David Feldman's book, Reverse Mergers: Taking a Company
Public Without an IPO, now in its third printing, was published in 2006
by Bloomberg Press (available on http://www.amazon.com).
View David Feldman's reverse merger blog at www.reversemergerblog.com.
Joseph Smith and David Feldman are coauthors of PIPES:
Revised and Updated Edition - A Guide to Private Investments in Public Equity
(Bloomberg Press, 2005) available on http://www.amazon.com.
In the News
Jospeh
Smith is mentioned in an October 10,
2002 article in The Daily Deal concerning
PIPEs.
INDUSTRY
INSIGHT: Under the Gun
by
Steven Dresner
The
year's third quarter has - thankfully
- come and gone. But for the many companies
that report earnings on a calendar basis,
it isn't over just yet. The financial
community now awaits bad news and balance
sheets. For those investors expecting
the worst, the bad news adds at least
some level of continuity to an already
miserable market. For those expecting
weak balance sheets, the reality will
be downright scary.
Scary not because all these companies
are in jeopardy of defaulting on debt
or violating finance covenants, but
because of the prospects that company
auditors will be looking for ways to
protect themselves in the wake of all
the accounting and corporate scandals
in 2002.
In the recent discussion with
my good friend and private-equity authority,
corporate attorney Joseph Smith, I was
introduced to a theory I just couldn't
ignore. It relates to the business of
Private Investments in Public Equity
(PIPEs) and the likely increase in fourth-quarter
deal activity. The supposition goes
like this:
As prosecutors and the Securities Exchange
Commission seek to restore the public's
confidence in the markets, there is
new scrutiny of the relationship between
a company and its auditors. In certain
circumstances this conservatism may
result in the increased usage of going-concern
clauses inserted into corporate financial
statements.
These clauses, long used as a means
of warning investors (and protecting
auditors) against the possible failure
of client companies, state the possibility
that a business may fall as a result
of having insufficient operating capital
and/or improbability that a company
will be successful in obtaining additional
capital.
This determination is highly subjective,
as it's difficult to say with certainty
that a company may fall if it does not
receive additional capital. But while
the going-concern clauses to companies
that in the past would not have been
considered at worst borderline as it
pertains to the probability of failure.
Decent companies that fall into this
category will surely battle with their
auditing committees over the specter
of a going-concern warning.
Again, such a warning is subject to
personal interpretation. There have
been, and will continue to be, many
companies that can achieve a turnaround
with little operating capital. They
will, in effect, be treated unfairly
based largely upon worried opinion.
Auditors' indifference to unquantifiable
characteristics such as management's
ability to execute a business plan is
indeed unfair. However, given the challenging
market environment, it's likely their
access to capital will decrease.
More to the point is that auditors just
might try to protect themselves by threatening
clients with a warning to fund up or
risk the dreaded clause in their year-end
financial audit. This means that in
order to avoid the disastrous ramifications
of the going-concern clause, companies
will be looking to put some equity on
those balance sheets by Dec. 31.
That's a tight time frame.
How will these companies raise capital
in such a tough environment? It won't
be though public offerings because everyone
knows there's zero demand. It won't
be through debt because that's part
of the problem to begin with. It'll
be through private equity investments
- or PIPEs. These privately negotiated
transactions will provide desperate
companies with quick capital and institutional
investors with potentially high returns.
Company management teams will not have
the luxury of telling their boards,
"We'll raise equity capital when our
stock price is fairly valued." The company
with a $5 stock can't argue it's really
a $10 stock and the $10 stock a $20
stock. Companies will either raise capital
in order to survive, or they'll soon
have a $0 stock.
What does this mean for the PIPEs business?
Busy times lie ahead. I believe it's
item for bankers to rev up the marketing
engine in anticipation of some bad news,
courtesy of accountants looking to cover
themselves.
Come late October, there will be lots
of boardroom discussions about changing
auditors. But ultimately, all auditors
will be concerned with the same thing
- reducing their exposure to failed
(or potentially failing) companies.
Smart bankers and investors need to
figure out which companies represent
legitimate opportunity and adjust their
strategy accordingly. Of the many companies
seeking quick equity in the fourth quarter,
most will not be in jeopardy of failing
- but all will be subject to the same
hysterical markets of 2002.
Determining which companies are unfairly
forced to raise capital will be a source
of both challenge and reward for those
in the business.
Steven Dresner is a private-equity
specialist who is completing a collaborative
book on PIPEs to be published by Bloomberg
Press in 2003.
