THE DEFINITIVE GUIDE TO SMALL-CAP GOVERNANCE
At a time when the U.S. economy is relying on small- and medium-sized companies to provide more jobs, the healthy functioning of corporate boards is more critical than ever. But the dialog on corporate governance has thus far focused predominantly on large corporations. As a result of "one-size-fits-all" governance, small-cap companies are routinely stymied by unique governance issues for which there has been no objective, practical guidanceuntil now.
The Perfect Corporate Board offers best practices designed specifically for smaller companies. It identifies the key challenges board members of smaller companies face on a routine basis, and it provides the solutions to resolve them. The book is organized into three thematic sections:
Corporate Finance - selecting a financing structure, hiring the right investment bank, negotiating definitive terms
Capital Markets - the realities of smallcap equity research, communicating clearly with the Street, understanding trading volume, stock buybacks, and reverse stock splits
Professional Service Providers - hiring and managing investor relations firms, purchasing legal services, thinking like an institutional investor
The Perfect Corporate Board is filled with
"what if?" scenarios of small-cap situations with a corresponding summary of suggested analyses and more in-depth discussions of the reasoning behind them.
If you are a small-cap director, The Perfect Corporate Board is the ideal tool for analyzing your governance challenges with an expertise previously unheard of. It serves as a resource you can return to again and again, as new governance issues arise.
Praise for The Perfect Corporate Board
“If you are a director of a small-cap company, you need this book.”
Karen Kane, Board Performance Specialists
“In a previous interview I did with the late David Thomson I asked him what he thought was the biggest deterrent to an emerging growth company’s success. To my surprise he said, ‘the corporate board.’ His response really got me thinking about why this is and why no one is really talking about it. Fortunately only a few months later, Adam Epstein wrote a great book talking about this topic as it relates to micro- and small-cap companies.”
Ian Cassel, MicroCapClub
“Epstein, a former hedge fund manager who advises small-cap boards, writes with the authority of an experienced investor in scores of micro-cap and small-cap companies, who has seen what can happen to companies with talented leadership and promising products, but which lack the kind of support from their boards that is uniquely needed by them.”
Brett Goetschius, Growth Capitalist
“I’ve already recommended the book to the board of one small-cap I recently invested in and to the CEO of a start-up I am considering. I’ll be expecting some interesting discussions with directors at both firms in the coming year, thanks to what I learned from The Perfect Corporate Board. Don’t go public without it.”
James McRitchie, CorpGov.net
“I wish I had read The Perfect Corporate Board years ago. Adam only wrote it last year. That’s my only excuse – if you are on a small-cap board and don’t read this then you will have no excuse!”
Julie Garland McLellan
“Adam has produced a first of its kind playbook specifically for a neglected segment which happens to drive most of today’s job growth and innovation small-cap companies. The Perfect Corporate Board is a remarkable new book.”
Dean DeBiase, Reboot Partners
|Publisher:||McGraw-Hill Professional Publishing|
|Product dimensions:||6.10(w) x 9.10(h) x 1.10(d)|
About the Author
Adam Epstein is a corporate director and capital markets expert with extensive finance, legal, and operating experience. He is a National Association of Corporate Directors Board Leadership Fellow, and he speaks and writes regularly in national forums with respect to corporate governance. Prior to governing and advising small-cap companies, Mr. Epstein comanaged a special situation hedge fund that invested in more than 500 small-cap financings. He has been featured on CNN and in the Wall Street Journal and has been quoted in, among others, Bloomberg Businessweek, CBS Marketwatch, Reuters, and Lipper Hedge World.
Read an Excerpt
THE PERFECT CORPORATE BOARD
A HANDBOOK FOR MASTERING THE UNIQUE CHALLENGES OF SMALL-CAP COMPANIES
By ADAM EPSTEIN
The McGraw-Hill Companies, Inc.Copyright © 2013The McGraw-Hill Companies, Inc.
All rights reserved.
START EVERY FINANCING WITH THE SAME THREE-STEP PROCESS
Three Steps to Start Every Financing
Key considerations for directors:
Step one: Assessing of gating issues which can immediately impact a company's financing plans.
Step two: Determining how much capital the company should try to raise is part art and part science.
Step three: The use of proceeds can impact what type of financing is possible.
Common mistakes to avoid:
Boards often outsource or delay vetting the pertinent "gotchas" to the detriment of shareholders.
Boards need to confirm that the counsel being used by management are qualified corporate finance lawyers.
Boards need to focus more on what is "possible" and less on what is "needed."
Boards often fail to think through how investors view the reasons why the company is raising capital.
By far the most common shortcoming in the way small-cap boards often approach a financing is the failure to begin by thoroughly and systematically vetting the factors, both inside and outside the company, that could materially impact how much money can be raised, when, and on what terms—the "gotchas." It is in the nature of gotchas that some are intuitive and in plain sight, while others are convoluted and obtuse. One thing is clear—boards that don't ask the pertinent questions in the formative stages of a financing and then have a replicable process for assimilating the answers risk unnecessary dilution.
GOTCHAS COME IN MANY SHAPES AND SIZES
Prior to delving into the three-step process, it would be helpful first to provide some context concerning how otherwise one-dimensional factors can coalesce under various circumstances to impact a company's ability to raise capital:
1. Market data and deal lawyers. Company ABC decides that it is going to file a Form S-3 registration statement. Upon it being declared effective by the Securities and Exchange Commission, the company will attempt to raise capital by selling registered common stock to investors. In its zeal to get the registration statement ("shelf") filed, ABC's board doesn't do any analysis of recent shelf offerings that were undertaken by companies like ABC. Moreover, one of ABC's directors is an outspoken critic of warrants and convinces the rest of ABC's board that the shelf registration should be limited to common stock only (i.e., no warrants). ABC's outside counsel, though from a large law firm, doesn't have much experience with small-cap finance and simply goes along with the wishes of the board. The SEC undertakes a full review of the S-3, and it's not declared effective for three months, during which time ABC's cash reserves have diminished considerably. Once the S-3 is declared effective, members of ABC's management meet with several bankers to decide which firm is best suited to assist with the raising of capital. Each of the banks, in turn, informs ABC that it can't raise capital for ABC because institutional investors won't consider investing in ABC unless ABC also offers warrants with underlying registered common stock. Upon consultation with counsel, ABC is informed that the S-3 can't be amended to add warrants and would need to be completely refiled. In order not to run out of money completely, ABC is forced to sell stock at a 50 percent greater discount to its closing bid price than other comparable companies have done recently in order to make up for the fact that it couldn't offer warrants. The key point here is that had the members of ABC's board taken the time first to review the terms of registered offerings recently completed by similar companies prior to filing the registration statement, they would have seen that every one of those financings included warrants, an outspoken board member's preference notwithstanding. Moreover, if ABC had hired deal lawyers with substantive experience in small-cap finance, that attorney likely would have advised ABC to file a universal shelf registration (which includes multiple different kinds of securities, and affords companies maximum flexibility without needing to refile).
2. Prior company financings. Last year, Company DEF sold convertible notes with warrants to investors. Among other things, the warrants provided that they were exercisable into DEF's common stock at $5.00 per share if certain conditions were met. The warrants also contained a provision that stated that if DEF were to sell any stock to investors while the warrants were still outstanding for a price that was lower than $5.00, then the exercise price of the warrants would reset to the lower price (this type of provision is quite common in small-cap finance and is commonly referred to as "price protection" or "full ratchet antidilution"). Upon closer inspection though, the antidilution went a step further and provided that in addition to resetting the exercise price of the warrants, DEF also had to issue those investors more warrants so that they could maintain the benefit of their prior deal (also known as "exploding warrants"). Subsequent to the convertible note financing, DEF's business had dealt with numerous challenges, it had only six months of operating capital remaining, and its stock price had fallen to $2.00. In anticipation of a new financing, the board and counsel confirmed that, though quite dilutive, the company had sufficient authorized shares to raise enough capital to provide four quarters of operating runway to turn things around. Then counsel for a prospective institutional investor established that the envisioned financing would trigger the warrant's antidilution mechanism since it would be transacted at a price under $5.00, and it would also trigger the exploding warrants. Consequently, DEF would not have sufficient authorized shares to issue to the warrant holders and the new investors: DEF would either breach the convertible note (by not issuing authorized shares to the warrant holders) and make it immediately due, or the company will have to delay the offering in order to solicit shareholder approval (which may or may not be forthcoming) to increase the authorized share count. The key point here is that, as is unfortunately quite common, many structured financings are challenging to understand even for experienced lawyers, much less nonlawyers. The complexity of these instruments is further compounded by members of the management team failing to carefully review them or failing to have them reviewed for the board in sufficient detail in advance of a financing.
3. Regulations and timing. Company GHI is running out of capital, and its senior secured lender is unwilling to give the company more room on the outstanding facility. GHI requests that the lender waive the prohibition against adding any subordinated debt, but the lender refuses. GHI's board approaches some of the company's existing investors and asks whether any of them would be inclined to invest further capital in the company in exchange for equity. Unfortunately, as GHI's fortunes have diminished, so has the average daily volume in GHI's stock. Therefore, existing investors are hesitant to invest a large amount of money in exchange for common stock because they fear that the trading volume is insufficient to support an exit should they want one. After looking outside the company unsuccessfully, GHI reapproaches its existing investors. The investors give GHI's board a choice of accepting a smaller investment in exchange for common stock, or they will consider providing the total amount the board has requested in the form of a convertible preferred instrument (i.e.; the thinking being that since further debt
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Table of Contents
Foreword Dr. Alexandra R. Lajoux vii
Part 1 Corporate Finance 11
1 Start Every Financing with the Same Three-Step Process 21
2 Selecting a Financing Structure 39
3 Hiring the Right Investment Bank-Every Time 75
4 The Unlikely Role of the Small-Cap Board in Investor Meetings and Roadshows 93
5 Negotiating Definitive Terms 105
6 Avoiding Common Postfinancing Mistakes 125
7 Workouts 135
8 IPOs and Independent Directors 145
Part 2 Capital Markets 159
9 Trading Volume Is Everything 165
10 The Realities of Small-Cap Equity Research 183
11 Avoiding Mistakes when Communicating with the Street 197
12 Toward a Better Understanding of Stock Buy-Backs and Reverse Stock Splits 221
Part 3 Professional Service Providers 231
13 Effectively Hiring and Managing Investor Relations Firms 233
14 Guide to Purchasing Legal Services 247
15 Audit Firms: Why It Pays to Think Like an Institutional Investor 259