Going Public Can Cause Unneeded Problems for Firms without Strong Track Records
Most companies that raise capital under Reg A+ have a good chance to create value with it, but being under the microscope of public markets every quarter makes the task more difficult. For most companies in a phase of high growth, it is more prudent to stay private until they’ve proven themselves to the investment community. That’s according to Victor MacLaughlin, founder and CEO of Capital2Market, which advises private companies on capital raises conducted via its own web platform. Currently, Mr. MacLaughlin is advising TerraCylce, which helps clients use hard-to-recycle materials in place of traditional ingredients, on a Reg A+ offering of up to $25 million in preferred stock. In a Q&A with RegAResearch, Mr. MacLaughlin explains the key points to consider when choosing to raise capital privately versus publicly.
RegAResearch: Most Reg A+ stocks have performed poorly since listing. What are the key reasons in your mind?
Mr. MacLaughlin: I believe there are a number of factors that have contributed to Reg A+ stocks performing poorly post IPO. After-market support from the underwriters is missing. Without the brokers’ support and financial commitment post IPO, protective tools are missing for the issuers. That scenario also seems to be providing an easy target for “fast money” and short sellers.
Another factor is the quality of the issuers and whether or not each company is ready to be public. Over the last 2 years we have seen the quality of companies utilizing Regulation A+ increase, which is positive. The negative is that some of these companies are not ready to be publicly traded. The allure of being a publicly traded company is attractive to issuers and the liquidity of an IPO is attractive to investors, but the fact is, most of these issuers need more time to create value with the new capital they just raised.
Philosophically, the JOBS Act was created to give companies the tools to raise capital in a lighter albeit similar process to public companies in the primary market and from investors of all types including individuals. This can also allow them to stay private longer, grow to a maturity, size and management maturity to transition being publicly traded.
Unfortunately, without equal access to liquidity, staying private is not as attractive to investors and the secondary market for private companies at this size is underdeveloped. That combination could be forcing some good companies to make suboptimal decisions to create liquidity by prematurely going public.
RegAResearch: What are the most important benefits of remaining private?
Mr. MacLaughlin: Corporate governance, the time to create value and achieving 1, 3, and 5-year corporate goals. Running a high-growth business is difficult enough for most CEOs, and adding investor relations (as needed for a public company) is another consuming role for the CEO which can take away valuable time to focus on the company.
Second, creating value from capital raises takes time. Most of the companies using Regulation A+ to raise $10 to $20 million will be able to create value, enabling them to have a much better opportunity for a successful IPO in the future. Being public instantly creates a microscope every quarter which is not typically to best way to run a high growth company.
Finally, a company that is capable to have a liquidity event in less than 5 years should consider staying private to provide the time required to create more value. There are significantly more successful acquisitions than IPOs. If the company is already growing and there is value that can be created, why force an IPO? Chances are more likely that you will be acquired without having to make a forced decision now.
RegAResearch: What advice would you give to clients who believe a public listing is important to prospective investors who need liquidity?
Mr. MacLaughlin: It would depend on the issuer. I would need to understand why the investors need immediate liquidity in order to invest in their company. As discussed, some good companies have had poor results from their IPOs through Regulation A+. In my opinion, very few companies are going to be successful taking the public route immediately unless the quality of companies in the space is improved. A future Regulation A+ offering, perhaps when valuation is higher and it’s possible to raise a larger sum, is an option to consider. Taking Spotify as an example, it has been shown that a company can have a successful IPO without firm-commitment broker backing. But, keep in mind its size, revenue and management solidification. We are talking about apples and oranges, comparing the size of that company to recent Regulation A+ offerings.
RegAResearch: What are the best ways for private companies to provide liquidity short of a public listing?
Mr. MacLaughlin: There is no perfect solution, but companies choosing to stay private do have some options in order to decrease investor thirst for liquidity. Structuring the offering to pay dividends to the investors, offering to purchase the securities back at some point in time, or allowing the investors to participate by selling their shares in future offerings are a few ways issuers can help with their investors’ anxiety without having to IPO. Above all is communications. A well-informed shareholder of a private company is far less likely to be compelled to sell.
RegAResearch: How does the fee structure differ for companies that choose to raise equity under Reg A+ but remain private for now?
Mr. MacLaughlin: The ongoing costs for a private company are less than a reporting company. Semi-annual reports with unaudited financials and an annual report with audited financials must be filed by a company that has completed a Regulation A+ Tier II offering. A reporting company must file 10-K, 10-Q and 8-K reports which are more expensive and onerous on the company.
RegAResearch: One criticism of non-traded equity is that companies don’t need to provide as much disclosure. How can that be addressed?
Mr. MacLaughlin: I think Regulation A+ disclosure requirements, especially for Tier II offerings, are suitable standards for private companies raising capital. Two-year audited financials, SEC qualification and a Broker/Dealer relationship should be enough due diligence to mitigate risk for the investors. A proactive approach and transparency with investors should be standard procedure for any company raising capital, especially when dealing with non-accredited investors. As we have seen recently, you will run into trouble if you incorrectly provide information to the SEC. Hopefully, now that issuers see the SEC taking action, it will deter them from filing false information.
Post offering, issuers should also understand the ongoing costs of reporting and work with the correct providers to assist with those needs. With technology today, it’s not difficult to develop to disseminate information to your investors from the start at a marginal cost. And to repeat a theme, above all is communications. A well-informed shareholder of a private company is far less likely to be compelled to sell.
RegAResearch: The reputation of Reg A+ may have been tarnished by the actions of a small number of companies. Is that fair and what can be done to restore confidence?
Mr. MacLaughlin: There are “unknowns” anytime you do something that hasn’t been done before. I would be careful to use the word “tarnished” because it would be negating the positive achievements and efforts those pioneering this industry have accomplished to fulfil the vision of the JOBS Act. Due to some early results, it is fair to say the market can be criticized for a few reasons with the most glaring being post IPO results. This can and must be fixed if this market is going to thrive, meaning a place for investors to trust with their capital. A high level of due diligence must be completed by the brokers and outside service providers on these issuers. Regulation A+ has a long way to go and I believe the best is yet to come. We’ve learned what should and should not be done and we are developing and implementing the processes to have it work properly and productively for all participants. In my opinion, the spirit of the regulation was intended to provide private companies new tools to access capital at scale and for investors or all categories be offered the opportunity to participate. So far, it has been utilized as an easier way to IPO.