Markets

APO Redux: New Solicitation Rules Open the Door for Direct Public Offerings

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No sooner had the ink begun to dry on the SEC’s recently adopted amendment to Rule 506 of Regulation D allowing the public promotion of equity private placements, and free-thinking securities attorneys and investment bankers began pondering the possibilities of their new-found freedom to hawk their wares from the mountaintops. Ever the innovators never willing to accept the well-trodden path when a cleverly engineered shortcut is available, in no time the cleverest among them began to imagine what was only recently regarded as unthinkable: the rebirth of the APO market. APOs, or “alternative public offerings,” are generally referred to a combination of a public shell company with a private operating business that is concurrent with an equity private placement by the public company, which results in a capitalized public company which owns the private operating business. APOs first became popular in the middle of the past decade, when a perfect financial storm of greed, demand and opportunity came together. The greed came from the surfeit of PIPE deal makers – fund managers, placement agents and deal attorneys – that had grown around the PIPE market during its heyday of 2000-2006, when a public offerings market in disarray and a whole generation of newly public internet companies in financial chaos combined to bring PIPEs issuers into the market by the bushel, offering fat discounts to investors who could lock in their returns with a quick call to their options broker.

Legal
SEC

Repeal of General Solicitation Ban Ushers in New Era for Private Offerings

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Last week’s long-anticipated repeal of the ban on public advertising of private securities offerings either ushers in a new era of transparent, information-rich, digitally-greased, and crowd-vetted capital markets, or it is a leap into the abyss that will pervert the most trusted capital markets in the world into a carnival midway of investment hustlers, crowd madness panderers and common thieves. That seems to be the consensus, or lack thereof, of regulators and growth capital professionals surveyed in the wake of the SEC’s action to implement the mandate set by Congress a year ago when it passed the JOBS Act. On July 10, the Securities and Exchange Commission held an open meeting regarding its nine-month old proposal to repeal the ban on the advertising and general solicitation of Regulation D securities offerings. Although the amendment, known as Rule 506(c), was ultimately adopted, concerns regarding investor protection were raised by two commissioners, Elisse Walter and Luis Aguilar. 

Walter’s concerns about the risks of fraud and the promotion of investments inappropriate to less sophisticated investors came short of persuading her to vote against the repeal. Aguilar was blunter in his criticism, decrying the Commission’s move to repeal the ban before approving additional mitigating rules aimed at keeping “bad actors” out of the market and strengthening disclosure requirements for private offerings.

Views

Don’t Confuse Growth Capital Investment and PIPE Financing

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Last month’s Growth Capital Investor webinar on negotiating with hedge funds for financing included a discussion by the program’s panelists, Joe Smith of Ellenoff Grossman and Schole, and Adam Epstein of Third Creek Advisors, over the differences between most hedge fund-originated investments in emerging growth companies and those made by other types of investors such as private equity, venture and mutual funds. The primary difference being that most hedge fund investments should not be considered investments at all. As Smith noted, hedge funds using PIPE structures to invest in small cap companies are better characterized as financiers rather than investors – a critical distinction that company management and boards too frequently fail to grasp, or choose to disregard. Epstein makes the same point in his recent book on small cap corporate governance, “The Perfect Corporate Board”:

“Even seasoned directors and investors sometimes fail to appreciate that in the small-cap ecosystem there are investors and there are financiers….The routine failure of small-cap companies to make that distinction is significant because officers and directors wrongfully assume that any party that invests capital directly into the company is a “partner.” Financiers, though, are not in the partnering business….”

Hedge funds exist in a place in the financial markets which allows them to raise ungodly sums of capital from other investors so long as they deliver to them on two primary objectives: uncorrelated risk-adjusted returns; and near-complete liquidity. These mandates engineer hedge funds to go where the profits come hot and fast.

Markets
Broken PIPEs

As Balance Returns to Growth EPP Market, Traditional Unregistered PIPE Banks MIA

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Five years ago, in the hey-day of the hedge fund-dominated PIPE market, micro- and small-cap market placement agents competed furiously for equity private placement (EPP) business wherever they could find it. While they might be stronger in one sector over others, none of the active banking firms shied from deals in unfamiliar industries – they were seen as growth opportunities. The same held true of issuance structures. Different banks had different strengths but few ever passed on a deal due to the issuer’s structural preferences, and most offered the full palette of structural options to issuers that could command them. The only significant structural specialization developed around equity lines of credit, and to a lesser extent, alternative public offerings (APOs).