Reg A is getting real (So, what’s next?)



Companies with a legitimate and growing business have a handful of good reasons to go public.  Namely, to use their stock as currency for acquisitions, to incentivize employees with monetizable options, and to gain a certain legitimacy amongst peers and competitors.

But there’s really only one great reason to go public – and that’s to raise cash. Or more accurately, to raise cash at a lower cost than you could as a private company.

The thinking goes that with liquidity, comes a cheaper cost of capital since as a public company you’re giving investors an exit any time they want by selling their stock into the secondary market.

In the 2006 to 2010 timeframe, when I was making investments in “alternative public offerings” like reverse mergers, I used to ask company management an important question:  Why go public?

If I ever got the impression management was using the going-public process as a tool for their own liquidity (as opposed to one of the reasons above), I’d head for the door.

I knew that going public was only the start of a company’s journey and I would look 6 to 12 months out from the date of becoming public and consider their ability to raise additional capital as a microcap company with a sub $1B valuation.  Every company I invested in fell into this area and relied on the PIPE market for follow-on financing.

For the uninitiated, PIPEs are private investments in public equities which are private placements just like venture capital, except generally with a lot more structure such as convertibles or equity with warrants.  The most active investors in these PIPE deals supply lower-cost capital but, at a cost. That cost is downside protection.

In the simplest form of a PIPE, a company issues new common stock at a discount to their trading stock price.  That discount could be 10% to 30%, on average. This discount depends primarily on trading liquidity because most PIPE investors aren’t long-term holders, they’re traders that will give a company a slug of cash but in return, they want a trading profit on the sale of stock they’ve purchased.

Not much has changed since 2010 in terms of the mechanics of the PIPE market or the most popular deal structures.  The major difference has been that alternative public offerings like reverse mergers have nearly dried up and lately, it’s looking like Regulation A deals might fill the void for these microcap IPOs.

Which brings me to the current crop of Reg A deals.

This past Monday, I read not one, but two stories on Business Insider covering soon-to-be-public companies using Reg A.  Chicken Soup for the Soul, which is a feel-good book publisher, and Bobby’s Burger Palace, which as the name implies, operates a chain of burger joints.  Without doing any in-depth analysis, both look like the type of legitimate, and growing businesses that could be successful.  And both companies are being steered into the public market by competent bankers.  (Note to companies: Don’t go it alone.)

After seeing this news, I thought to myself, “Wow, this Reg A thing is getting real.” So, I figured I would check up on the three Reg A companies that recently listed on major exchanges, just to see how they were making out.

All three companies, Adomani, Myomo, and ShiftPixy, have been trading up from their going-public prices. Over the past week, the stocks have declined but they’re all still trading with good volume.

No doubt, these companies (and their bankers) are all thinking about how they can raise even more cash than they did in their Reg A deals – especially now that secondary market investors have pushed up their valuations.

The problem is going to be that darn PIPE market.

I took a look at the fundamentals and while these look like decent companies, their valuations are going to be hard to justify to savvy PIPE investors who are used to getting their way with microcaps. That average discount of 10% to 30% on common stock?  No way.

Instead, PIPE investors are going to want a major discount to the stock or, they’re going to push for a structured convertible to protect their downside.  But in any case, these companies are headed for a dose of follow-on reality.

Kudos to the folks who’ve been advising these listed Reg A companies. One look at their stock charts and trading activity goes a long way toward supporting the case for doing a Reg A IPO. With every new and successful deal, more attention will surely be paid to this strategy, and in turn, the investment bankers promoting it.

A few bankers I’ve talked with have suggested that most of the investment in these deals came from retail. I suspect much of the trading activity is also driven by retail. So, it’ll be interesting to see what kind of institutional interest there is when it’s time for follow-on financing (and what kind of deal structures are cooked up in the process).  Will there be a retail component to these PIPE deals?  Will the SEC change its rules on Reg A to let public companies use it?

In any case, it’s undeniable there’s increasing momentum behind Reg A.  And that’s good. But at the same time, it’s never too soon to be thinking about what comes next.

Have a great weekend,

Steven