Pros and Cons of Equity Lines for Micro-Caps.

Pros and Cons of Equity Lines for Micro-Caps.

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.

For more on equity lines (and their big brother, the ATM facility), check out this cool white paper from Practical Law Company HERE.

Did I miss any of the pros and cons of equity lines for micro-caps? Please feel free to comment and share.


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 more, please follow on Twitter.


NOTE: THIS BLOG AND ALL OF ITS CONTENTS (THE “SITE”) ARE FOR ENTERTAINMENT PURPOSES ONLY. THE VIEWS EXPRESSED ARE SOLELY THOSE OF THE AUTHOR. THIS SITE SHOULD NOT BE CONSTRUED AS AN OFFER TO BUY OR SELL ANY SECURITIES OR AS AN OFFER TO TRANSACT. NOTHING ON THIS SITE SHOULD BE CONSIDERED FINANCIAL, LEGAL, OR TAX ADVICE.
Advertisements

2 thoughts on “Pros and Cons of Equity Lines for Micro-Caps.

  1. Great article, I believe the all discounts and any accompanied upfront fees can be negotiated. I think that there are 4 to 5 such firms that finance micro-caps and some tend to seem like long term capital partners based on the fact that they pay for the selling shareholders registration statement. If a young company with better and strong fundamentals partners with such a firm I think that the firm doing the equity line should/would not be willing to sell the stock immediately, what do you think? Or do you think they would not care regarding the quality of the paper?

    Liked by 1 person

    1. Hi HK,

      Glad you liked the post!

      That’s an interesting point. While the funder isn’t obligated to sell the stock, I think the purpose of registering the stock is to sell it. Holding the stock poses the risk of losing money versus selling the stock immediately for a profit.

      Granted, if the investor truly believes the stock is going to skyrocket, they may hold on to the stock but the upside would have to be substantial. I think investors using an equity line as a funding mechanism are looking for a safer investment versus upside.

      Just my opinion. Thanks again!

      Like

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s