Frequently, private firms aim to grow and become public companies at some point in their evolution. This is one of the ways you can also provide liquidity for early investors. Yet by becoming a “registered” or “reporting company,” you must comply with a heightened degree of regulation that includes greater cost as well as ongoing reporting requirements.
Going public is not for all companies, but for those who see it as a goal, you must be prepared to commit resources and significant time to make the journey successful. Under the Reg A+ securities exemption, issuers may choose to trade their shares after a funding round – something that has made it easier for a company to become public and a unique characteristic of the exemption.
This past week, OTC Markets (OTC:OTCM) published a blog that addressed the “Small Cap IPO Cycle,” labeling it “Lawful but Awful.” The report was authored by Jason Paltrowitz, a Director and Executive Vice President at OTC Markets. Paltrowitz is well-known in investment crowdfunding circles.
Paltrowitz justified his note of caution, explaining that smaller, private firms are frequently encouraged to pursue a public offering by investment bankers or advisors – individuals who may not have the best intentions for these firms. Paltrowitz stated:
“…small companies are often misled by the specter of IPOs and advisors pushing them to go public before they’re ready, and can fall victim to these short-sighted intentions and a lack of long-term strategy.”
In a study conducted by OTC Markets, which valued 91 IPOS that were listed on NASDAQ CM and NYSE AMEX, a majority of these listings (92%) delivered a negative return from their offering price once they became public.
- 34% of companies appeared on an exchange non-compliance list post-IPO
- 51% of companies completed reverse splits either prior to their IPO or post-IPO
- Five bankers accounted for over half (51%) of smaller IPOs in 2022, with five law firms advising over one-quarter (26%) of transactions
- Two-thirds of these deals included banker warrants (which could lead to more dilution for shareholders)
Paltrowitz lambasted the small IPO advisor sector as “a small group of conflicted investment banks, lawyers, and advisors looking for financial transactions to monetize are pitching a false narrative. Aggressively selling small companies on listing on an exchange when it is too early, not appropriate, or will harm existing shareholders. Using the glamour of an exchange listing to hide the financial engineering and destructive nature of the transactions.”
The interesting report is available here on OTC Markets.
CI reached out to Paltrowitz with a few additional questions, starting with his opinion on when a company should go public.
Paltrowitz said he wanted to make clear that the issue isn’t about going Public; the issue has more to do with going public on an exchange, noting that all companies that trade OTCQX/OTCQB are public companies.
“At issue are the small private companies that IPO directly onto an exchange or the OTC companies that are sold an Exchange “Up list” that are the issue. The Exchange Up list/IPO model should be for companies whose business size, cap table, legal/regulatory infrastructure are ready for the cost and requirements of being an Exchange-listed company,” Paltrowitz explained. “The fact is (and the SEC has data on this) that most companies below $500MM market cap fail to attract institutional investors in the magnitude that would justify the costs of being on an exchange. What we are trying to highlight in this document is less about that and more about the “hucksters” that sell the promise of an exchange IPO that are really destroying the company for their own financial benefit. Reverse splits, banker warrants, etc. Shares are being placed with stock flippers – not long-term holders. The financings are dilutive. Value is being destroyed. Real investors are being hurt. Everyone highlights the “success” of the IPO because a certain amount of money was raised, but no one has looked at the after effect of these “lawful but awful” deals.”
Paltrowit said they think there is a role for the exchange and that regulators should look more closely at this. His first question is how is it possible that NASDAQ CM can keep companies on their markets for so long that trade below $1, are bankrupt, are delinquent, and do multiple reverse splits as a means to restart the bid-price compliance clock.
He said that on OTC Markets, they will not approve companies with multiple dilutive financings, and they alert investors when there are promotions taking place or when there appears to be fraud risk in a security.
“NASDAQ/NYSE do not do that – they leave it to the SEC,” said Paltrowitz. “Once the SEC gets involved, however, it is usually too late.”
Paltrowitz reflected on Stratton Oakmont back in the 90s – the firm that spawned the Wolf of Wall Street saga – when the firm fleeced investors to enrich themselves. He said that these IPOs were listed on NASDAQ, providing a veneer of credibility, which, in the end, empowered the fraud.
“While I am not suggesting fraud, the same thing is happening now.”
Predatory bankers are currently talking to unsophisticated CEOs, encouraging them to list on exchanges, using the exchange as the selling point and then placing shares with unregistered intermediaries that flip the stock, exercise warrants that drive down the price and dilute founding investors, Paltrowitz cautioned.
“… they take their fee and move on, and the company is left in a cycle of reverse splits, compliance notices – fighting to stay listed rather than focusing on building their business,” Paltrowitz said. “One need only look at the 92 deals from last year to see the players and the pattern.”