What Type of Financing Does My OTC Listed Company Qualify For?

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Mark Twain


Mark Twain once remarked, “A banker is a fellow who lends you his umbrella when the sun is shining, but wants it back the minute it begins to rain.”


While there is undoubtedly some truth in Mark Twain’s analogy, we find the key to success in financing OTC businesses rests with the right combination of instruments.  All financing instruments have their pluses and minuses, and often a company needs more than one tool to fit its needs.  A successful OTC financing matches a company’s current situation and future needs with the financing tools that have the most benefits for the company.


We talk with CEOs of OTC listed companies every day who want our capital to help them grow their businesses.  Surprisingly, in spite of the sophistication that many of these executives bring to their business operations, we have found that many are not well informed about their financing options and which types of financing their company would qualify for.  This article intends to shed some light on the subject.


First of all, here is the answer in graphical form, showing you which type of financing your business would qualify for:


Financing Matrix


There are three basic questions you need to ask:

  1. Does your business report its financials to the SEC or are you an alternative reporter?
  2. Are you current or non-current in your financial filings?
  3. Are you listed on the OTCQB or OTCPink market?

The answer to these questions determines which types of financing your business will qualify for.  There are essentially five types of financing that we see commonly extended to OTC listed business.

  1. 3(a)(10) liability for equity conversion. This is not technically a “financing” because no cash comes in to your business.  However, liabilities and payables are removed from the business’ balance sheet, satisfying your payment obligations and giving the company more runway to operate.  We often see companies use this instrument to pay for consultants, inventory, and accountants.  Sometimes, companies also negotiate discounts with old creditors and then have a financier come in and pay off the old creditors at this discounted price.  The 3(a)(10) has the distinct advantage of being available to all SEC listed companies regardless of reporting and exchange status.  While the instrument itself is actually an elegant tool to clean up your balance sheet, some less scrupulous financiers have given it a bad rap amongst CEOs.  Therefore, do some internet research on your financier before entering into a 3(a)(10) transaction.


  1. Convertible Note. The convertible note is a very standard finance instrument used to fund OTC listed businesses.  Proceeds can be used as the borrower sees fit, although the lender may require a portion of the proceeds to be used for certain purposes, like payment to an auditor.  The interest rate, lookback terms, and conversion discount are typically negotiated based on the share price, liquidity, market cap, and overall quality of the business operations.  Sometimes the lender will also take security in some of the assets of the business, if they exist, which can reduce the cost a bit.  For convertible notes to SEC filers, the lender can convert out after six months.  Convertible notes are rarely extended to companies that are not current SEC filers, because the lender will have to wait at least a year before it can convert out of the loan.  Most lenders are not willing to take that risk and want to get repaid more quickly.  Some lenders may structure a convertible note as a preferred stock investment rather than note.  This has a few balance sheet advantages but is otherwise economically the same in structure.  Borrowers need to be careful when considering convertible notes.  They are in some ways the “crack cocaine” of the OTC financing industry.  They are the fastest way to get fresh money into your company.  It is therefore very easy to get addicted to them, without considering the future consequences.  Unfortunately, a tsunami of converting debt may at some point in the future destroy your balance sheet and share price and leave you unable to obtain further funding.  Therefore, consider the future implications of the convertible debt.  Often there are better financing solutions available.


  1. Equity Line. The equity line is a very elegant way to finance an OTCQB listed business.  Proceeds can be used as the firm sees fit.  Mechanically, the financier enters into a contract to buy a certain maximum amount of stock from the company, at a set discount to current market value, over a certain number of years.  The Company can draw on the equity line at its discretion, whenever it desires funds.  Equity lines are subject to a registration statement, so the shares purchased can be immediately resold.  Typically equity lines have the lowest overall cost in OTC financing because the risk to the financier is reduced.


  1. Reg A offering. A Reg A offering is a great way for a non-SEC filer to get fresh cash into its business.  Proceeds can be used as the company sees fit.  In order to have a Reg A offering, you will need to have current financials, but they do not need to be audited.  A Reg A offering requires a prospectus referred to as an offering circular to be filed with the SEC.  The shares purchased can be immediately resold.  A Reg A offering occurs at a fixed price, and in order to change the price, you have to refile the prospectus.   In order to avoid having to refile, it is advisable to set the offering at a substantial discount to the market price.  It is advisable usually for the company to work exclusively with one financing party, so that the flow of shares can be controlled into the market.  Obviously, if it is an open offering, the market price will converge quickly to the offering price, and then no one will buy the shares anymore, which will render the Reg A offering ineffective and drive down the publicly traded share price.


  1. Fixed Price S1. This is an offering, subject to a registration statement, of shares at a fixed price in the market.  For companies who are OTC Pink listed but SEC Reporting, this is a fixed price financing alternative.  Again, like in a Reg A offering, in order to make the offering attractive and avoid having to refile, it is good to set the offering at a substantial discount to the market price.  Additionally, the company may want to limit, who it allows to buy shares and how many shares it allows to be purchased, in order to avoid immediate convergence of the market price to the offering price.  Sometimes companies offer warrants in these deals to sweeten the offering if the discount is not very substantial.


We do not mention warrants as one of the five main financing types, because it is very rare to see warrants sold for cash as a primary financing tool.  Rather we see warrants offered as a sweetener to convertible notes, equity lines, Reg A offerings and Fixed Price S1s.  A warrant gives the financier an option to buy shares at a certain price or discount sometime in the future.  Warrants can be exercised for cash, but many also have a cashless exercise feature that reduces the number of shares based on the difference between the market price and the exercise price.  Warrants are therefore, not really a form of future financing that a business can count on for funding, because it is never clear if they will be exercised or not, and if the exercise will be a cash or cashless exercise.


Lastly, we must issue a few words of caution to all the OTC companies who are out in the market looking for financing.  There are many predatory financing schemes which can leave your company worse off than it would have been without taking the financing in the first place.  Just as there are many OTC companies that are not running legitimate businesses, there are also many financiers engaged in unscrupulous financing schemes.  We see this all the time.  Often companies come to us after having been hurt by a predatory financier.  Sometimes it is not always possible to help, depending on how much damage was done.  Therefore, it is very important to do your research and choose your financing partner wisely.


If you are considering financing your OTC listed business, please contact Carden Capital for a financing offer.  We are fast, informed, and interested in long term business relationships.  We want to compete for your business.



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