelf registration statement is usually filed with only a minimal base prospectus, which incorporates most relevant information from the company's historic SEC filings. The information actually included in the shelf registration statement itself is usually limited to the types of securities registered, a brief description of the company, risk factors, a ratio of earnings to fixed charges (if debt securities or preferred stock is registered) and a very broad and open-ended use of proceeds section and plan of distribution.
  • Continuous updates not required: As discussed above, at the time of initial filing, a company may satisfy most Form S-3 disclosure requirements by reference to that information in reports previously filed with the SEC. After initial effectiveness of the shelf registration statement, all reports subsequently filed by the company with the SEC are also automatically deemed to be incorporated by reference into the shelf registration statement. The company does not need to update the registration statement before securities can be offered "off the shelf."

To be sure, there are more questions that would need to be asked and answered in connection with executing a successful capital raise. Knowing the answers to these basic questions, though, will immediately help you better understand what options are available to your bank and how you can take advantage of opportunity when the market presents it.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.