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Capital Raising During Times of Uncertainty — Issuers Beware!

As the public market for thousands of early stage and growth companies, OTC Markets Group has seen the good, the hard and the plain ugly when it comes to what happens after a capital raising.  Even in the best of economic times, issuers often fall prey to bad advisors offering “too good to be true” financings with terms that dump shares, dilute shareholder value and destroy companies.

Small and micro-caps have always had to work harder to secure growth capital. These challenges have only been exacerbated by the current Covid-19 pandemic and its effects on the global economy.   In navigating financing options, management teams need to develop the skills necessary to discern a good deal from a bad one, avoid questionable players and successfully raise capital in turbulent times.

Josh Lawler, Partner at Zuber Lawler points out: “If you are looking for a capital infusion to maintain operations, recognize that it may come at greater cost, both financially and in terms of governance, liquidation preferences and like non-financial terms.” 

But what good is raising money now if it will ultimately destroy the company later?

Best Practices for Securing Growth Capital

Below are some helpful tips based on our years of experience in the small/micro-cap financing space.

First and foremost, it is important to do your due diligence on the advisor/investment banker offering to help you with the raise.

Doug Ellenoff, Managing Partner of law firm Ellenoff, Grossman & Schole suggests: There are many firms across the country, select the bank that is appropriate for your size company and knows your industry. Make sure that they have been active in the capital markets recently. Ideally, make sure that the firm has depth of experience in your industry. Do they mention your industry on their website? Do they have analyst coverage? Do they write research? Do they know public market investors that they work with regularly and are familiar with your industry and your business? Just because you haven’t heard of them before, shouldn’t mean that you shouldn’t talk to them or that they aren’t very credible. They may be but do your homework. Speak to other clients and get a sense of them, whether they over promise, avoid finders. If they aren’t licensed broker dealers, they cannot get paid for helping you raise money. There are individuals that opportunistically want to prey on your desperation, so do not dispense with good judgment and your own proper due diligence.”

How Not to Fall Prey to Bad Actors

As with any industry, there are several “bad actors” in the private placement and convertible note[1] financing space. Know all the players in a financing and their associates.  We recommend that any issuer investigate the principals of any prospective lender and their history of deals.  Financings through offshore entities, newly formed or anonymous vehicles with opaque ownership should raise red flags.

FINRA’s Broker Check, the SEC’s SALI Database, and the various enforcement materials made publicly available by state regulators are good resources for an issuer to start their research. The Canadian Securities Administrators, the collection of provincial regulators, also has a large, publicly available repository of individuals that have been the subject of securities-related disciplinary actions.

Once you have decided on an advisor or banker to help with your raise, the most important thing is to KNOW THE TERMS!  Receiving the money is the end goal, but it should not be done at the expense of your company’s long-term viability.

Private Placements and Convertible Debt

We all know that private placements and convertible debt[2] arrangements are intentionally structured to maximize profits for lenders. From an issuer’s perspective though, there’s no excuse for not understanding the mechanics of this type of financing. Issuers should fully comprehend all the terms of any arrangement, paying particular attention to the specifics regarding conversion and default.

Conversion features at a fixed price, especially one that closely resembles prevailing market prices, pose fewer risks to an issuer and its shareholders. Conversely, variable priced conversion features that are based on the market price of an issuer’s securities, sometimes called “Death Spiral” or “Toxic” financings, can have more drastic effects. In our experience, notes with these features commonly lead to dilution and can depress the trading price of an issuer’s securities– and, the worst, can dilute existing shareholders holdings[3] to almost nothing.  Industry practices differ, but these features generally allow for conversion at anywhere from 95% to as low as 50% of the market price (resulting in discounts of 5%-50% for the lender).

Additionally, many of the most egregiously structured conversion agreements peg the conversion to the lesser of the company’s lowest trading price or closing bid price over a specific time period.  So, not only do the notes always convert at a discount to the market price but will generally be at the absolute bottom of the company’s recent price range.

The default provisions of convertible note financings typically exacerbate an issuer’s situation when they’re deemed to be in default. When an issuer is deemed to be in default for whatever reason (of which there can be many hidden in the worst financing agreements) these clauses often increase the total amount owed by an issuer by adding multipliers to the outstanding principal and interest.  In some cases, a default also allows lenders to convert debt at an even steeper discount.  It’s important for an issuer to understand what constitutes a default event and, to the extent they’re able, avoid defaulting on notes.

Beneficial Ownership

Convertible notes are also intentionally structured to impose limits on the amount of shares a lender can obtain. The most common terms specifically prevent situations where the lender could be deemed to be a five or ten percent beneficial owner of a class of the issuer’s securities. This is done purposely to avoid disclosure and various other requirements employed under federal securities laws. While not necessarily indicative of any wrongdoing, issuers should be aware that these limits are present in convertible notes for a reason, including perhaps to avoid the scrutiny or detection by existing investors or regulators.

Dilution and Effect on Trading Price

Issuers raising capital with convertible note financings should know the risks as they relate to the dilution for existing shareholders and the effect that convertibles can have on the trading price of their securities. These arrangements (especially those with variable price conversion mechanics) subject the issuer’s securities to dilution and downward pressure as a result of lenders converting debt to shares and selling those shares. Generally, lenders will convert notes in tranches with a view to quickly liquidating their positions. As lenders sell their newly issued shares, the price can decline quickly, allowing them to convert portions of the note into larger and larger share amounts. The overall effect reduces the proportional ownership of other existing shareholders and can drastically reduce the trading price for an issuer’s securities.

Monitor News and Promotional Activity in Your Stock

After you have done the financing, it is very important that management teams monitor the news and promotional activity in their stock.  We often get calls from management teams claiming that there must be naked shorting in their stock given price activity.  Yet, often, this price activity can be directly tied to a recent financing.   In certain cases, lenders may coordinate their selling of an issuer’s securities with stock promotion campaigns. To optimize their returns, a lender might initiate an anonymous promotional campaign touting an issuer while they attempt to sell of a tranche of shares at inflated prices. These promotional campaigns by third parties often make unsubstantiated or fraudulent representations.  Promotional campaigns can be a short as one or two day– -long enough for a lender to sell of most of its position.

The process can be chronic as anonymous bad actors seek to stay under 5% ownership. A lender might convert another portion of a note when the share price has receded after a promotional campaign has ended and then begin a new campaign to sell that portion later. Issuers should be aware that lenders have a vested interest in maximizing their return from these financings.  All these sales have the net effect of putting downward pressure on an issuers stock and destroying shareholder value.

Josh Lawler adds: “…. you must keep in mind that any transaction that heavily dilutes or subordinates your existing investors will be scrutinized.  Especially if insiders are part of the purchasing syndicate.”

Where Issuers May Run Into Trouble

Accepting financing in the form of convertible notes can be a decent short-term option for meeting an issuer’s cash flow needs. That said, some issuers run into trouble when they resort to this type of financing habitually.  Issuing convertible debt to repay debt obligations from other notes is a poor outcome for issuers and their shareholders, so institutional and long-term investors will avoid companies with these bad habits.

It’s possible for an issuer to improve its standing by negotiating with its existing noteholders rather than continuing to seek further financings to meets its obligations. There have been cases where outstanding debt is forgiven as a result of negotiations and issuances of other classes of securities. In other cases, issuers have renegotiated the terms of their outstanding debt to restrict the amount that lender can sell during specified periods.  Issuers overwhelmed by their debt situation should consult with their securities attorney to construct a plan that’s right for them.

As Yoel Goldfeder from VStock Transfer notes, “We realize that things may be difficult now, but always remember that as an officer or director you have a duty to your shareholders. Make sure that you understand all the benefits and risks associated with your decision and consult with experts in the space who have had many years working with companies like yours.”

Lawler adds: “True that the challenge is often the opportunity, but both success and failure will be magnified.  Follow good practices and you will survive, and possibly thrive.”

[1] https://www.bloombergquint.com/business/death-spiral-whiz-kid-sason-sued-by-sec-for-penny-stock-fraud

[2] https://www.sec.gov/fast-answers/answersconvertibleshtm.html

[3] https://www.wsj.com/articles/a-shipping-companys-bizarre-stock-maneuvers-create-high-seas-intrigue-1499960367

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Navigating Investor Engagement in the Wake of Travel Restrictions

As guidance from the World Health Organization continues to evolve, many organizations and businesses are encouraging remote work and limiting travel as a way to help protect their teams.
With more and more conferences and company road shows being cancelled daily, we are seeing an increased interest from issuers, conference …

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Davos: A Glimpse Into The Global Innovation Economy, The World Economic Forum gives valuable insight into the trends of the next decade.

Each year, the World Economic Forum (WEF) meets in Davos, Switzerland to engage the most influential political, business, cultural and other society leaders to shape global agendas. At the WEF, there is the shared understanding that the themes discussed at the Forum are often more widely representative of broader social trends. This year, increased pressure from geopolitical and economic instability brought with it a greater commitment to the original intentions of the WEF: identify leaders who are making waves in the world economy today and encouraging the growth of emerging markets all over the world. All discussions resulted with one underlying theme: progress happens when people who have the drive and influence to make positive change come together.

This year, the forum was focused on themes we have seen burgeoning along every aspect of our global economy: highlighting inclusivity, an increasingly professional demeanor of emerging industries, and the focus on an international perspective. As I reflect on this year’s event, the WEF proved progress will come from a rapid shift in priorities and bold recognition of criticisms of failure to act enough upon the most pressing global concerns.

Focus on Inclusivity

The attitude at Davos 2020 marked a transition towards greater inclusivity and the possibility for solutions to stem from smaller companies — companies pushing the envelope and innovating on the edge. This year was a critical crossroads for innovation and global markets leadership, and many industries are up for the challenge. Attending and participating in Davos gives industry leaders the opportunity to share their ideas and debate their differences.

Diverse yet transparent markets increase and promote greater competition. They also fuel growth and yield innovation. Many in attendance promoted capital formation and helped foster smaller companies and entrepreneurs to become blossoming corporations and better corporate citizens. Innovative or emerging industries, such as cannabis, need to build a global community who support their cause, believe in the products they produce and encourage their growth — leading to greater economic opportunity.

In Davos, this community exists and industry acceptance, adoption and growth is achieved. We saw investors, entrepreneurs and government officials come together to have those difficult conversations and reach a mutual conclusion — global acceptance, adoption and growth requires all voices to be heard. When this happens, innovation can thrive, economies can benefit and change happens.

While in Davos, we were encouraged to hear chatter about alternative routes to the public markets and capital formation — via direct listings and crowdfunding. This venture mentality is what our market is built on and where innovation thrives. At OTC Markets Group, we’ve seen industries such as digital currencies and biotech earn the “street cred” they deserve by using old concepts in new and innovative ways and being brave enough to experiment with the unknown. The result? New companies demonstrating good governance and building long-term value for investors and stakeholders alike.


With the Triple Bottom Line, a framework or theory that recommends that companies commit to focus on social and environmental concerns just as they do on profits, being tossed around quite a bit, it is clear, this is increasingly becoming the new standard. No longer can companies exclusively serve the interests of only shareholders; now they must consider a broader range of stakeholders — from employees to suppliers, the environment, and even the communities in which a business operates — are all equally important.

Companies and the executives who run them are being held to very high standards — and our economies and communities are better for it. Companies that trade on our market understand the need for disclosure and transparency to attract sophisticated global investors. This renewed focus on better corporate governance is good for companies, good for investors and good for our markets.

An International Perspective

While there was plenty of doubt and criticism on the global stage in Davos, that pessimism was overshadowed by a renewed appetite for innovation, global cooperation and achievement. We should expect to result from shared dialogues and ideas. From inclusivity and professionalism, to gaining a broader international perspective, the themes and ideas we heard in Davos have been tested in front of a global audience and are poised to drive an innovative global future.

Source: OTC Markets Blog

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Rising Above with a Winning IR Strategy

When the fundamentals of Investor Relations – telling a compelling story to the right investors – are upheld, the results can be extremely positive. However, it can be difficult for small and microcap companies to properly resource IR given that their smaller teams are often tasked with multiple responsibilities.

Over the past three years, OTC Markets and IR Magazine have co-hosted the IR Magazine Awards – Small Cap. The most recent awards provided key learning on how a well-designed IR strategy helps drive the success of the company.

Our recent whitepaper with IR Magazine underscores a range of IR best practices from the nominees and winners, including:

  • A successful rebranding campaign by Safehold
  • Industry-leading investor targeting by RMS Medical Products
  • Enhanced investor communication by NAPCO Security Technologies

Portfolio managers also share what they are looking for in terms of a winning IR strategy from the companies in which they invest.

To view the complete report: “What does it take to have a winning IR strategy?”, please visit IR Magazine.

Source: OTC Markets Blog

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Proposed SEC rule changes could impede investor activism

The Securities and Exchange Commission (SEC) is considering rule changes that could undermine investors’ ability to push for better environmental performance at publicly traded companies by creating new restrictions on who is eligible to file shareholder proposals and how much support they need to make it onto the proxy statement.

A network of corporate oil and gas interests appears to be behind the new proposals, partly by manipulative means, according to an extensive Bloomberg investigation.

To understand why you should be watching what would seem at first blush to be mundane, technocratic tinkering with wonkish regulation, it helps to understand the mechanisms at play.

Shareholders in publicly traded companies have the right to vote on certain corporate matters. As most people cannot attend companies’ annual meetings, corporations offer shareholders the option to cast a proxy vote by mail or electronic means. While most proposals originate with company management, a growing investor movement uses shareholder proposals or resolutions to promote more sustainable business practices. This is becoming increasingly difficult for corporate boards to ignore.

This process is codified under SEC Rule 14a-8, and investors with an interest in environmental protection consider it a useful way to proactively and constructively engage with the companies in their portfolio. Sustainability-minded investors have made unprecedented headway with shareholder resolutions in the last few years, achieving increasingly high votes in favor of their proposals and, for the first time in 2017, receiving a majority of votes in favor. These developments came about in no small part because major institutional investors, including BlackRock, Vanguard and Fidelity, threw their support and weight behind some proposals.

Indeed, it is acknowledged in the investment community that environmental and social issues have a significant bearing on financial outcomes, according to the Sustainable Investments Institute (Si2). The biggest mutual funds, which control large swaths of the financial markets, are paying closer attention to engagement on these issues with their portfolio companies. Their support for many ideas expressed in shareholder resolutions has both driven support higher and made companies more likely to reach agreements with shareholder proponents.

Furtive backlash

Not everyone is happy with the increasing success of shareholder resolutions, and the SEC appears to be responding to calls to constrain the process.

The proposed revisions to Rule 14a-8 (PDF), which the SEC published Nov. 5, would place new restrictions on who may file proposals, increase the amount of support a proposal must earn to qualify for resubmission the following year, and impose new requirements on proxy advisory firms.

These ideas are the long-held aspirations of business groups such as the Business Roundtable and the National Association of Manufacturers (NAM), according to Si2. The SEC is accepting public comments on the proposed changes.

Bloomberg reporters Zachary Mider and Ben Elgin published an investigation Nov. 19 that bolstered claims of a clandestine campaign by oil and gas interests to promote the proposed changes at the SEC. The investigation found evidence that a coalition of industry groups including NAM — of which Exxon Mobil and Chevron are members — sought to manipulate the public comment process to create the impression that droves of ordinary Americans passionately support the rule revisions.

SEC Chairman Jay Clayton even held up some letters from “long-term Main Street investors” at a meeting in Washington, D.C., as a source of support for the changes. But according to Mider and Elgin, “a close look at the seven letters Clayton highlighted, and about two dozen others submitted to the SEC by supposedly regular people, shows they are the product of a misleading — and laughably clumsy — public relations campaign by corporate interests.”

The arguments

NAM, the Main Street Investor Coalition it founded, the U.S. Chamber of Commerce and the Business Roundtable argue that the investment process has become politicized, and that corporate management teams and boards should focus on maximizing profits. Further, some suggest that individual investors are being subsumed by the shareholder resolution process.

However, individual investors almost never vote their proxies, and the Bloomberg investigation revealed that those few who appeared to take the trouble to comment on the SEC proposal lent their names to the letter-writing process after being persuaded to do so by a public relations firm. The PR firm wrote the letters, and the people whose names were signed acknowledged after the fact that they were entirely unfamiliar with the topic of proxy voting.  

On the other side of the fence, Ceres — a coalition of investors and companies working to solve sustainability challenges — cautions that the proposed rule change would “restrict an important avenue that investors use to manage risks and respond to emerging trends.”

Josh Zinner, CEO of the Interfaith Center on Corporate Responsibility, echoed the position of many investors who oppose the revisions: “For over 75 years, the shareholder proposal process has served as a cost-effective way for corporate management and boards to gain a better understanding of shareholder priorities and concerns, particularly those of longer-term shareholders concerned about the impact of environmental, social and governance issues on the long-term value of the companies that they own. We see this unjustified action by the SEC as part of a broader move across this Administration to realign the regulatory landscape in favor of corporate interests at the expense of the public interest.”

The specifics

The proposed rule changes would:

  • Increase the value of stock shareholders need to own before they can submit proposals if they haven’t been invested for three years;
  • Raise the level of support shareholders need to resubmit a proposal that previously had failed;
  • Eliminate investors’ longstanding practice of pooling their shares to meet filing thresholds; and
  • Place substantial new requirements on proxy advisory firms to share their recommendations with corporate management before shareholders could see them, and to allow companies time to review and comment on the firms’ advice.

The impact

Ceres contends that the additional requirements of proxy advisory firms will undermine their independence, objectivity and effectiveness.

Si2 conducted a backtest analysis of previous shareholder resolutions and found that more than 14 percent of them would have been excluded under the proposed resubmission requirements. It also found that the new rules disproportionately would have disqualified shareholder resolutions seeking greater transparency and disclosure on corporate political spending and lobbying. The SEC did not evaluate the nature of the resolutions that would be affected in its economic analysis.

“The SEC’s economic analysis appears very thin and lopsided, and does not even attempt to evaluate the benefits of the shareholder resolution process,” said Heidi Welsh, Si2’s executive director. “Shareholder proposals provide an early warning signal of risks and opportunities for management and boards. It allows them to test the waters with their broader investor base on issues identified by smaller investors, and to get more information about their shareholders’ views. Why would less information about complex matters be better? The SEC doesn’t provide a good answer for that.”

Consider the case of Boeing. Under Si2’s analysis, a shareholder resolution requesting more disclosure from the company on its lobbying activities would not have been allowed to proceed past 2016, despite that proposal’s generally upward trend in support. In the past year, we have seen the tragic cost in human lives of poor regulatory oversight of Boeing’s safety procedures. Of course, a complex set of factors contributed to the Boeing 737 Max crashes, but a case could be made that some of the company’s shareholders had detected a problem well in advance of the crisis.

While no database exists that would allow similar backtesting of the proposed changes in stock ownership thresholds and pooling elimination, investor groups who have been active in submitting proposals say their ability to do so under the new requirements would be significantly hampered.

The proponents of the rule changes declined to comment further beyond their existing public statements. High-level managers at several energy and oil and gas companies allowed, off the record, that shareholder resolutions had been instrumental in driving support for important environmental innovations within their organizations, and expressed concern that any weakening of that signal could stymie important progress.

What’s next

The public comment period is open to all until Feb. 3. Thereafter, the SEC will have to hold another vote to finalize the rules. It has not yet announced the timing of that process.

Editor’s note: At GreenBiz 20, we’ll host the second annual GreenFin Summit, bringing together 200 or so companies, institutional investors and ratings organizations for two half-day sessions to identify opportunities to align corporate reporting with investor needs. 

Source: GreenBiz.com