Why Small and unprepared private companies go public! This is simple they are sold a bill of goods that it will be easy to raise money and they will create liquidity for the principals. There are three programs first the promise of Equity Lines of Credit in the form of PIPE’s (Private Investment in Public Equities) or Convertible Debt that can be converted into free trading shares or forward split of shares, all of these programs result in large blocks of stock flooding into the market tied to a promotion to maximize cash for the participants.
In almost all cases there are Promoters, Key Insiders and Consultants make money. The current shareholders and new ones to be attracted thru the promotion get screwed, not all however will lose out because in any good Ponzi scheme you have to have some winners (early buyers and sellers) to get the scheme going “the momentum curve” but when the promotion stops the last ones in will be the losers every time.
One must point out as well that investors who are willing to act on tips and promotional alerts are not as much victims as they are enablers of the process. In this day and age anyone with an internet connection can research transactions with a couple of stokes on the keyboard and disprove the claims.
One must wonder why these issues do not seem to draw more attention from the regulators. Every element in which these shames are perpetrated the process is either regulated by the Securities and Exchange Commission (SEC) the Issuers and FINRA the self-regulatory agency for Broker Dealers who effect the share transfer. It seems to me that regulators are ineffective in policing this type of transaction and stymy those options such as the JOB’s Act that could benefit the SME business market.
The Red Flags to look for;
1. Large authorized number of shares
a. There is not a legitimate reason to have hundreds of millions of shares. In most cases this is a telegraph of what is to come which is massive dilution and stock manipulation.
2. Sharp increase in shares issued and outstanding
3. Lack of reporting data (compliant public filings)
a. Not a trustworthy transaction.
4. Preferred shares convertible to large number of common for insiders
a. In many cases this preferred position is to protect insiders from dilution and maintain their equity while other shareholders are diluted.
5. Financial commitments based on equity lines and or convertible debt
a. Any financing that is based on a discount to share price with compensating balance covenants are extremely toxic to everyone but the lender.
6. Investor Relations Campaigning
a. The hyping of the company in the open market with little or no validation!
7. Increased number of press releases
a. Increasing press releases with little or no substance validated the potential of an IR campaign.
8. Recent volume spike or spikes
a. For no apparent reason other than an IR campaign is underway.
9. Management turnover
10. Mounting Financial Losses
a. Companies that have never made money will most likely not do so without a significant change in its operation objective.
11. Decreasing or no Shareholder Equity
12. Decreasing or no Gross Revenue
13. Unresolved Litigation
It is my opinion that some of these deals (reverse acquisition) could have worked if they had been approached with a proper plan. The first step in any transaction such as this is the assessment of the company viability as a publicly traded company moving on to preparation and being sure that you fully understand the process not just what you are being told “trust but verify”. It is very unlikely that companies pursuing this type of deal will be able to raise capital other than on a very toxic basis. The only way to raise a sustainable amount of capital is thru a registration which requires a real business fundamentals and business plan. There are no guarantees that even with a registration they will be successful.
Further it is my opinion that a qualified smaller company can employ a public offering to achieve their corporate goals. A company with an established business with growth opportunities based on business and financial fundamentals can control the cost of going public as well as the maintenance and ongoing compliance. The primary reason for going public is the access of fresh capital, create liquidity for current stakeholders! The fresh capital must be adequate to achieve business goals that can provide an increased Return-On-Investment (ROI) for the insiders as well as the new stakeholder’s this includes the added cost of being public and the dilution that insiders will face.
I have been writing about the future of SME size transaction and the future public markets.