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The Journey From Public “Shell” to World’s Largest Ad Agency – 8 Business Lessons.

One of my favorite microcap success stories is that of WPP – a British multinational advertising and PR company that grew from public shell to the world’s largest advertising agency through an aggressive acquisition strategy. 

WPP stands for “Wire and Plastic Products”, a public company founded in 1971 as a manufacturer of wire shopping baskets.

In 1985, “With help from a stockbroker“, Martin Sorrell (founder and current CEO of WPP) “looked for a small, publicly traded business that [he] could take over as a shell company and grow by acquisitions into a major global marketing organization.” The company they decided on was Wire and Plastic Products and “It was worth about $1.3 million at the time.

Sir Martin Sorrell
Sir Martin Sorrell

In 1986, Sorrell took over WPP and made 18 acquisitions in his first 2 years as CEO. Sorrell’s acquisition strategy focused on firms specializing in, what are known in the industry as, “below the line” marketing functions.

After the first 18 acquisitions, WPP went on to make more acquisitions including the acquisitions of  J. Walter Thompson (for $566m in 1987), Ogilvy Group (for $864m in 1989), Young & Rubicam (for $5.7 billion in 2000), and  AKQA (for $540 million in 2012).

Today, WPP is worth about $30 billion and does over $10 billion in annual revenues. Sorrell continues to serve as CEO of the company. He was also knighted in 2000 and, in 2007, Sorrell was awarded the Harvard Business School’s highest honor, the Alumni Achievement Award.

The Sorrell and WPP story provides a lot of great insights for entrepreneurs and especially for microcap management teams. Below are 8 business lessons I learned from studying WPP and Martin Sorrell. 

1. Build Your Reputation – Sorrell says “My father had always told me that I needed to build a reputation in an industry before going out on my own. By 1985 I was 40 years old, I had a $2 million stake in Saatchi & Saatchi, and I had built the reputation I needed.” When Sorrell was Saatchi’s group finance director (from 1977 to 1984) he designed and carried out many of Saatchi’s agency acquisitions.

2. Put Your Money Where Your Mouth Is –  Sorrell leveraged his stake in Saatchi to get a loan to purchase his initial stake in Wire and Plastic Products. Sorrell says in his HBR pieceWhen I first invested in this company, I took a gamble with my $325,000… The only time I ever sold shares was to fund my divorce, so all my wealth is tied up in WPP. That’s the way I like it.

3. Boring Can Be Profitable – In Sorrell’s first two years as CEO, WPP made 18 acquisitions. These first acquisitions focused on firms specializing in what are called ‘below the line’ marketing functions. Sorrell describes ‘below the line’ as “the unfancy, unsexy stuff—packaging, design, promotions. Below-the-line agencies never get much attention, but they can be good businesses.” Not only did WPP’s revenues and market share grow but its market cap did too. Sorrell says, “The stock market liked our strategy, and our market cap kept growing.

4. Use Stock For Acquisitions – WPP’s first 18 acquisitions included 15 UK and 3 US companies to become the largest ‘below the line’ business on either side of the Atlantic. Sorrell says they completed those first 18 acquisitions “using mostly our shares as financing“. After the first 18 acquisitions, WPP was worth about $250 million. They then purchased  JWT for $566M (half cash, half stock) and two years later they acquired Ogilvy & Mather in adeal worth $850 million (half in cash, half in convertible preferred stock).

5. It’s Better To Have a Small Piece of a Big Pie – Today, WPP is worth $30 billion and Sorrell owns 2% of it. Sorrell’s use of stock to complete acquisitions often diluted his ownership but increased the value of his smaller stake. For example, when WPP was worth about $250 million, he acquired JWT for $566M, half cash, half stock – in this instance Sorrell gave up nearly half of his company but increase the value of the company by more than 3x. 2% of a $30 billion company ($600M) is worth a lot more than 100% of the $1.3M shell!   

6. Invest In Your People – As the parent company of all of these acquired businesses, WPP was always looking to add value as a parent. One of the top ways WPP does this is by investing in their people.  WPP invests in their people a number of ways including; a fellowship program that “is regarded as the industry’s gold standard and is harder to get into than Harvard Business School“, the Leadership Equity Acquisition Plan (“LEAP”) in which top operating and parent company executives are offered an opportunity to invest their own money in WPP shares and are “paid out a multiple of that investment over a number of years—if WPP’s share price outperforms its peer group“, and more!

7. Embrace Change – As a result of a recession immediately following the Ogilvy & Mather acquisitions, Sorrell had what he calls his “come-to-Jesus moment” that forced him to reconsider what WPP needed to do to fuel growth. Some of those changes WPP made to fuel growth include early entrance into BRIC countries a focus on digital earlier than their competitors. In 2000 about 12% of WPP revenue was coming from Brazil, Russia, India, and China and today nearly 1/3 comes from ‘fast-growth economies’. Digital accounts for as much as 40% of WPP revenue today and Sorrell says that “someday that will probably be 100%.

8. Dream Big – When Sorrell took control of a public shell worth  $1.3M he had no clear idea how big the firm would become, he says, but knew he wanted to do something of size. “I didn’t want, forgive the phrase, a Mickey Mouse kind of thing: I wanted to do something of scale. Putting it grandly, from an intellectual point of view, I thought it interesting.

 

If you want to learn more about WPP/Sorrell’journey from public shell to world’s largest marketing agency, Sorrell penned his own piece in the Harvard Business Review titled; “WPP’s CEO on Turning a Portfolio of Companies Into a Growth Machine” and The Guardian has a great piece titled; “Sir Martin Sorrell: advertising man who made the industry’s biggest pitch“.


About Ben Kotch:

Ben Kotch is a managing director and investment committee member at Acquis Capital, LLC, a private investment firm that specializes in acquisitions. 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 GENERAL INFORMATION 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.

HIGH Cannabis Company Valuations.

HIGH Cannabis Company Valuations.

The other day, I read a post on Axial about “5 Predictions for Cannabis Investing in 2017“.

One of the predictions was that “Valuation multiples may be on the rise” in the cannabis space. The below chart of price to sales ratios for cannabis companies was included in the post.

0117_CannabisChart_03.png

At first glance, I thought an average valuation of 16.4X sales was very HIGH. I then realized that these are public (mostly microcap) cannabis company valuations. As many of you know, the majority of these companies have market caps of $10 to $50 million despite little or no sales.

I understand that two things factor into these high valuations; 1. Cannabis is a very high growth and relatively untouched industry and 2. public cannabis companies have inflated valuations because they are the only way for the masses to participate in this blossoming industry.

What I don’t understand is how “investors” plan on making a return on investment at these valuations!

I think very few of these investors will make a return for two reasons:

1. Most Cannabis Companies Will Fail. 

Unfortunately, the vast majority of startups and early stage businesses fail. Due to the age of the legal cannabis industry, virtually every cannabis company is early stage. Cannabis companies are even more likely to fail because there are a number of untested unknowns including significant legal gray area.

2. Institutional Investors Can’t Justify These Valuations. 

The exit for every investor is either repayment from a company’s cash flow or selling a position to another buyer.

Repayment from cash flow is highly unlikely since you are already buying unprofitable businesses at 16X revenue! Assuming 20% margins at scale, the company’s revenues would need to grow 8,000% to generate enough cash to return your investment.

Your other option is to find someone else to buy your position. Looking at the chart above, valuations are already falling which would make it hard to find a buyer for your position at a higher (profitable) valuation. If the company does grow to the size where institutional investors become interested, institutions will usually not be interested acquiring companies (or taking a position) at 16X sales (primarily for the reasons above).

In short, I think the cannabis industry is a very exciting space but it’s also a very risky space. Becuase of the risk/reward balance, I think the best way to value a small cannabis business is the same way you value any small business. Based on my previous posts on small businesses valuation and general M&A multiples, it’s clear to me that public cannabis company valuations are just too high.

What do you think? Am I missing something? How can a sub $1M revenue cannabis company justify a 16X sales valuation?  Let’s discuss in the comments below or email me.


About Ben Kotch:

Ben Kotch is a managing director and investment committee member at Acquis Capital, LLC, a private investment firm that specializes in acquisitions. 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 GENERAL INFORMATION 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.

 

Penny Stock State of Mind.

Have you ever seen a microcap stock go from unknown and illiquid to a 10X price jump and a 1,000X liquidity increase? I know I have and, if you have been around the microcap space for more than a few hours, you probably have too!

Just the idea of buying a stock for pennies and becoming a millionaire overnight is enough to drive countless retail investors to buy microcap stocks every day. Unfortunately, that “get rich quick” mentality is killing the microcap space! Not only are high school kids, trading on their lunch periods, enchanted by the idea of fast cash but more and more microcap CEOs are too.

In my opinion, microcap CEOs can be split into 3 buckets;

1. CEOs who are trying to build businesses with real value,

2. CEOs who are trying to build a market for their stock,

3. a combination of both.

In my experience, 1s have the highest chance of success, 3s can succeed, and 2s are destined to live the life of penny stock hustler (unless they change). 

1s and 3s usually understand that they need to build value in their company and, eventually, their stock’s value will follow. 2s usually think the opposite.  For 2s, they need to have a $100 million market cap and trade $1 million a day so that they can raise millions of dollars to build their business.

Unfortunately for 2s, it’s nearly impossible to create a liquid, high-priced stock with no underlying business value. If a 2 somehow manages to do it, there are very few investors looking to invest significant capital in a company with little tangible value.

Now it isn’t necessarily the 2s faults. Many CEOs went public thinking a public stock was a license to print money.  When they find out it isn’t, many end up believing market cap and liquidity will turn on the money machine. While liquidity and market cap can help generate funding, it is usually smaller amounts, less company-friendly, and short-lived (not to mention, generating liquidity and market value without tangible value is expensive!).

In short, don’t be a microcap CEO who is chasing the quick money and don’t let others divert your focus. Build a business with real value and eventually, the market will realize that value and reward you!

 

What do you think? Do you know any 1s or 2s? Have you ever seen a 2 succeed?


About Ben Kotch:

Ben Kotch is a managing director and investment committee member at Acquis Capital, LLC, a private investment firm that specializes in acquisitions. 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 GENERAL INFORMATION 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.

Where Did The OTC Graduates Go?

otc-uplists-by-year

Last week, Acquis published the 2016 OTC Markets’ Graduate Review and the data was very interesting.

According to the report, 35 companies uplisted from the OTC markets to the NASDAQ, NYSE, or NYSE Mkt in 2016. That’s a huge drop from 2015 (60 uplists) and an even bigger drop from the average (80 uplists) of the five previous years!

I don’t have a definitive explanation for large decrease in graduates but I do have two theories;

1. More Private Capital – Private capital providers like venture capital, private equity, and angel investors have seen huge growth in the last few years. Even more traditional investors are getting in on private company investing. With tons of capital available to private companies, that wasn’t available 10 years ago, private companies have more funding options than ever before. More private capital means higher valuations, larger funding rounds, and access to a diverse pool of investors – all things that where once reserved for public companies. 

2. Improved OTC – A lot has changed at the OTC Markets in the last few years. The OTC Markets Group has increase the quality of their OTCQB and OTCQX by providing more support to QB and QX issuers and holding those issuers to a overall higher standard. With all of the improvements at the OTC, many issuers are choosing to stick around rather than take on the increased cost and complexity associated with senior exchanges.

The two trends above seem to have a direct correlation to the decrease in OTC graduates.

So, why the drop in OTC graduates? In short, as the OTC Markets improve, less companies want to leave and, as more capital becomes available privately, fewer companies need to go public to raise growth capital.

Click to view the “2016 OTC Markets’ Graduate Review

What do you think? Why did we see such a huge drop in uplists this year?  Share in the comments or tweet at me @Benjamin_Kotch


 

About Ben Kotch:

Ben Kotch is a managing director and investment committee member at Acquis Capital, LLC, a private investment firm that specializes in acquisitions. 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 GENERAL INFORMATION 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.

 

Spitting Watermelon Seeds.

Spitting Watermelon Seeds - Entrepreneur

The other day I saw a post on LinkedIn by Ryan Holmes titled: “3 Worst Entrepreneurial Habits Revealed (by a watermelon)“.

Holmes tells the story of a friend who spent time living in a Canadian village accessible only by plane. Because of the distance, food prices in the village were very high. One day a watermelon arrived in town and the shopkeep placed a $85 price tag on it.

$85 was a lot of money for the people in the village. The community members came up with a solution; cut up the watermelon and sell it in individual pieces so everyone could have some and share the cost. While the community members’ solution seemed logical, the store owner refused to cut up the watermelon. Eventually, “the rare and precious fruit was left to rot on the shelf, unbought and uneaten“.

Holmes say this story shows “three of the worst entrepreneurial bad habits converge: inertia, ego and fear“. He then goes on to detail each bad habit. It’s a great post and I suggest any entrepreneur give it a read.

You can find Ryan’s post on LinkedIn HERE

In the comment section, a LinkedIn user asked; “why no one decided to buy the watermelons themselves and sell them in parts.

This user’s comment highlights the most valuable lesson from this story – good ideas are a dime a dozen but the ability to execute is rare.

The town’s people all thought the shop owner should cut up the watermelon and sell it in pieces but no one wanted to take the risk and/or put in the effort to do it themselves. No one executed!

Some might be surprised at how often I speak with different management teams with nearly identical business plans. While some succeed, others don’t and failure is usually not because of a lack of good ideas. I’m also guilty of thinking of “great ideas” only to never do anything about them and later see an article in TechCrunch or VentureBeat about someone who is executing on my idea. Success or failure isn’t a result of the quality of an idea, it is a result of the quality of execution!

So, if all you have is a great idea and no execution, you are just spitting seeds…


About Ben Kotch:

Ben Kotch is a managing director and investment committee member at Acquis Capital, LLC, a private investment firm that specializes in acquisitions. 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 GENERAL INFORMATION 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.

Acquisitions By MicroCaps Aren’t The Problem…

Acquisitions By MicroCaps Aren't The Problem...

I recently read a blog post titled “Why Do Most Acquisitions by Microcaps Destroy Shareholder Value?“. The author points out that “50-90% of all mergers and acquisitions fail to meet financial expectations” (a statistic some considered to be skewed by unrealistic expectations, billion dollar M&A blunders, and a lack of data on lower market M&A).While it’s very true that many M&A transactions fall short, I disagree with the author’s implication that most microcap acquisitions directly destroy shareholder value.  

I would argue that M&A actually increases a microcap’s chance of success. In fact, the author writes “Even though M&A is rarely successful, the irony is that some of the biggest microcap success stories had disciplined acquisition strategies“.

A few examples of successful microcap acquirers include; 1. Middleby Corporation, 2. MTY Food Group, 3. WPP plc, and 4. Cisco Systems. While the list goes on, and I don’t know the exact statistic, I would guess that over 50% of public companies that grew from a valuation of less than $50M to over $1bn grew through M&A. 

Those familiar with microcaps, or small businesses/startups in general, know success is extremely rare. While M&A failure is pegged at 50-90%, we can’t forget that the rate of failure for startups is very high and it’s even higher for microcaps!

There is no absolute formula for value creation (or destruction). Saying most acquisitions by microcaps destroy shareholder value is akin to saying most microcaps in a specific industry or with management teams of a certain pedigree destroy shareholder value. 

So what reason does the author give for his statement that “Most Acquisitions by Microcaps Destroy Shareholder Value”? Well, he lists 5; 1. Quality, 2. Equity Dilution, 3. Acquisitive Management Teams Using Equity, 4. Large “Transformational” Acquisitions Using Equity, and 5. Too many Too Fast Using Equity. 

In short, the author is saying that most acquisitions made by microcaps fail because most microcap management teams are unqualified and lack the discipline required to execute an M&A strategy (or any strategy). And on that point, I couldn’t agree more! 

What do you think? Is “Most Acquisitions by Microcaps Destroy Shareholder Value” a fair statement? Are there better ways to grow a microcap than M&A? 

Keep an eye out for my next post on this topic where I will discuss ways to overcome the 5 reasons most acquisitions by microcaps destroy shareholder value.  


About Ben Kotch:

Ben Kotch is a managing director and investment committee member at Acquis Capital, LLC, a private investment firm that specializes in acquisitions. 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 GENERAL INFORMATION 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.

Pros & Cons Of Converting Micro-Cap Debt To Equity.

Pros & Cons Of Converting Micro-Cap Debt To Equity.

It seems like more and more small investment firms in the micro-cap space are looking to convert third party debt of micro-cap public companies into equity. Most micro-cap CEOs probably get calls every day with offers to “restructure their debt”, “clean up their balance sheet”, “convert their old debt to equity”, “eliminate liabilities”, etc.

Using  rule 144 and/or the exemptions available under Section 3(a)(9) or 3(a)(10) of the Securities Act, investors usually create free trading stock quickly by eliminating an issuer’s debt. While there are instances where converting debt to equity can be truly beneficial for an issuer, the majority of micro-cap debt to equity conversions leave issuers worse off than before the restructure.

So when does converting micro-cap debt to equity make sense?  In my opinion, debt restructures are most helpful for revenue generating companies who can use cash, that would have been used to pay debt, to fuel growth. For pre-revenue companies,  a debt restructure tends to be a much riskier proposition.

Below, I break down the Pros & Cons Of Converting Micro-Cap Debt To Equity.

PROS:

1. Repurpose Cash Flows – Revenue generating companies can repurpose cash flow to fuel growth. Income that would have been slated to pay liabilities can be used for other purposes. By reducing or eliminating payables for things like inventory, marketing, R&D, and general admin, a company can temporarily increase available cash flows from operations and use those cash flows to fund growth.

2. Maintain Creditor Relationships – Converting liabilities into equity allow issuers to maintain a strong relationship with creditors. Meeting obligations to creditors (including investors, lenders, suppliers, and service providers) allow for continued access to those credit sources.

3. Speed – When creditors need to be satisfied quickly, converting debt to equity tends to be one the fastest options. With no registration statements, no extensive underwriting or due diligence, and “boilerplate” legal documentation, investors in these transactions can fund in as little as a few days with minimal upfront costs to the issuer.

CONS:

1. Little Value Creation – Debt to equity conversions usually do little in the way of creating traditional value for micro-cap issuers and their shareholders. Maintaining a strong relationship with a key creditor or supplier can be important and beneficial but the costs often outweigh the benefits.

2. Poor Reception – Investors usually view these transactions as a last ditch effort by management. Some of the standard debt to equity terms can be discouraging to market investors and future direct equity investors. With little value creation and less than ideal terms, market support for newly issued (primarily free trading) equity tends to be limited.

3. Temporary Solution – These transactions usually don’t solve long-term cash flow and/or financing problems. Rather, they tend to hamper an issuer’s ability to raise future funding and don’t provide a path to satisfying the same creditors in the future. Additionally, satisfying older liabilities, that may not have required immediate payment, only increases short-term dilution without solving the issuer’s short-term business or financing needs.

In short, converting debt to equity can be a useful tool but it is often used in the wrong situations, by the wrong companies, for the wrong reasons. In my opinion, these types of transaction best serve revenue producing companies and do more harm than good for pre-revenue micro-cap issuers.


About Ben Kotch:

Ben Kotch is a managing director and investment committee member at Acquis Capital, LLC, a private investment firm that specializes in acquisitions. 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 GENERAL INFORMATION 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.

Sellers NEED To Take Stock!

Sellers NEED To Take Stock!

In previous posts, I’ve discussed how seller financing is the key to acquisition financing. While seller notes are certainly helpful, nothing pushes an acquisition like a seller excited about owning stock in the newly combined entity. For cash-strapped micro-caps, sellers really need to take some stock for the deal to close.

At Acquis, we know how important is is that buyers, sellers, and investors, “row the boat in the same direction”. In fact, our logo represents that coordinated effort. Buyers clearly have a goal of seeing the newly combined entity succeed and, as equity driven participants at Acquis, we too have a lot riding on future business success. Seller motives, on the other hand, tend to vary.

I have seen sellers begging for more stock and I have seen sellers literally say “I don’t want any of your company’s stock”. As a buyer, which of these two extremes would you prefer to work with? Hopefully, you agree that it’s the seller who wants your stock.

A seller who believes in the future of the business (and proves it by taking a significant equity position a/k/a a “rollover“) is the kind of seller who will encourage investors & lenders, be flexible with a buyer to make the deal work, and help the newly combined entity succeed in the future.

So what if a seller only wants cash? My advice would be to proceed with caution. While there are often legitimate reasons for wanting more cash, those reasons typically don’t favor the buyer. For cash-strapped acquirers, raising capital can be difficult and that process is made even harder when sellers ask for more cash as they signal that they don’t believe the future of the business. Not taking stock signals that sellers don’t think the newly combined entity will be successful and perhaps they don’t believe in the future of the target itself.

I speak with a lot of cash-strapped acquirers. Some run around spending money they don’t have on targets that are looking for a big payday while others target deals using stock and other forms of seller financing (with small cash components). In my experience, the buyers who spend too much money they don’t have don’t succeed and those that “sell” sellers on the future of the combined entity have a much higher success rate.

 


About Ben Kotch:

Ben Kotch is a managing director and investment committee member at Acquis Capital, LLC, a private investment firm that specializes in acquisitions. 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 GENERAL INFORMATION 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.

5 Reasons Why M&A Is The Best Way To Grow A Micro-Cap Public Company.

5 Reasons Why M&A Is The Best Way To Grow A Micro-Cap Public Company.

Growing a micro-cap public company can be very difficult. Many approach growing a micro-cap public company the same way they would a start-up. While organic business growth is important, it is usually too slow and expensive for a micro-cap public company.

In my experience, the best way to grow a micro-cap public company is through acquisitions. Micro-caps are basically designed for growth through M&A. In a previous post, I compared a micro-cap public company to a Ferrari and M&A to the open highway.

Some of you reading this might be thinking; “how could anyone compare a micro-cap to some of the finest luxury sports cars in the world?” If you are one of those readers, your question is probably a result of watching directionless drivers attempt to drive their Ferraris through the mud.  By driving through the mud I mean, trying to grow a micro-cap public company like a private business.

There are numerous examples of micro-caps succeeding by growing through acquisitions (if you don’t want to take my word for it, check out the companies that “uplisted” from the OTC to a senior exchange last year). In this post I will explain why, in my opinion, M&A Is The Best Way To Grow A Micro-Cap Public Company.

M&A Is The Best Way To Grow A Micro-Cap Public Company for 5 reasons; transparency, equity currency, accretion, capital markets, and net operating losses.

Transparency – Whether SEC reporting or meeting an alternative reporting standard, public companies are required to maintain a relatively high level of transparency. From PCAOB audited financials to timely disclosure requirements, public companies (big and small) are held to a higher standard than private companies. While complying with these requirements can be burdensome (as many of you know), compliance also provides sellers and investors with a certain level of comfort. Sellers (receiving notes and/or stock as part of the purchase price), equity investors, and lenders can be confident in publicly available information regarding the acquirer and know that the acquirer will continue to meet important transparency standards in the future. Transparency encourages sellers to require less cash up front and lenders/investors to provide greater funding under better terms.

Equity Currency – Because public companies (should) have stock that is liquid with a third party (market) valuation, stock can be used to pay for part or all of an acquisition.  In theory, stock in a public company can easily be sold for cash affording sellers the opportunity to take stock for future upside while maintaining the option to liquidate at any time. In fact, nearly 20% of M&A transactions in 2015 were all stock transactions. It’s much more difficult for private companies (especially smaller private companies) to use stock for acquisitions because sellers will need to wait for a liquidity event (IPO or acquisition) to turn their stock into cash and the valuation of a private acquirer’s stock is much more abstract.

Accretion – Micro-cap public companies, with exciting growth stories, often have stronger valuations than comparable private companies. Stronger multiples mean companies can acquire private companies at lower valuation multiples and receive a higher valuation on the newly acquired business in the public market (a/k/a: accretive acquisition).

Capital Markets – Access to the capital markets (and the liquidity and valuations they provide) let public companies raise more equity capital faster, and at higher valuations, than comparable private companies. Combining equity capital with stock consideration, seller notes, and traditional acquisition financing; micro-cap acquirers can complete larger acquisitions faster and for a smaller percentage of equity.

Net Operating Loss – While a net operating loss (“NOL“) may be considered a bad thing because they are a result of a business losing money, in many cases NOL’s can be used to offset taxes on future profits (including the profits of acquired businesses). Micro-caps with long operating histories, high legal/accounting/compliance expenses, and little revenue can often offset the tax bills of profitable targets. By levering  past losses a micro-cap acquirer can increase the bottom line of a profitable target once acquired thus increasing its own bottom line.

Those are the  5 reasons why (I believe) M&A is the best way to grow a micro-cap public company. Next time you see a someone lost in the woods with their micro-cap Ferrari, do them a favor and direct them to the M&A highway.

Do you think M&A is the best way to grow a micro-cap public company? Do you have a better strategy? Please 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.

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.