Diaries of an OTC Financier: How NOT to Fund Your OTC listed Business

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Are you ready for the inside scoop on how to outsmart greedy OTC financiers?

 

Like many other entrepreneurs you went through the trouble of listing your business on the OTC markets to fund the next step of your firm’s growth. Once your business started trading, financiers began calling, offering different types of financing with cryptic terminology, strange terms and intransparent deal structures that were quite difficult to compare even for corporate finance professionals like ourselves. Sound familiar?

 

Swim with the Sharks

In this series of articles, we aim to shed light on an otherwise highly opaque market in order to help inform entrepreneurs seeking capital about best practices and the most cost-effective funding options.

 

The OTC funding market is a bit like the Wild West. It is an intransparent market with a multitude of different players and deal structures where pretty much anything goes. Like in poker, you need to understand the game to play with the sharks. Otherwise, you will end up paying much more for your financing than necessary, and potentially cause long-term harm to your company. Unfortunately, we have had to witness both too many times.

 

Think Like a Financier

While there are many different financing options available for OTC companies, most deals are ultimately equity related. The advantage of being listed on the exchange is that you, the entrepreneur, now have a publicly traded currency, your shares, that can be used to finance your business. The fundamental premise behind any equity financing is that the financier will give you money in return for the opportunity to purchase your stock at a discount to the market price. The financier will then sell the stock at market and book a profit (or loss).

 

What is the problem? You printed currency and everyone currently holding your currency, i.e. your shareholders, will be diluted. Dilution is not a big problem if it is kept reasonable in relation to the value the company is deriving from the funding received. However, if it is not kept to an acceptable amount, dilution can cause significant share price drops and leave your company in a difficult position for future fundraising.

 

For you to negotiate the best deal for yourself and your shareholders, think the way the financier thinks:

  1. What rate of return can the financier get on the capital they make available to you?
  2. What risk of loss is the financier forced to take and for how long is their capital exposed?
  3. What IR strategy do I have ready to win new shareholders and help maintain a healthy share price while the financier is exiting their position?

 

You may have already experienced, and perhaps felt insulted by, the fact that most financiers were less interested in your actual business than in the liquidity of your stock. This is because ultimately they want to sell your stock into the market to lay off risk and realize a profit as quickly as possible.

 

Why, you might ask, is this their focus? Why are they not interested in holding my stock forever? Unlike a venture capital deal, where a financier invests for the long term and receives a liquidation preference and seat on your board, in this deal your financier has no liquidation preference and no say in your business. This makes a long-term hold risky, especially in highly volatile OTC stocks. Thus, the financier will be looking to the liquidity of your shares both when the deal is signed and also at the future exit date in order to make a return with as little risk as soon as possible.

 

For you, the entrepreneur, the consideration is very simple: What is the gain from the financing in return for the downside of dilution. This consideration is different in every case. However, one thing is certain: If you are able to maintain a higher share price throughout the financing, you will minimize dilution and have more future funding opportunities available to your business.

 

Minimize Dilution

How do you maintain a higher share price in a financing? The answer is very simple. You need to have a good IR strategy. Of course this does not mean creating fake news! This means crafting a strategy in conjunction with a high-quality IR firm to get the story of your company out to as many people as possible and generate interest in your stock. Acquiring new shareholders is a lot like acquiring new customers. In both cases you need to go out and tell your story, share your unique selling points, and convince the customer or future shareholder why they should buy your product or stock. And, the more people you can approach, the more success you will have.

 

We find many companies spend a lot of time evaluating their financing alternatives only to neglect their IR strategy. A good IR strategy goes hand in hand with a good financing package. Having a well-crafted IR strategy can radically decrease the cost of funding because the financier will be selling at a higher share price and thus place far fewer shares into the market reducing dilution. Unfortunately, many companies neglect the finer details in both the financing and the IR strategy and inflict unnecessary dilution on their existing shareholders.

 

Lastly, and we mean this, make sure to work with someone who has a good reputation and a solid background. There are a lot of sharks out there in the OTC financing world who are not looking to generate a long-term relationship with you, but rather to make the most money as quickly as possible.

 

They may engage in many shady practices, including shorting your stock ahead of the deal. So make sure to check references, hire good counsel, and protect yourself contractually.

 

Shed Light on the Details

If you enjoyed this article, bear with us! In future articles we will discuss in detail the following financing structures and their benefits and drawbacks:

  1. Equity Lines
  2. Convertible Notes
  3. 3(a)(10) Liability for Equity Conversions
  4. Reg A offerings
  5. PIPEs
  6. Unit Financings
  7. Warrants

 

We will also cover regulatory requirements, discounts, and explain how to negotiate the best deal possible for financing your business. Stay tuned for more!

 

Looking to finance your business? Contact us today!

 

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