By David Weild and Daniel Barfield
Weild & Co.
As Reg A+ deals begin the rigors of marketing and taking reservations from potential investors can you explain the process of converting a "reservation" into an actual buy? What is the process and who does it?
A “reservation” is a very soft indication of interest that is received by a Company during a “Testing the waters” marketing campaign of a Reg. A+ deal. It is a non-binding indication of interest that may take place before anything is filed with the SEC (Securities & Exchange Commission). During “Testing the waters” there is no offering and thus there is no mechanism to accept cash into escrow. Companies that use “Testing the waters” must, if they later decide to pursue a Reg. A+ offering, file with the SEC under Tier II of Reg. A+ because otherwise “Testing the waters” activities are likely to cast them afoul of state regulations (see accompanying Chart from Mintz Levin entitled, “Comparison Chart of Various Securities Offerings”).
The use of “Testing the waters” (not to be confused with the version that precedes the filing of an S-1 or full-blown IPO and is used to poll institutional investors) and “reservations” in Reg. A+ is intended to help the Company gauge the likelihood that a deal can get done BEFORE the Company decides to incur the cost of preparing and filing Form 1-A (the Regulation A+ placement memorandum) with the SEC. The investor may place a non-binding “reservation.” Because there is no obligation on the part of the person making the reservation, some reservations will be inflated in size or simply fabricated by individuals who have no intention of making an investment.
Testing the waters in Reg. A+ is generally accomplished through email or social network messaging to the natural affinity group of a given company. For consumer companies, their affinity group is typically made up of customers. For social networking companies, their affinity group will be made up of users. For companies that are posting on a crowdfunding portal, their affinity group will include members of the portal. Companies with larger and more “engaged” affinity groups are likely to see a greater number of “reservations” from a testing the waters exercise. These companies, market conditions aside, should have a higher likelihood of raising more money than companies with smaller and less engaged affinity groups.
Why is it that although Reg. A+ is gaining in popularity but the closing of deals is off to a slow closing rate? And many deals are not closing at all.
Weild & Co. advises companies on putting together management groups for underwritten offerings (e.g., traditional IPOs filed under Form S-1). We are beginning to do this for Reg. A+ issuers (e.g., offerings filed under Form A-1). Recently, we reached out to and spoke to as many active Reg. A+ filers as would speak to us. What we discovered is an emerging marketplace where companies and service providers are learning as they go, and in the process, making every mistake in the book. The market is characterized by naïve but eager participants and a lack of quality advice on deal structure, packaging, distribution and marketing. This combination, we expect, will lead to a very high failure rate for these companies. Common mistakes we see being made include:
i. Unmarketable deal structures – Whether it be the use of non-voting shares or deal sizes that are too large for the stage of company or the size of the affinity group, many issuers have expectations that are not grounded.
ii. Poorly articulated story – Investors and sales people need to immediately “get” a company’s value proposition, its business and how the company will provide returns to investors. If the story isn’t made obvious and it doesn’t “resonate” the offering won’t stand much of a chance of getting done.
iii. Institutional story in a largely retail market – Crowdfunding and Reg. A+ will largely succeed by attracting retail investors. This is because institutional investors require greater liquidity than small offerings can typically provide. While there are some exceptions to this, those institutions tend to be private placement buyers and the terms and conditions that those buyers require are markedly tighter than what is typically experienced in public offerings.
iv. Inadequate distribution – Most of the distribution groups that we see backing Reg. A+ offerings are undersized. Having priced over 500 IPOs earlier on in my career, I was frequently asked, “How much of the offering should go institutional and how much should go retail?” I would reply, “That is the wrong question?” You should be asking, “How can we maximize demand to create allocation options and leverage?” Companies need to come to market as if they have to sell 100% of the deal out the direct retail channel, the retail broker channel and the institutional investor channel. They need to bring their “A” distribution game. Most Reg. A+ issuers are mounting a “D” distribution game. At this point, I would be giving out no “As” and may one or two “Bs.” That doesn’t bode well for completion percentages.
v. Inadequate marketing budget – It costs money to market stocks and we find that many companies are woefully underestimating the war chest that they will need in order to adequately support the marketing of their offering.
Looking ahead into the future, what can investors in Reg A + deals expect as their exit strategies?
There are likely to be two types of Reg. A+ transactions: 1) Ones that trade publicly and 2) Ones that don’t trade publicly. In the case of a publicly traded Reg. A+ offering, the investor’s exit path is to sell the stock in the public market. However, be careful, because if the stock is traded in the OTC Market and the original placement was quite small, the stock is apt to be illiquid, unsupported, and the transaction cost may be very high as measured by trading “spread” and impact on the stock price. For larger offerings and offerings that are listed on NASDAQ or NYSE, it may be easier to sell the stock. For Reg. A+ offerings whose shares are restricted from trading, the investor will generally need to wait for the Company to be sold or to do a formal IPO. Thus, for investors that are considering an investment in a company whose shares will not be traded, investors should factor into their investment decision the likelihood of an exchange listing, IPO or sale of the Company. If the Company does not paint a credible picture of a path to liquidity, investors are less apt to buy the stock.
Traditional Wall Street investment bankers look to company valuations when determining capital formation looking at before capital infusion and after capital infusion for valuation and deal pricing. How would you compare determining Reg A+ companies’ valuations methods to traditional Wall Street methods?
Reg. A+ companies are still companies. Reg. A+ investments are still investments. As such, the valuation methodologies used should be no different than those applied by professional investors, investment bankers and research analysts that are “reasonably schooled in the art.” Treat investors with respect. Provide value. Have a good business model and a qualified management team. Don’t look to the Reg. A+ market as a place where you can get take shortcuts or inflate values because it will end badly for everyone. As is standard for all types of investments, if there is no liquidity (e.g. private placement) or the prospect of limited liquidity, investors will demand a significant discount to the valuations of larger, more established and liquid companies.
You are a well-known and sophisticated person in the small company space, what's your opinion on the state of Reg A+ at this time? Where is it headed? What needs to be done?
The Reg. A+ market is a “Bad News | Great News” Story. The Bad News is that many people are experimenting and there will be many mishaps and lots of failure. The Great News is that there are a lot of people experimenting that this will drive learning curves, innovation, lobbying and improvements in outcomes, rules and regulation enabling small business to access capital.
We are on the ground floor of a revolution that will, when fully developed, reshape the U.S. economy for the benefit of generations to come. The road to public capital formation had been closed to small companies. Today, it’s open, but there are potholes, roadblocks and detours in the way. Just like any great infrastructure project, there will be companies that will navigate past the potholes, roadblocks and detours while others will never make it to their destination. However, the armies of entrepreneurs that have been unleashed by the JOBS Act in the name of “Access to capital” will, we believe, grind away the potholes and roadblocks while removing the detours. We will look back on this chapter in our history and find that Reg. A+ became a formidable contributor to America’s growth economy.
David Weild is known as the “Father of the JOBS Act.” He is CEO of Weild & Co., the disruptive investment bank creating a network of investment bankers to rekindle small cap, microcap and private company finance. Weild was vice chairman of The NASDAQ Stock Market and head of equity capital markets and investment banking at a major investment bank. He testifies frequently in Congress, at the SEC and has spoken at the G-20, OECD, Budapest Economic Forum, European Federation of Exchanges, Arab Federation of Exchanges and numerous conferences on the JOBS Act and emergent forms of finance including Reg. A+ and Crowdfunding. Weild is a graduate of Wesleyan University and the Stern School of Business. (See www.weildco.com)
Daniel Barfield is a banking, legal and legislative analyst at Weild & Co. He is a graduate of the University of Texas at Austin.
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