The last post showed that among public companies that seek external financing under Regulation D, Nevada appears to have overtaken Delaware as the top state of incorporation. This statistic is a little bit misleading, however, as we see in this post.
The definition of a "public" company for securities purposes is often tied to whether the company is required to file reports under Section 12 of the Securities Exchange Act of 1934. By this definiton, Nevada is clearly an important player in the incorporation market, with about the same share as Delaware in recent years. But many of the “public” corporations that one finds in Nevada are not what one might expect—companies with substantial assets and traded on a major exchange and therefore required to be report under Section 12. In fact, it appears that many of them in fact have no significant operations at all, and their primary purpose for existing is to file reports under Section 12.
To examine this seemingly odd claim, I collected data on whether companies in the data set fall into several categories that are subject to special treatment by the SEC. Specifically, I searched the 10-K (or 10-Q if no 10-K was filed) of each company for the following terms: (1) “reverse merger”, (2) “penny stock company”, (3) “shell company”, (4) “development-stage company”, and (5) “blank-check company.” Each of these terms is used by SEC regulations to denote a set of companies that are singled out for special scrutiny because of the potential for abuse. Note that none of these categories indicates that a company is violating the law, merely that the company has limited operations and assets and is susceptible to being a vehicle for securities fraud.
The Table below sets forth the percentages for various states of each category for Nevada and Delaware. More data is available in the paper that accompanies this analysis.
State of Incorporation |
Percentage of Public Companies in Each State That Are: |
||||
Reverse Merger Companies |
Penny Stock Companies |
Shell Companies |
Development Stage Companies |
Blank Check Companies |
|
Delaware |
16.6% |
30.5% |
8.0% |
18.6% |
3.3% |
Nevada |
28.4% |
64.4% |
15.2% |
43.6% |
2.0% |
The table shows that Nevada has about twice as many companies in each of these categories, except “blank-check companies” where it is second to Delaware. Indeed, most of Nevada’s public reporting companies (64%) are penny stock companies, which generally refers to companies not traded on an exchange with a share price of less than $5. These statistics would not be encouraging for a substantial operating company considering reincorporating in Nevada.
Because many of the categories above are overlapping, perhaps more telling is the percentage of “normal” public companies in each state. By “normal” companies, I mean those that are not in any of the five categories above. Turning the analysis above areound, the next table gives the percentage of normal public companies together with the percentage of public companies in the top 10,000 public companies according to the SEC.
State of Incorporation |
Percent of Public Companies That Are Normal |
Percent of Public Companies That Are in Largest 10,000 |
Delaware |
55.8% |
58.4% |
Nevada |
14.3% |
14.5% |
The information in the table is striking. Only about 14% of Nevada's public corporations are normal public corporations, where in Delaware the majority are. It is also clear that normal public companies are in the top 10,000, and being a non-normal companies are not in the top 10,000.
Why are these companies public reporting companies when they are so insignificant? In many cases the whole purpose of the companies is merely to be public so that they can serve as a "back door" IPO vehicle for another company. The real question is why has Nevada attracted so many companies in these categories? I will leave this to future posts and the comments.