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.
