Understanding the Difference Between Shelf and Shell Companies

After the release of the Panama Papers in 2015 and the subsequent reporting by journalists in 2016 the terms “shelf company” and “shell company” became synonymous with fraud, tax evasion and other illegal acts. While it cannot be denied that certain bad actors do use these vehicles for illegal purposes, it should not be concluded that all shelf and shell companies are used for criminal endeavors.

As with any instrument, financial or otherwise, shelf and shell companies can be used for good or for bad. They are simply tools and the human behind them will determine if they follow or deviate from the law. What follows is an introduction to these entities and a review of some of the instances in which they may be used.

Shelf Company

A shelf company, also called an aged corporation, is a company that has been legally created and has had no activity since inception. The entity has literally been left on the shelf to age. While the entity has been inactivate it is important to note that it has fulfilled necessary legal requirements such as registration and payment of state fees. An individual or other corporate entity looking to avoid the lengthy process of registering a new company may elect to purchase a shelf company.

A shelf company may make sense if:

• It is important to reduce the time required to establish a new entity. For example, a deal may be closing that requires a corporation or LLC. Normally this would take time to establish and file all the appropriate paperwork. Purchasing a shelf company can eliminate this timing issue so the deal can close as desired.
• It is necessary to bid on contracts as some jurisdictions require a business to have been in existence for a specified number of years before they are allowed to bid.
• A perception of longevity is desired. Individuals who have operated as a sole-proprietorship for a number of years and finally want to form an LLC or incorporate do not want to appear as a new entity.

The above list is not exhaustive, and reasons may vary for different buyers of shelf companies.

While some buyers may benefit from purchasing a shelf company it is necessary to consider the drawbacks before starting a transaction.

1. Obtaining credit may not be easier. Lenders conducting due diligence may require proof that the entity was in fact conducting business, generating cash flow and has been profitable. Simply demonstrating that an entity has been in business for a number of years is not enough.
2. Obtaining a shelf company will most likely not reduce the requirements when going public. The Securities and Exchange Commission has a plethora of rules in place that cannot be avoided simply buy purchasing an aged company.

As is true with many things in life, honesty is the best policy. Shelf companies are legal and may serve a purpose for some strategic buyers. However, it is important to be honest as to the date the entity was acquired and other material facts.

Shell Company

Shell companies, as described by the Financial Crimes Enforcement Network (FinCEN), are “non-publicly traded corporations, limited liability companies (LLCs), and trusts that typically have no physical presence (other than a mailing address) and generate little to no independent economic value”[1]. Shell companies do have legitimate purposes such as holding intangible assets of other business entities or conducting cross-border transactions[1]. However, they do pose a risk for money laundering and other financial crimes due to the ease and low cost to form and operate a shell.

Valid reasons for utilizing a shell company do exist. A few of these reasons are outlined below.

• A reverse merger may allow a startup or small company to avoid the high costs and time commitment of the traditional IPO. This strategy is not right for every business and many risks must be addressed.
• Shell companies may create a stable investment company for investors and entrepreneurs around the world. In today’s business environment global borders are blurred and disappearing. It is commonplace to have business partners across the globe. A shell company may allow a group of investors who come from different countries with different laws to pool their funds in one vehicle. This could help reduce risks such as currency volatility
• Transferring assets from one entity to another may prove another use for shell companies. For example, when Sega Sammy Holdings acquired Index Corporation in 2013 a shell was used to receive the assets from Index. The shell entity held a clean title to all of the assets and Index was left to be dissolved[2].

Public shell companies can come in many flavors. A brief overview is given below. Those seeking additional and more detailed information are encouraged to see our earlier article on types of public shells.

Trading, Non-Reporting

These entities are usually found on the Pink Sheets and may include delinquent filers that are no longer current with the SEC.

Reporting, Non-Trading

Typically a blank check company that does not have any business but has filed a Form 10K.

Non-Trading, Non-Reporting

Only has a shareholder base and no registered stock symbol.

Trading and Reporting

Current on filing both annual 10K reports with an audit and 10Q and 8K reports.

If you decide a public shell is right for your business needs, you have the options of purchasing an existing shell or manufacturing your own.

Both shelf and shell companies have a purpose and can be used in a completely legal manner. As always, do your research before creating or purchasing either entity.

[1] FinCEN (2006). Potential Money Laundering Risks Related to Shell Companies. Retrieved from https://www.fincen.gov/resources/statutes-regulations/guidance/potential-money-laundering-risks-related-shell-companies
[2]Sega Sammy Holdings. History of SEGA SAMMY Group. Retrieved from https://www.segasammy.co.jp/english/pr/corp/history/

Originally published at investmentbank.com on March 30, 2018.