Dangerous Delay

Dennis McCarthy – dennis@boustead1828.com – (213) 222-8260

My colleagues and I at Boustead noticed what may be a dangerous trend among microcap public companies.

When we suggest that microcap public company management should take advantage of the favorable stock market environment to raise some capital, many microcap CEOs and CFO’ tell us they want to wait before raising capital.

Wait for what?

  1. Wait for a Higher Stock Price?

In general, microcap valuations are relatively high now according to an index maintained by LD Micro, the well-respected independent resource.

To quote LD Micro’s September 17, 2017 email  – “After several attempts and a few close calls, the LD Micro Index finally hit an all-time high on Friday.”

Microcap stock prices might rise to yet newer highs, but there’s no certainty.

  1. Wait for Projected Performance Improvement?

We know that company management is often optimistic about a company’s future performance.

Plus, wouldn’t having more capital actually help management to achieve the performance improvement?

  1. Wait Until the Capital Need is Urgent?

Capital is not always available for microcap companies.

We’ve experienced periods, sometimes long periods, when microcap companies can’t access capital at any reasonable price.

Also, raising capital can take longer than expected, even when it is available.

Take Capital When Available

Our Advice is Take Capital When It’s Available

For those who are optimists, waiting for a higher stock price, think of it as averaging up.

For those who’ve lived through periods when capital wasn’t available to microcap companies, recall the anxiety and avoid it this time.

As the Saying Goes “Get Your Umbrella Before the Rain Starts”

It’s ironic but capital is most available when not needed.

Companies raising capital now may have more alternatives, so they can choose an attractive structure.

Microcap Funds Have Capital

At Microcap Funds, Money Is Burning a Hole in Their Pocket

As I noted above, recently, microcap funds have had good performance and fundraising has been productive.

Microcap funds have capital to invest and pressure to put it to work.

Microcap funds typically aren’t very large.  Fund managers want to deploy their capital and then raise another fund.

Investor Preferences

I would note a good development for both managers and microcap companies, many of the new funds permit their fund managers greater flexibility regarding investment structure.

In another article, I’ll discuss those features which seem to be most appealing to microcap public investors.

Consider these when preparing for a financing.

Please contact me to discuss your capital market goals. 

Financing Season

Dennis McCarthy – dennis@boustead1828.com – (213) 222-8260

During this financing season, my colleagues and I are active assisting our clients with a number of financing projects.

We’re raising private capital, arranging debt and organizing public offerings.

This is a great time of year for a company to be in the capital markets.

Investors and lenders are ready to focus and make decisions before year end.

Here are some ideas where investment capital is available now.

Cash Flow Investments

Many investors prefer businesses or projects which give them a current return, like a dividend, often with some equity upside.

We know lots of investors ready to invest to get a current return.

Click the link below to view a video on that capital source.

http://capitalmarketalerts.com/investor-demand-cash-flow-deals/

Growth Capital

Growth capital is available for companies which are past the venture capital stage but not yet mature enough for classic private equity.

Growth capital, in either debt or equity, can help your company to accelerate its growth.

Click the links below to view  videos explaining more about growth capital.

http://growth-cap.com/types-growth-capital/

http://growth-cap.com/growth-capital-in-capital-markets/

Public Offerings

The public offering market is available too.

One of my current projects involves a traditional registered public offering.

Others at Boustead have raised capital using the newly revised “Reg A+” public offering.

Click the link below to view an interview of my colleague, Dan McClory, about one of our recent Reg A+ offerings.

https://www.boustead1828.com/single-post/2017/08/22/Small-Cap-Nation-SCN-interviews-Dan-McClory-on-Bousteads-recent-Reg-A-and-IPO-deals

Whichever form of public offering, we’re finding investor demand for attractive companies.

Conclusion

So, the bottom line is, this is a good season to consider raising capital in a variety of forms.

Please contact me to discuss your goals.

Expansion of Private Financing Sources

We, at Boustead, see a trend of big investors and company buyers, including pension funds, family offices and wealthy individuals, choosing to make direct investments in companies and projects rather than invest through intermediaries like hedge funds and private equity groups.

Boustead’s professionals talk with investors and acquirers daily which gives us a good sense of this trend.

In fact, we posted an article in early 2016 describing that in response to this trend and in order to get the best deal for our clients, we regularly reach out to a broader universe of potential investors and buyers including those pension funds, family offices and wealthy individuals.

It caught my attention, therefore, when Axial, the huge online deal source database, reported that it too has seen the direct investment trend and described several driving forces which are likely to continue the trend (click here).

Axial’s three driving forces are:

  1. Greater private company information availability which diminishes the value of deal intermediaries’ famed proprietary deal networks.
  2. Greater capital source information availability due to online resources such as Axial.
  3. Reported “fee fatique” which may simply be a reaction to lower returns generated by hedge funds and private equity funds. I wonder, if returns were strong, would there be fee fatigue?

Neither Boustead nor Axial is forecasting the end of hedge funds and private equity groups.  Rather, the trend signals that there are more funding and sale options available. For companies looking for capital or for a buyer, and for their investment bankers, that’s good news.

Please contact me to discuss any capital market project whether raising capital, equity or debt, or M&A.  Thank you.

Cash Flow Deal Funding Gap

Dennis McCarthy – dennis@boustead1828.com – 213-222-8260

In prior articles, I’ve highlighted investor’s strong demand for current cash flow deals.

Many investors want to get a good portion of their return along the way and don’t want their whole return at risk for the future.

In today’s financial market, that makes sense.  Who knows what economic environment we’ll face in the next 5 years, not to mention further into the future.

So, capital is flowing into funds providing current returns, like infrastructure, energy, alternative energy, real assets, mezzanine and similar funds.

This capital inflow is generally good for bankers like me with projects seeking capital.

The problem, however, is that with so much capital flowing into funds, funds have grown to be enormous. These enormous funds look to invest in projects requiring large amounts of capital.

Ironically, with all that capital flowing into funds looking for a current return, there’s a funding gap for smaller projects and companies.

For example, we’re in the market with a renewable energy project with a total capital budget north of $350 million.  That amounts gets attention.

The project, however, has attracted strong interest from lenders so the actual equity check required is only 10-15% of the capital budget.

Sounds good, doesn’t it.  The problem is that many funds find a project requiring less than $50 million of equity to be too small. For many funds, under $100 million is too small.

Fortunately for our client, and us, some funds will consider smaller equity investments, preferring to avoid the intense competition for large deals.

I believe that when we look back in 5 to 10 years, smaller equity check deals, under $100 million, will have provided a better return than that of the huge deals.  Time will tell.

If your fund will consider a project where the equity check is smaller, please contact us.  We have attractive projects and would like to get to know just what type of project fits your fund.

Also, if you have a cash flow project, please contact us to discuss your capital market plans.

Investor Demand for Cash Flow Deals

Every day, I talk with institutional investors about deals.  Institutional investors have capital which they need to invest. So, what do I hear from these investors?  What are they looking for?

Today, many tell me they want predictable quarterly cash returns.

Some want fixed payments, something in a debt instrument.

Many, however, will accept some variability in the payments. they’ll take some equity risk, to get a better return.

I’m seeing a large and growing universe of these investors.

If you can offer investors a generally predictable cash return, you can get investment capital.

Naturally, institutional investors will ask what could go wrong to diminish their cash return. The better your answer, the stronger the investor demand and the lower your required payments.

Also, if your investment has underlying assets, like real estate or equipment that can be sold to raise capital in a pinch, this also makes your investment more attractive.

So, if you’re raising capital for an investment that generates strong cash flows, consider using those cash flows to pay investors a periodic cash return. 

I recognize that if you pay out the cash flow to investors which you need to reinvest for growth, you’ll have to raise more capital.

The good news is that if you’ve gained a track record for paying investors their periodic cash return as promised, you’ll have no trouble raising capital at attractive terms.

Please contact me to discuss your capital market goals. Thank you.

Dennis McCarthy

Dennis McCarthy

Court Criticizes Legal “Racket”

A well-regarded Jurist in the Seventh Circuit issued a ruling which was highly critical of a legal practice (called a “racket”) in which in response to a large public corporation’s filing with the SEC for a strategic transaction, one or more plaintiff’s counsel file suit to challenge the adequacy of document disclosure. Rather than fight the suit, many corporations simply settle paying plaintiff’s counsel a handsome fee while making no substantive modification to the SEC documents in question.

For background, when Wallgreens issued a proxy statement to request a vote to reorganize after its combination with Boots, the UK pharmacy chain, Walgreens was sued for a failure of disclosure.

The court noted that such suits are commonplace because, in recent years, 95% of strategic transactions for public companies with market values over $100 million receive such challenges.

In Wallgreen’s case, the Court responded to what appears a simple payoff to plaintiffs’ counsel who received $370,000 for its one month suit. Walgreens put up no resistance. The Jurist stated that the value of the supplemental disclosure added to the proxy “appears to have been nil”.

The Jurist concluded, “[t]he type of class action illustrated by this case — the class action that yields fees for class counsel and nothing for the class — is no better than a racket.”

Corporations and plaintiffs’ counsel are now on notice that the Seventh Circuit will review settlement cases carefully.

For a good explanation of the practice and the ruling in the Walgreen’s case, please read Sheppard Mullin’s article in its Corporate & Securities Law Blog (click here).

Please contact Monarch Bay to discuss your company’s capital market goals.

Regulating Social Media Influencers

The fact that social media influences consumers’ spending decisions should come as no surprise.  Given this power, the Federal government is now applying its rules to the growing phenomenon of online marketing and influencers.

Federal Trade Commission

The Federal Trade Commission, the FTC, is beginning to crack down where social media influencers fail to disclose that their endorsement is paid and often directed, like an advertisement.

For example, the FTC recently settled with Warner Brothers which had used one of the most popular social media personalities, PewDiePie with over 50 million Youtube followers, to promote its new videogame without any indication that Warner Brothers paid for and directed the endorsement.

The FTC wants more clarity for consumers.  A paid endorsement, for example, might include an indication of this fact by including the hashtag #ad early in the copy.

Bloomberg, the online datasource and magazine, carried an interesting story on the FTC’s crackdown which also highlights the growing influence of online content for consumer marketers (click here).

Excerpt

It’s up to the FTC to be more clear and consistent about their policies and enforcement, she said. A lot of influencers think they are following the rules, but in fact are falling short. More than 300,000 sponsored posts on Instagram in July used hashtags like #ad, #sponsored and #sp, up from about 120,000 a year earlier, according to Captiv8. The FTC thinks #ad is okay if it’s at the beginning of a post, but #sp and #spon aren’t.

“If consumers don’t read the words, then there is no effective disclosure,” Ostheimer said. “If you have seven other hashtags at the end of a tweet and it’s mixed up with all these other things, it’s easy for consumers to skip over that. The real test is, did consumers read it and comprehend it?”

Food and Drug Administration

The FTC is not the only Federal agency focusing on online endorsements.  Not long ago, a drug company using Kim Kardashian for a social media promotional post, ran afoul of the FDA, the Food and Drug Administration (click here).

Securities and Exchange Commission

Online promotion of investments, including the new forms of offerings such as crowdfundings and Reg A+ offerings is regulated by the Securities and Exchange Commission, the SEC.

At this time, there appears to be a great deal of experimentation by social media marketers as to what’s effective yet acceptable by regulators.

Monarch Bay is closely following developments in social media marketing especially as applied to the capital markets and the new offering techniques.  For example, Monarch Bay recently posted “Crowdfunding Communication Do’s and Don’ts” (click here).

Please contact Monarch Bay to discuss how these evolving social media marketing techniques might benefit your company’s capital market goals.

Progress on Proxy Access

In a milestone event, ExxonMobil’s shareholders recently approved relatively progressive proxy access board provisions.

Proxy access provisions enable shareholders of a public company to submit director nominees and measures into the corporation’s annual shareholder proxy to be voted on by all shareholders.

The battle to obtain proxy access has been long and contentious (click here for my 2012 post, “Just a Small Leak”).

For an introduction to proxy access, click here for an article by the Council of Institutional Investors.

Excerpt

“Proxy access” is shorthand for a crucial mechanism that gives shareowners a meaningful voice in corporate board elections. It refers to the right of shareowners to place their nominees for director on a company’s proxy card. This lets investors avoid the cost of sending out their own proxy cards when they are dissatisfied with a corporate board and want to run their own candidates for director.

 CII believes that proxy access would invigorate board elections and make boards more responsive to shareowners and more vigilant in their oversight of companies.

What makes the ExxonMobil vote so momentous is the percentage of the vote in favor and the fact that this vote was tinged with climate change controversy, not just good corporate governance (Click here).

Excerpt

The so-called proxy access measure was the first Exxon shareholder proposal since 2006 to be approved, and it was the only one of 11 proposals related to climate change to pass at meetings held Wednesday by Exxon and fellow U.S. oil giant Chevron Corp.

More than 60 percent of Exxon shareholders backed proxy access, which was narrowly defeated last year.

Perhaps this issue has reached a tipping point as ExxonMobil shareholders got a letter recommending acceptance by two of the largest US institutional shareholders, California’s CALPERS and the Comptroller of the City of New York representing NYC’s pension funds (click to read).

We’ll monitor developments on proxy access and report important milestones.

Please contact me to discuss your capital market goals for raising capital and M&A.

New S-1 Registration Provisions

A provision of the recently enacted legislation, known as the FAST Act, makes it easier for smaller public companies to conduct registered offerings.

The reason why this is significant is that smaller public companies face a very unreceptive market when raising capital via private placements, known as PIPE offerings.

Burden to Qualify to Invest in Private Placement

In general, the requirements to qualify as an investor in a private placement leave only a small universe available to consider a private placement offering.

A private placement investor must undergo the paperwork burden to prove the investor qualifies as an accredited investor, with

  • the capability to evaluate the risks of the offering;
  • the willingness to forego immediate liquidity of the securities purchased in the offering; and
  • the ability to sustain the total loss of the investment.

Given the limited universe of investors for private placement offerings, in today’s capital markets, smaller public companies, especially OTC listed companies, typically find only toxic financing available from PIPE investors.  That is, the issuing public company may be able to raise capital but the form of the securities demanded by investors has features which are extremely expensive to the issuer and may, in certain circumstances, result in severe negative impact on the issuer’s stock price, perhaps due to substantial dilution of shares.

In contrast with the limitations of a private placement, an investor in a registered offering:

  • has no paperwork burden to prove eligibility to purchase the securities; and
  • has immediately tradable securities, subject only to the liquidity of the company’s stock.

Given these features of a registered offering, issuers can tap a much broader universe of potential investors for a registered offering which should enable an issuer to obtain better terms than for a private placement.

Why then don’t smaller companies issue shares through registered offerings?

The reasons typically given include:

  • raising capital via a registered offering involves upfront and ongoing costs for legal and accounting work to file an S-1 registration statement without certainty of success in actually raising capital,
  • offering size may be small in relation to the fixed upfront costs noted above; and
  • filing a registered offering is public and would enable a stock short seller to short the issuer’s stock depressing its price then cover the short at a profit with stock purchased on the offering.

The new rules enabled by the FAST Act don’t eliminate all these impediments but eliminate one of the costs and risks, which is the requirement to file additional S-1 supplements once the S-1 is declared effective.

Final rules issued by the SEC on January 13th, implementing the FAST Act, enables companies using the S-1 form of registration statement to incorporate by reference required SEC filings after the S-1 is declared effective.

Up until now, S-1 registration statements could only incorporate by reference prior SEC filings. Larger companies, able to use S-3 registrations could incorporate future SEC filings.

Now a smaller company using an S-1 registration statement, which makes the election to incorporate future SEC filings by reference, need not file an update to its S-1 registration when a new SEC filing is required, such as an 8-K or 10-Q, and risk SEC review and comments.

This is a substantial cost and time saving benefit of this provision of the FAST Act.

Interestingly, this is not the feature which got the attention when the FAST Act was passed or the final rules issued.

Please contact us to discuss your capital market plans.

For background reading on this and other capital market provisions in the FAST Act, please click on the following:

Goodwin Procter article

Excerpt:

The amendment to Form S-1 requires smaller reporting companies that make this election to state in the prospectus contained in the registration statement that all documents subsequently filed by the smaller reporting company pursuant to Sections 13(a), 13(c), 14 or 15(d) of the Exchange Act before the termination of the offering shall be deemed to be incorporated by reference into the prospectus.

This amendment will permit smaller reporting companies to eliminate the additional costs and delays of manual updates to “shelf” registration statements on Form S-1 for resale transactions and continuous offerings that commence promptly after effectiveness and continue for a period in excess of 30 days after effectiveness. This amendment does not change the current requirement that companies must conduct delayed offerings under Rule 415(a)(1)(x) under the Securities Act of 1933 using Form S-3 or Form F-3.

In addition, this amendment does not change the eligibility requirements for companies that wish to incorporate documents filed after the effective date of the registration statement under General Instruction VII to Form S-1. The principal eligibility requirements include the following: (1) the company is required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act, (2) the company has filed all reports and other materials required by Sections 13(a), 14 or 15(d) of the Exchange Act during the preceding 12 months or such shorter period as the company was required to file such reports and materials, (3) the company has filed an annual report required under Section 13(a) or Section 15(d) of the Exchange Act for its most recently completed fiscal year, (4) the company is not a blank check company, a shell company or a registrant for a penny stock offering and (5) the company is not registering an offering that effectuates a business combination transaction).

Corporate Vs Institutional Investors

Corporate investors provide a meaningful portion of the total capital deployed in early to late stage companies today. “In 2015, corporate venture groups participated in 17% of all North American deals, accounting for 24% of the total venture dollars deployed to VC-backed startups” according to data from CB Insights in an article by Rita Waite of Juniper Networks, one of the corporate investors (Click here).

Corporate and institutional investors often differ in motives and styles which Rita Waite summarizes.

In our experience, these differences may be dramatic and may be in conflict as these points illustrate.

Corporate Investors

The Good

Corporate investors may pay a higher value because the candidate may enhance the corporate investor’s business, therefore, return on the investment isn’t solely dependent on the candidate’s performance.

The corporate investor may bring to the investment knowledge, contacts, assets or other advantages while an institutional investor typically brings only capital and less specific synergy.

The Bad

The corporate investor may require some “hook” in the investment agreement to give it a special right to buy the candidate in the future, perhaps at a favorable price or to prevent the sale to a competitor.

The high corporate valuation may dissuade financial investors thereby making the candidate dependent on the corporate investor for capital.

Corporate investors may exert influence to keep the candidate focused on whatever is the business most valuable to the corporate investor, regardless of other opportunities which may present themselves.

The Good

Corporate investors typically want to avoid having the candidate consolidated for financial accounting and, therefore, structure the investment to be a minority interest with essentially no operating influence.

The Bad

Since institutional investors want the opposite, commonly wanting control in both value and major decisions, so teaming corporate with institutional investors can be complicated.