What is a shell company?
The term “shell company” is narrowly understood as a public limited company which has largely ceased its operative business but whose stock exchange listing still exists despite minimal sales turnover. In practice, these are usually former traditional companies of the Old Economy which have experienced an economic decline due to structural changes or severe management errors. The actual inventory which this comes from is structurally weak industries such as railway companies, breweries, mining companies or mechanical engineers. In addition to this are, of course, companies which came onto the stock-exchange at the peak of the New Economy in the late 1990s. In this case, it often became apparent very quickly that the business model was not sustainable and these companies either went into insolvency or were able to close down or sell all loss makers, and “survive” with the remaining assets.
The common factor for these companies, apart from the loss in operative sales revenues, is that, after a delivery versus payment (DvP) sale of the relatively easily payable asset items, only part of the remaining stock of hard-to-use basic assets remains, or other assets which are currently not sellable or only sellable with large depreciations. The stock exchange listing of the shell generally represents the deciding value for potential buyers. If the shell company is purchased, the company’s new owner can flexibly change the corporate purpose and incorporate its own forward-thinking business potential into the company.
Shell companies enable an alternative means of going public without the long-winded, complicated proceedings of the traditional IPO process. The entrepreneur controls the concept of going public itself and is not dominated by banks, advisors, lawyers and auditors.
Shell companies offer the entrepreneur with a high degree of independence from its credit-providing banks through a quick and easy path to the stock exchange, and enable direct access to the capital market and therefore the acceptance of interest-free share capital (equity capital).
Shell companies also enable a clear increase in the popularity of the company through its future positioning in the capital market.
Why do I need a shell company?
The reasons for the constant capital weaknesses of many firms are complex and well known. However, favourable financial framework conditions for companies are essential for growth and revenue. The tightened equity capital regulations for banks (Basel II), which have been in effect since January 2004, mean allocation of credit by banks will tend to become even more restrictive in the future. Entrepreneurs will thus need to use alternative forms of funding. Growth funding for going public and subsequent corporate action has become more popular in recent years, even in Germany.
As a result of the crash of the New Economy and the massive decline of the DAX Index and all other German indices which lasted until 2003, it became almost impossible to go public until the end of 2003. In times when the new issue pipeline was almost completed (10 cases of going public from 06/2001 to the end of 2002, none in 2003) or the markets corrected their over-valuations, like in January 2008, the purchase and re-organisation of a shell company provides a practical IPO alternative for all businesses. The dilemma for everyone who is now intensively involved with the idea of going public is only that, due to the reticence of the affected banks and their vast staff cutbacks, the IPO pipeline is currently only available to large businesses, and the medium-sized businesses are often put off. However, this is where the possibility of gaining complete independence from the aforementioned problems by purchasing a shell company comes into play.
By purchasing a shell company, the buyer can not only control share sales and share re-allocation more easily, it also gains access to investors who are prepared to provide equity capital for solid corporate planning. This takes place through capital increases offered to free and third-party shareholders for subscription. Capital increases and so-called secondary placements (private placements) are the only remaining alternatives for acquiring capital through the capital market. Many entrepreneurs have also been able to achieve a clear higher valuation, and therefore an increase in the company value, by listing their company on the stock exchange. This is due to the fact that unlisted companies (limited partnerships (KGs), Ltds. (GmbHs) or real estate) are only valued using certain multipliers generally found in the mid single-digit region. However, the stock exchange allows additional growth and profit predictions which are reflected in extra goodwill and therefore higher multipliers. This higher valuation can already display clear value growth with an increase in the multiplier by 1 or 2 points.
How do I use the shell company?
The shell value’s stock exchange listing generally represents decisive value for potential buyers. If the shell company is purchased, the company’s new owner can flexibly change the corporate purpose and incorporate its own future-oriented business potential into the company. This usually happens through two mechanisms:
- Sale of the business/real estate/securities/etc. to be incorporated to the shell company enterprise, or, alternatively,
- Incorporation of the business (real estate/securities/etc.) into the shell company via a capital increase through investments in kind.
The 1st option is unproblematic as long as the shell company enterprise pays an appropriate purchase price for the assets to be acquired. This should also be supported by a recognised auditor through a substance or capitalised earnings report. The 2nd option involves a series of formal requirements (detailed under “what are the different market sectors for shell companies?” depending on the market sector).
A valuation (expert report) must be submitted for the assets to be incorporated, and this valuation determines the value of the investment in kind. This value, together with an eventual cash capital increase, determines the value of the overall capital increase, and is placed in proportion to the shell company value produced from the stock exchange valuation. This ratio then determines the subscription right for the capital increase. A simplified example of this is given below:
The shell company has 1 000 000 outstanding ordinary shares at 1 Euro each.
The market rate is 1.50 Euros, so the value of the company is currently 1.5 million Euros. The investment in kind has a value of 3.375 million Euros. The principal shareholder, who wants to incorporate the investment in kind, holds 75% of the shell company. The free float will produce a cash capital increase with a subscription right. Based on the valuation of the investment in kind, the cash share for 25% of the share capital (represented by the free float) is 1.125 million Euros, so the cash/real capital increase totals 4.5 million Euros, which produces a subscription ratio of 1 to 3 for 1 Euro. The new share capital then totals 5.5 Euros.
This simple calculation does not involve any possibilities like a premium or similar. It only represents the calculation of a capital increase.
The investment in kind (real capital increase) is generally accompanied by a cash component, so that the free float has the opportunity to make use of a subscription right to be guaranteed to it in order to not be diluted to the amount of its share (mixed cash and real capital increase). Of course, a real capital increase can also take place with a subscription right exemption, as long as this is in the articles of association (authorised capital affected by a subscription right exemption), or a shareholder meeting authorises a subscription right exemption. A real capital increase is generally decided on at a shareholder meeting, as it is usually more extensive from the value than a 50% capital increase in the existing share capital, which would be possible from the authorised capital with the consent of the supervisory board and without the shareholder meeting.
At the shareholder meeting which decides on the investment in kind, the buyer of the shell company generally also changes the articles of association, the company's registered base and name to reflect the name of its (area of) business, if necessary, in the name of the listed company. The capital market experts of Instant IPO are happy to advise you on all queries and subsequent action.
What are the different market sectors for shell companies?
Until October 2007, the German share market had three sectors: Official Market, Controlled Market and the Open Market. On 1 November 2007, the Official and Controlled Market sectors were then combined with the Regulated Market so that there are now just 2 sectors: the Regulated Market regulated by law and the Open Market regulated by the stock exchange. The essential difference between the sectors is the strictness of the publicity and formal regulations. While the Regulated Market displays the strictest publicity and transparency requirements with its sub-areas of Prime and General Standard, the very popular Open Market (even among foreign companies), with its sub-sector of Entry Standard, can be described as an ideal entry and medium-sized business sector with lower demands.
Formal requirements in the Regulated Market:
1. Publicity duties
Quarterly reports, ad-hoc publicity regulations and compulsory registration when participation thresholds of 3, 5, 10, 15, 20, 25, 30, 50 and 75% are achieved according to the Securities Trading Act are the most important methods to be taken into account. In addition to this are the director’s dealings according to which the bodies of the companies concerned, as well as their family members, have to share all purchases and sales with the Federal Financial Supervisory Agency within one week, and publish these.
2. Formal requirements
Issuings such as capital increases, acquisitions through an investment in kind (share trade) and similar transactions must generally be accompanied (offered) by a sales prospectus. This must be signed by a bank or a securities trading bank and submitted to the Federal Financial Supervisory Agency. Investments in kind must be accompanied by two separate reports by auditors who are not auditors of the company concerned.
3. Take over
For an take over of more than 30% of the outstanding share capital of a Prime or General Standard company, a so-called compulsory offer according to the Securities Acquisition Act must be submitted to the free float. This was governed by the “Law on regulating company acquisitions and public offers to purchase securities” of 20 December 2001. The basis for the settlement amount to be submitted is the higher rate of either a.) the average, weighted share price 90 days before the control is notified or b.) the purchase price per share paid by the buyer to gain control.
Prime and General Standard
The “Prime Standard“ and “General Standard“ were introduced in early 2003. In addition to the previous publicity requirements, international financial accounting standards (IFRS), a copy of a company calendar, an analyst conference at least once a year, and the issuing of ad-hoc notices in German and English are also required.
SDAX, MDAX and DAX are indices and not market sectors. Admission into these indices essentially takes place through the two criteria of market capitalisation and sales turnover in the share. The company’s industry is also an important criterion.
Open Market exception
The Open Market is an exception to these rules. Legal entities have a certifiable threshold of 25% of the share capital of the company concerned. No compulsory offer is stipulated when purchasing more than 30% of the outstanding share capital.
How to buy a shell company?
Instant IPO offers various shell companies which can be individually customised to the buyer's demands. Shell companies are available in every sector and mainly differ in important aspects such as amount of the share capital holding to be acquired and the associated amount of the free float. Different criteria for purchasing a shell company apply for each buyer. For instance, it may be of interest to acquire a shell with a relatively high share capital holding. This is the case when a holding is to be incorporated into the shell at very low book values. Of course, the free float also participates in this sort of favourable incorporation. On the other hand, it can be of interest to have a high free float if the shell has high cash balances which can then be “controlled” with a lower share capital holding. The share capital holding is also not decisive insofar as one has the relative qualified majority at the shareholder meeting (75% of the represented share capital). The 75% threshold is important for essential shareholder meeting decisions, such as corporate action and changes to the articles of association.
Instant IPO acts as a competent advisor for shell company acquisition in order to reach good solutions for the buyer(s), seller(s) and still outstanding shareholders. As Instant IPO always only offers flawless shell companies, it often takes months or even years for a shell company to be approved for purchase. It is only offered to interested parties once our shell company experts have been able to ensure that a shell company is free of any bad debts such as liability risks, balance sheet risks, personal risks, cost risks, contractual risks, tax risks and process risks. This task is completed in the so-called due diligence in the lead-up to the sale of a shell. However, every buyer should carry out its own due diligence to assess the accepted characteristics of the shell company offered. The process for acquiring a shell company can be completed within a few weeks or even days.
In July 2003, the Federal Court of Justice enacted the so-called Old Shell Decree (FCJ, Resolution of 7/7/2003 – II ZB 4/02 / OLG Brandenburg). This states that when a corporation (GmbH (Ltd.), AG (plc)) is re-organised, the shareholders (partners) are liable pro rata for the difference between the nominal capital (subscribed capital) and the actually available share capital. This generally makes it necessary to adjust the share capital – as part of the items to be decided on anyway at a shareholder meeting – to the actually available share capital through a capital cut.
It should only be mentioned here that the legislator has gained an additional, important liability possibility which is, however, completely cleared after the capital cut is made.
Selling a shell company?
Instant IPO is not just interested in selling, but also particularly in acquiring potential shell companies. Together with the owners of potential shell companies, we determine the value of the (their) business (potential shell company) and ascertain the best strategy to divest/sell the operative business sectors which may be important for the seller. These can be subsidiaries, real estate, machines, patents or naming rights. Instant IPO has extensive experience in both practical implementation and the formal implementation under stock corporation law (company contracts, valuation reports, (extra) ordinary shareholder meetings etc.).
The seller can determine the value of its potential shell company together with Instant IPO. If its earlier activities are affected by legal challenges and/or shareholder compensation claims, this does not pose as an obstacle, as it generally requires extensive, value-adding action by Instant IPO in order to transfer a company to the status of a shell company.
How much does a shell company cost?
Shell company prices vary and depend on the market sector, the percentage holding, and the balance structure of the company, so there is no “price list”. Shell costs are individual and must be determined according to the case at hand. However, it is certain that the costs for acquiring a shell company are clearly lower than those of a bank-assisted IPO, which can be between € 1 million and x million, depending on the issue volume and the share placement success for bank customers. Legal and tax due diligence costs generally amount to several hundred thousand Euros, as the advisors and banks are liable for the issue prospectus. “Every stone” of the IPO candidates must therefore be “overturned”, so to speak. Following the 1998 IPO boom, the banks have been lavished with a glut of so-called prospectus liability claims. In order to prevent this (as far as possible) in future, due diligence today is extremely thorough.