What do Unicorns & Micro-Caps have in common?

ratchet

The recent IPO of Square, Inc. has many taking a closer look at Silicon Valley and their “unicorns”. In  a previous blog post I discussed  how “For Unicorns, It’s a Long Road Out of Silicon Valley.” While its a difficult journey for unicorns, its a little easier on investors because of “ratchets”. If you are the CEO/CFO of a microcap public company, the ratchet concept is probably very familiar to you (although you may be familiar with terms like market conversions, downside protection, market adjustment, etc.). For those of you unfamiliar with the concept, Investopedia defines a “full ratchet” as;

“An anti-dilution provision that, for any shares of common stock sold by a company after the issuing of an option (or convertible security), applies the lowest sale price as being the adjusted option price or conversion ratio for existing shareholders.”

Simply put, ratchets allow companies to raise capital at high valuations by promising investors, that if shares are issued at a lower price, they will have their investment repriced at the new (lower) price or a discount to the new price. For public companies the ratchet is usually based on market price or some calculation thereof. For private companies the ratchet is usually based on the valuation of future private funding rounds, an IPO price, or the sale price (if the company gets acquired).

Those in the micro-cap space know that virtually every funding deal has a ratchet because of volatility in the market and substantial risk. Often, those in the micro-cap space think the ratchet is  an aspect unique to small public companies. What many don’t know is that even Silicon Valley unicorns have ratchets in their funding transactions.

According to law firm Fenwick & West LLP, about 30 percent of private unicorns have/had a ratchet in place with at least some of their investors. In the case of Square, some investors were “guaranteed returns of as much as 20 percent on their investments“. Whats more, in addition to ratchets, unicorn funding transactions also include things like liquidation preferences, board seats, and controlling preferred stock (just to name a few). If you’re a micro-cap CEO, next time an investor asks for downside protection  just sit back and smile because at least you’re not a unicorn!

 

About Ben Kotch:

Ben Kotch is a managing director and investment committee member at Acquis Capital, LLC, a private investment firm that specializes in acquisition funding. He has extensive experience with both private and public companies. Ben graduated with an economics degree from Bentley University where he concentrated in entrepreneurship and law.

 

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NIBA in Paradise!

NIBA in Paradise

As some of you may know, I am a pretty big Jimmy Buffett fan (or parrott head). As some of you may also know, the National Investment Banking Association (or NIBA) will be holding their next investment conference at Jimmy Buffett’s new Margaritaville Beach Resort in Hollywood, FL.

So for those of you that are wondering “what are NIBA conferences?“, I will do my best to explain. To start “Since 1982, The National Investment Banking Association (NIBA) has been a not-for-profit association for national, regional and independent broker dealers, investment banking firms, investment advisors, and related capital market service providers”. Or, for a more simple quote from their website, NIBA members “Are responsible for 90% of all IPO’s under $20MM.” Basically, the conferences are a collection of i-bankers, (mostly public) companies raising capital, investors, and service providers. Like most events in the space, NIBA conferences usually take place in major coastal cities and include company presentations, expert panels, and 1-on-1 meetings.

This is really the ultimate work and play one-two-punch for any parrott head working with small public companies. I’m trying to overcome some scheduling conflicts in order to attend but in the words of Alan Jackson; “What would Jimmy Buffett do?”

 

To register for the February 10-11, 2016 event, click HERE.

 

About Ben Kotch:

Ben Kotch is a managing director and investment committee member at Acquis Capital, LLC, a private investment firm that specializes in acquisition funding. He has extensive experience with both private and public companies. Ben graduated with an economics degree from Bentley University where he concentrated in entrepreneurship and law.

 

For Unicorns, It’s a Long Road Out of Silicon Valley.

Unicorn Silicon ValleyThe trending buzz word in venture capital over the last few years has been unicorn. Investopedia defines unicorn as, “a company, usually a start-up that does not have an established performance record, with a stock market valuation or estimated valuation of more than $1 billion.” Examples of unicorns cover the “who’s who” of tech startups, from Uber to Airbnb.

Square, Inc., a mobile payment processing company founded by twitter co-founder Jack Dorsey, recently shook up the unicorn world when they went public at a lower valuation than their last round of private funding. The Square IPO is just another example of how (what many not drinking the Silicon Valley kool-aid have thinking/saying) extreme private valuations don’t translate into traditional value.

The majority of unicorns are not profitable and thus need to constantly raise capital.  Not only do unicorns constantly raise capital, but they are pressured to raise each subsequent round at a higher valuation than the last.  As valuations climb to extremes ($10 billion +) it becomes harder and harder for unicorns to raise capital at higher valuations than previous rounds.

Unicorns eventually have four options;  (1) run out of cash, (2) raise funding at a lower valuation, (3) sell, or (4) go public. For the majority of unicorns all of these prospects can be very scary! The first option, running out of cash, is just a nice way of saying going out of business. Shutting down is probably not the preferred option for any unicorn’s leadership team and shareholders. That leaves unicorns with three choices; (1) raise capital at a lower valuation, (2) sell, or (3) go public.  All three of those options usually mean accepting a lower valuation than previous rounds. The lack of options is the primary reason many high-profile unicorn investors are beginning to “write down” the value of their unicorn holdings. 

So , why is it that all paths out of Silicon Valley, for unicorns, lead to lower valuations? Let’s breakdown each option individually.

(1) First option is to continue raising capital as a private company. As the excitement fades and best case expectations are replaced with reality, it becomes harder to convince big money investors to value what is essentially a “start-up” equal to traditional billion dollar companies.

(2) Option two is to sell. The problem is, there aren’t many companies with the ability or appetite to purchase multi billion dollar startups! Most multi-billion dollar M&A transactions are of successful target businesses with billions in assets, revenues, and profits that allow acquirers to leverage a target’s financial strengths to finance the deal(s). While there may be some acquirers with the ability to make $10 billion+ acquisitions, without outside financing, they  are often public and can’t justify spending billions of shareholder’s capital to acquire what is essentially a start-up.

(3) The last option is to go public. Many unicorns (Square, FitBit, GoPro, etc.) have chosen this path and have struggled in the market. Most recently Square priced its IPO below the expected price range (although it seems to have recovered for now). FitBit and GoPro stock have both been roller- coaster rides for investors. While Square, GoPro, and FitBit still have the opportunity to prove themselves to the market, perhaps we can look at companies of the dot-com bubble for clues of what might become of today’s unicorns.

While the journey out of Silicon Valley is a difficult one for unicorns, don’t feel too bad for them because they are still unicorns or “wild, un-tamable animals of great strength and agility”!

 

For more on the “Unicorn Bubble” check out these links:

“We’re witnessing a slow motion tech wreck” by Sara Ashley O’Brien

Start-ups raising money, staying private” by Josh Lipton

 

About Ben Kotch:

Ben Kotch is a managing director and investment committee member at Acquis Capital, LLC, a private investment firm that specializes in acquisition funding. He has extensive experience with both private and public companies. Ben graduated with an economics degree from Bentley University where he concentrated in entrepreneurship and law.

 

Micro-Caps are Made for M&A.

In early October, a short article on CFO.com shook up the micro-cap space. The author posed the question “Should Microcap Companies Go Private?” That question also prompted my firm, Acquis Capital, LLC, to post a blog commenting on the article.

In short, the author said there are two ways for companies to justify being public as a microcap. Both involve leveraging publicly traded stock to grow. The first is to use stock to raise capital and the second is to use stock to do acquisitions. Acquis‘ post pointed out that the best way to make the most of being a micro-cap is to combine both (i.e. raise capital and use stock to do acquisitions). To prove the concept I wanted to share micro-caps that have leveraged their microcap status to succeed.

I’ve picked 3 companies to highlight. All have uplisted from the OTCQB to the NASDAQ and all have grown aggressively through acquisitions.

  1. The first is a software-as-a-service company called ARI Network Services, Inc. (NASDAQ: ARIS). While ARIS experienced strong organic growth, by the end of 2013 ARIS had also successfully completed 13 acquisitions.  In December of 2013, ARIS uplisted from the OTCQB to the NASDAQ .
  2. The second is Staffing 360 Solutions, Inc. (NASDAQ: STAF). The staffing company completed 6 acquisitions, adding approx. $140 million in annual revenues, in the 24 months  prior to uplisting. STAF up-listed from the OTCQB to the NASDAQ in September 2015.
  3. The third example, Solar3D, Inc. (NASDAQ: SLTD), uplisted from the OTCQB to the NASDAQ in March 2014. Prior to up-listing, SLTD acquired two profitable solar installation companies with combined annual revenues of approx. $20 million.

In 2014, only 84 out of the thousands of securities listed on the OTC made the jump to a senior exchange like the NASDAQ or NYSE Mkt. Acquisitions played a key role in the growth of many of those 84 issuers. These issuers, and many others, have uplisted by leveraging the unique attributes of microcaps to grow through acquisitions. In conclusion, a micro-cap public company is a Ferrari and M&A is the open highway. If you have a Ferrari, don’t try to take it off-road, keep it on the highway where it belongs and enjoy!

 

To read the CFO.com article, click HERE

To read the Acquis Capital post (“Why are YOU public?“), click HERE

 

About Ben Kotch:

Ben Kotch is a managing director and investment committee member at Acquis Capital, LLC, a private investment firm that specializes in acquisition funding. He has extensive experience with both private and public companies. Ben graduated with an economics degree from Bentley University where he concentrated in entrepreneurship and law.