So how does one deal with the challenge of building market support for a reverse merged company? This section examines the change in attitude one needs, the importance of retaining a strong investor relations fi rm, the process of earning rather than manufacturing support, and how to build the company to a point where trading is possible on a larger exchange.
Get a New Attitude
Patti LaBelle’s song “New Attitude” serves as a good metaphor for those seeking to go public through a reverse merger—they need a new attitude.
The old-fashioned world thinks the only way to get a company public is through an IPO and an immediate jump in stock trading—activity and
FIGURE 6.1 Recent IPO Deal Activity
MEAN MARKET
RANGE OF IPO SIZES CAPITALIZATION YEAR MEAN SIZE OF IPOS (LOW/HIGH) AT TIME OF IPO
2000 $236.6m $4.1m–$10.6bn $1.4bn 2001 $478.8m $6.0m–$8.7bn $2.0bn 2002 $319.6m $5.7m–$4.9bn $1.1bn 2003 $210.6m $6.0m–$3.0bn $672m 2004 $204.3m $7.7m–$2.9bn $767m 2005 $169.4m $2.7m–$5.1bn $495m
Source: Dealogic. Includes IPOs registered with U.S. Securities and Exchange Commission.
Source: TKTK
buzz. Press reports judging an IPO’s success solely by its fi rst day of trading have been hard to counter.
Practitioners of alternatives to IPOs have found Patti’s religion and un- derstand that going public is not the end of the process, but the fi rst step in a company’s journey as a public company. The fi rst day of trading—or even the fi rst week or month—is not too important. Smart, in-the-know professionals realize that what counts is trading activity one year to eigh- teen months following the reverse merger (or IPO, for that matter).
A company has to think about the long-term benefi ts of being public.
A heavily traded stock is an important goal, but there is no reason it needs to be an immediate goal. Management must not forget the other reasons it had for going public. It is still possible to raise money even if the stock trades thinly. It is still possible to use stock as currency for acquisitions.
It is still possible to use stock options to provide incentives to company managers.
If the stock is thinly traded, it may take a little longer than one might have hoped for investors or founders to be able to cash out of their shares at a fair price. Financings may not be done immediately at the most favor- able valuations. Acquisition targets may need an education as to the true value of a company as opposed to value gauged by market capitalization alone. And if these things need to be put off for a year to eighteen months, in the worst case, until the stock is trading better (you hope), so be it. The company should be focused on its long-term goals.
The Importance of Investor Relations
A strong, reliable, and legitimate “IR” or investor relations fi rm can make all the difference in achieving a solid, long-term trading market for a company’s stock. These service providers help attract attention from Wall Street fi rms and, ultimately, research analysts to improve trading and stock price.
The more capable IR fi rms do not strategize quick fi xes or immediate pops in the stock. They take a measured and longer-term approach to building support. They introduce management to key players at broker- age fi rms that have the ability to encourage investment in a company’s stock. They talk to hedge funds, institutions, and large private investors, arranging “meet and greet” sessions and road shows, which highlight the company’s performance and prospects. Some use technology and online tools to enhance the process, directing the Wall Street pros to a Web-based video or other presentation.
Great IR fi rms go even further and help with strategy and key deci- sion making by offering the Wall Street perspective on any contemplated business maneuver. Sometimes perfectly reasonable business decisions can
Source: TKTK
have a deleterious impact on the trading of a company’s stock. For ex- ample, a decision to enter a new line of business, which might involve signifi cant, long-term investment whose benefi ts current investors will not see for years, might be a smart thing to do. But an announcement of this kind could send a stock spiraling downward if investors believe that divert- ing management attention from current profi t-making opportunities is not in investors’ best interest.
There are many shady and sleazy IR fi rms that promise quick and seemingly impressive results. Even if their activities may not be technically illegal, oftentimes, some of the shoddier fi rms are simply conducting bad business. They create temporary, semibogus support for a stock just long enough to bring in their investor friends, watch the stock rise, get their friends out, and then disappear forever. (This is not too dissimilar from some of the IPO antics that can take place.) After the IR promoter disap- pears, a company can be left with a big mess to clean up and, sometimes, shareholder and SEC lawsuits. In later chapters, we will cover how to spot and avoid some of these bad players.
Earn Your Support
A famous old commercial for the brokerage fi rm Smith Barney included the quote, “We make money the old-fashioned way. We earn it.” Similarly, the best way to build support for a company’s stock, regardless of how it goes public, is to earn it.
Support is earned when a company achieves the things it promises to achieve. Maybe even more important, support is earned when a company does those things that investors and Wall Street want or expect from it.
Paying off a market maker (this is illegal) or hiring a sleazy IR fi rm to hype the stock is not the way to go. Manufacturing events and transactions, as real as they may seem, primarily for the benefi t of getting more attention, rarely makes any sense. It is often said, however, that a company must sell both its products and its stock; and proper utilization of an IR fi rm and making decisions that will yield positive reactions from investors are important steps to take.
In the end, though, sticking to a company’s mission and philosophy has a better chance of paying off than tricks and short-term fi xes. Of course, the mission and philosophy may need to be adjusted over time, and there does need to be some recognition of the need to “please the Street” in the company’s decision-making process. By focusing, however, on running a business to generate profi t and create long-term value for shareholders, a company will generally achieve the best results in terms of stock price appreciation and developing a steady liquid market for its securities.
None of this guarantees success, of course. Sometimes, despite the best
Source: TKTK
efforts of management, IR fi rms, and others, despite sticking to the mis- sion, support simply does not develop. This can happen even if a company is successful and achieving its mission. The time may not be right for the company’s industry in the public markets. The IR fi rm may not have the right connections. The plan may be good but lacking the kind of growth or direction the Street wants to see at that particular time.
These are critical moments in a company’s history as a public entity. At these times, it is important to question whether being public made sense in the fi rst place. Sometimes, the difference between profi ts and no profi ts is the cost of being public. If the company is not using its public status to its benefi t, an honest review of its goals makes sense.
Going public is not without risk. Many who attempt the transition do not succeed. They may end up shutting down or fi ling for bankruptcy.
That is why I recommend careful consideration of the pros and cons be- fore proceeding. Reverse mergers are riskier than IPOs because most of the companies pursuing them are at an earlier developmental stage and, therefore, subject to all the risks of businesses that are hoping to grow.
Many young businesses, whether public or private, do not make it. A company’s public status rarely is the primary reason for failure. In other words, these companies are not more likely to fail simply because they are public. In fact, most end up lasting longer than they might have because of additional rounds of fi nancing or other transactions made possible because they were public. An investor views these opportunities through typical risk-reward analysis, determining that the greater risk of being involved in smaller, earlier stage companies is worth the much greater potential upside if a company is even modestly successful.
PRACTICE TIP
Support from Wall Street should be built the old-fashioned way—
by earning it.
Movin’ on Up
When smaller companies go public, they start out on the OTC Bulletin Board or Pink Sheets, hoping to move up to trade on Nasdaq, the American Stock Exchange, or the “big board,” the New York Stock Exchange.
Why is it important for a company to be able to make this move?
Because everyone from Wall Street to Main Street pays more attention to the company. As a result, stock prices and market capitalizations gener- ally are higher, fi nancing comes easier, short sellers have a tougher time manipulating the stock, acquisitions are more available, attracting senior executives becomes less challenging, and so on. Basically, all the benefi ts of being public truly come into focus on the larger exchanges.
One obvious way to overcome the challenge of building market sup- port on the OTC Bulletin Board or Pink Sheets is to build a company to the point where it qualifi es for listing on one of the major exchanges.
FIGURES 6.2 and 6.3 provide the respective current listing requirements for each of these exchanges.
Each exchange has both qualitative and quantitative criteria it uses to allow a company to list its securities. Each requires hundreds of sharehold- ers, either signifi cant revenues and profi ts or signifi cant assets, a minimum stock price, corporate governance standards, and other requirements. The qualitative review can be tricky, since the listing committee simply may not like a company and declare it is not in the public interest to allow its stock to trade. This gives the examiners enormous latitude and power.
Most newly reverse merged companies are not at the point where listing is possible on Nasdaq or a higher exchange. This is not a negative. It should
FIGURE 6.2 American Stock Exchange Listing Standards
STANDARD 1 STANDARD 2 STANDARD 3 STANDARD 4
Operating History N/A 2 years N/A N/A
Stockholders’
Equity $4 million $4 million $4 million N/A
Net Income* $750,000 N/A N/A N/A
Total Market
Capitalization N/A N/A $50 million $75 million or
Total Assets N/A N/A N/A $75 million and
Total Revenues N/A N/A N/A $75 million
Minimum Price $3.00 $3.00 N/A N/A
Market Value of
Public Float $3 million $15 million $15 million $20 million Distribution
Alternatives 800 public stockholders and 500,000 shares publicly held or 400 public stockholders and 1 million shares publicly held or 400 public stockholders, 500,000 shares publicly held, and average trading volume of 2,000 shares for last 6 months
*Net income requirement applies to previous year, or 2 out of the 3 most recent years.
Source: DealFlow Media
be considered helpful for the newly trading company to “practice” being public, and for management to get used to all the requirements and obliga- tions of being public before a very close scrutinizing eye is upon them on a larger exchange.
For example, it might take time to assemble a proper board and audit committee. Below the major exchanges, no independent board members or audit committees are required. On Nasdaq and above, a majority of the board must be independent, and a completely independent audit commit- tee is required by the Sarbanes-Oxley Act of 2002 (SOX). In addition, the audit committee must include a “fi nancial expert” who has audited a com- pany’s books or served as a CFO (if they do not have such an expert, they have to explain in their SEC fi lings why they do not have such an expert).
FIGURE 6.3 Nasdaq Listing Standards
SMALL-CAP MARKET NATIONAL MARKET
Operating History 1 year and N/A 2 years and N/A Stockholders’
Equity $5 million or $15 million $30 million N/A Net Income* $750,000 or $1 million N/A N/A Total Market
Capitalization** $50 million N/A N/A $75 million or
Total Assets N/A N/A N/A $75 million and
Total Revenues N/A N/A N/A $75 million
Minimum Price $4.00 $5.00 $5.00 $5.00 Market Value of
Public Float $5 million or $8 million $18 million $20 million Number of
Stockholders 300 400 400 400
Number of Publicly Held
Shares 1.0 million 1.1 million 1.1 million 1.1 million
*Net income requirement applies to previous year, or 2 out of the 3 most recent years.
** If $50 million market capitalization is satisfi ed for small cap, then there are no operating history, stockholders’ equity, or net income requirements.
Source: DealFlow Media
Source: TKTK
Since these requirements do not exist on the lower markets or exchang- es, after trading begins the company can begin putting together a board and audit committee that would satisfy a larger exchange.
Nasdaq and the higher exchanges also require a company whose securi- ties are listed on their exchange to hold an annual meeting of shareholders to elect board members and take other necessary action. This meeting is not required on the OTC Bulletin Board or Pink Sheets. Most states’ cor- porate law (such as the popular incorporation site of Delaware) requires an annual meeting, but in many states (including Delaware) the only penalty for failure to hold an annual meeting is the right for a shareholder to bring a lawsuit to compel the meeting to be held. Thus, as a practical matter, the meeting is not required.
I generally encourage public clients I represent on the OTC Bulletin Board to hold an annual meeting as practice for a higher exchange. The meeting also helps protect the board from any suggestion they are too entrenched and not subject to reelection.
Therefore, a terrifi c way to overcome the challenge of obtaining mar- ket support is to build a company to that point where a Nasdaq, Amex, or NYSE listing is possible. Sometimes a company conducting acquisitions or large fi nancings can satisfy the listing requirements and can get there quicker than they thought.