What Is a Qualifying Transaction?

Malcolm Tatum

A qualifying transaction is a scenario in which a private company is acquired by a larger entity and then issues shares of stock that are traded publicly. Typically associated with a strategy that is sometimes used by what is known as a capital pool company, a qualifying transaction allows that private company that is now operated as a subsidiary of that capital pool to rework its stock offerings so they are traded publicly. This approach can aid the capital pool company, which does not issue stocks on its own, to generate revenue based on the demand for the stocks issued by its private subsidiary.

Man climbing a rope
Man climbing a rope

To understand how a qualifying transaction occurs, it is necessary to envision a private company that currently issues shares to a small group of investors. Assuming the company is perceived as having a great deal of potential, a capital pool company will acquire all the issued shares by purchasing them from the investors, ultimately gaining full ownership of that company. Since a capital pool company does not maintain any type of commercial operation and holds only cash assets, the operation of that subsidiary, including the issue of publicly traded shares of stock, becomes a significant source of revenue.

In nations that allow this type of business structure, such as the nation of Canada, there are usually some provisions what are used to determine if a capital pool company can actually participate in a qualifying transaction. This typically includes the ability to manage the purchase of the private company in question, and the ability to fully comply with all regulations within 24 months of the acquisition. Failure to do so could lead to the suspension of trading on those shares issued by the private subsidiary, and possibly the expulsion from trading altogether.

There is some risk associated with a qualifying transaction. The capital pool company takes on the risk that public interest in the acquired company and its public stock options will not be a high as anticipated, leading to a lower asking price per share. In addition, changes in the marketplace could undermine the business volume of the acquired company, which would further drive down the value of the issued shares. When this is the case, officers of the capital pool company may find it necessary to withdraw the shares from the public market and sell the company as a means of minimizing the total amount of the loss.

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