Capital markets are broken. As I write this, the S&P TSX Venture Index is flirting with intra-decade lows (again). The cannabis industry is in the trough of a deep re-valuation to the downside, and cheque writers for even 5 cent seed rounds are nowhere to be found. Meanwhile, the S&P 500 and the S&P TSX Index continue to notch record highs as government subsidization of stock markets in the form of QE and ZIRP flow only into this uppermost region of the capital markets food chain.
The inability to finance small companies and startups is mostly due to the value-destructive layers of the capital markets ecosystem. The zero-value layers occupied by investment bankers, promoters and insiders whose only skill set is being drinking or golfing or skiing or boating buddies with the serial market rapists of the first two varieties.
But thats what capital markets have always been: a wealth transfer mechanism where predatory intermediaries prey on un-sophisticated retail investors to take as much of their money as possible under the pretence of offering investment. It’s almost hard to remember what the original social contract was between entrepreneur and investor with so many corrosive elements in the mix.
But Regulation A+ is about to change all of that.
Reg A+ is an exemption for small issuers that enables them to raise capital directly from investors – both accredited and non-accredited – in small sums and through advertising and incentives. Issuers can register with the SEC by submitting audited financial statements and an offering memorandum. Upon approval, issuers can raise up to US$20 million as a Tier 1 issuer, or US$50 million as a Tier 2 issuer.
But the really awesome opportunity for investors in Reg A+ offerings is the structure of the whole. There is no room in a Reg A+ offering for any of the corrosive elements that typically contaminate the earliest rungs of the value ladder that entrepreneurs try to build for their investors. There are no investment bankers to charge egregious fees and blow out all their stock at the first opportunity. There is no ability for the insiders to flood the market with stock that they got for pennies. And since there is no obligation to seek a public listing, there is no room for short traders or scalpers to step in front of earnest investors and drive the value of issuers lower.
But note that I said there is no obligation to seek a public listing.
The cool thing about the whole Reg A+ universe is that it gives the issuers the ability to conduct trading days at its own discretion that allows individuals and existing shareholders to trade shares among each other. All of the shenanigans that go on the public market under the cloak of anonymity that public markets provide is absent in such a private trading environment.
But the relationship between the entrepreneur/issuer and the investor is, through Reg A+, one of relative purity, compared to that in a public market forum, which has the intermediate layer of vultures ever present to step in front of a bid or an offer with some value destructive scheme. As long as the company stays private.
Once they elect to go public, the locusts descend, and investors are fed upon like herring by whales.
But this is the opportunity. In the Reg A+ environment, investors are going to be able to find premium opportunities by participating in Reg A+ offerings where management is committed to the idea of avoiding a public listing until the company has achieved sequential double-digit revenue growth and profitability. They will still have liquidity in the trading days declared by the issuer. But without the games of short sellers to drive prices lower.
There Will Be Blood
But don’t think that the magnificent Reg A+ funding concept won’t attract its disproportionate share of abusers. Already, the Reg A+ pipeline is chock-a-block with flimsy snake-oil deals whose chance of delivering a profitable experience to investors is as likely as the rotation of the earth reversing.
Reg A+ will see many failures. But the ability for retail investors to find legitimate businesses into which they can directly invest, with no brokers, finders, agents, bankers or promoters to take a cut of the proceeds, and to have the relationship directly with the issuer as a shareholder, is the unprecedented chance of a lifetime.
Midas Letter is launching a new service in 2020 called RegAPlusDeals.com, where we will be actively monitoring the pipeline of new Reg A+ applicants to find the best in class companies for subscribers.
Midas Letter is provided as a source of information only, and is in no way to be construed as investment advice. James West, the author and publisher of the Midas Letter, is not authorized to provide investor advice, and provides this information only to readers who are interested in knowing what he is investing in and how he reaches such decisions.
Investing in emerging public companies involves a high degree of risk and investors in such companies could lose all their money. Always consult a duly accredited investment professional in your jurisdiction prior to making any investment decision.
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