If you run an SEC reporting micro-cap public company, you have probably been offered financing through what is commonly referred to as an equity line (also referred to as equity purchase agreement or credit line). Equity lines usually require an issuer to register stock (through an S-1) to be sold from time to time to a private investor via “put notices”.
Often, micro-cap management teams get into financing situations without fully understanding the pros and cons of specific financing structures. I will attempt to outline some of the major pros and cons of equity lines for micro-cap public companies below.
Benefits of Equity Lines for Micro-Cap Issuers: Low cost & high control
Relatively Inexpensive Capital – Compared to the equity funding options available to most micro-cap issuers (especially for general working/growth capital), equity lines have a relatively low cost of capital. Most lines have discounts to market of 25-5% on the date of each put. Often these discounts are accompanied by upfront fees and small ongoing fees. Among other things, registration greatly decreases the investors risk and thus decrease the cost of capital to the issuer.
Management has Control – While naturally all equity financing have some dilutive properties, equity lines allow management teams to control the dilution.Because the issuer elects when to draw down the line, they can draw down when the market price is high and liquidity is abundant. Low cost coupled with high control make equity lines a great financing option for issuers with strong valuations and liquidity or issuers that plan on building strong valuations and liquidity in the near future.
Negatives of Equity Lines for Micro-Cap Issuers: SEC registration, funding based on market & upfront costs
SEC Registration – Equity lines require the filing of an S-1 registration. Any funding is dependent on the SEC reviewing that filing and declaring it “effective”. Those who have gone through the SEC registration process before know it can be a long, expensive, and exposing process.
Market-Based – Funding from equity lines are completely contingent on liquidity and market price. While the issuer can control when to submit put notices, management can’t or won’t submit a put notice when the market price is low or there is little liquidity. In most cases, because the stock is registered, the private investor receiving the stock via the equity line will be selling the stock immediately. If an issuer submits a put notice when there is no liquidity, all they are doing is dumping stock on their own market. Without liquidity, the price will fall too low for another put. While management probably has their own limit for a minimum put price, equity line documents also set a minimum price. Not only can management effectively block the use of the equity line with excessive puts but, if the price falls for other reasons the equity line still becomes unusable.
Upfront Expense – Private investors providing capital via equity lines usually charge high upfront fees. Fees can range from $10s of thousands in cash to $100s of thousand in promissory and/or convertible notes (or both). These fees usually don’t cover/include all of the expenses of preparing the S-1 filing, amending the filing, and having attorneys communicate with the SEC.
In summary, if you have liquidity, a strong valuation, a clean operation, time and excess capital – an equity line is a perfect funding option for you! Equity lines are a great way for micro-caps to raise equity capital as long as they understand the requirements.
Did I miss any of the pros and cons of equity lines for micro-caps? Please feel free to comment and share.
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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