The Correct Use of Shares
William Cate
July 2004
[http://home.earthlink.net/~beowulfinvestments/]
[http://home.earthlink.net/~beowulfinvestments/globalvillageinvestmentclubwelcome/]
Textbooks on Going Public in America advise that being published is an exit strategy for a company's insiders.
The textooks are wrong!
If you follow their advice, in time you will destroy your public company. (98% of all companies going public in the United States fail within ten years.) In doing so, you will destroy our public shareholder base. Let me show you why this happens.
The Float
The shares held by the public are called "the float." When your public company insiders sell their shares to the public, they add that many shares to the company's float. Remember that sentence. I'm going to repeat it further into this explanation.
Who Sells Your Company to the Public?
Every public company is totally responsible for finding buyers for their float. No one else will do it for your company. This responsibility begins even before the company actually goes public and remains throughout the life of the company.
If your company fails to do this, the company will quickly go out of business. In order to find those buyers, the company must spend money. (And important rule to be remembered here is that "Stocks are NOT bought. Stocks are SOLD!" With thousands of companies offering their stocks to the public, your Investor Relations efforts must be aimed at getting buyers with limited investment funds to choose YOUR company's stock instead of another company's stock.)
The money spent finding and convincing those buyers doesn't create any additional revenue for the company. It's simply part of the cost of doing business as a public company. Tens of thousands of public companies have not paid their Investor Relations bill and, instead, have paid the ultimate price of doing business. They have failed and disappeared.
Stick with me now, as I'm going to explain how these costs re figured. They remain pretty much the same for and all public companies and have been learned through long experience.
Figuring Your Costs
The actual cost to our public company to find buyers for the float is a simple multiple of two things: (1) the number of shares in the float and (2) your company's share price. So the greater the number of shares in the float, or the higher your company's share price, the more money your company must spend to find buyers for the company's shares.
Simply to maintain the share price in most public companies requires the company to find buyers for the float every quarter of the year. (Investor "A" may have an illness in his family, which requires the shareholder to sell some stock, let's say 1000 shares. The public company's Investor Relations program must find potential investors and promote the company to those potential buyers for that shareholder's 1000 shares of stock. If they fail to do so, the share price will drop. The falling share price will encourage other shareholders to sell their stock. If the buyers can't be found, the share price will continue to fall. Eventually, the shares will trade for less than once cent and the company will be delisted from the stock exchange.
The Company Isn't the Only One Issuing Shares
Most shareholders leave their shares with the Depository Trust Company (DTC) in "Street Name." Their stockbrokers strongly encourage this practice since the DTC pays them for doing so. However, the shares held in "Street Name" are used by "short sellers," professionals who are betting that your company's share price will go down. These shares, "borrowed" from the DTC, are sold into the company's float. As long as that short position exists, the company is required to find buyers every quarter for the short shares. A multimillion-share short position will destroy the strongest public company in time.
Thus the primary concern for any Investor Relations program is to encourage the company’s shareholders to take possession of their stock certificates and remove those shares from the DTC. If there is no stock in "Street Name," there can be no short selling. Our program is focused on reducing the stock held by the DTC in "Street Name" to less than 20,000 shares. This policy limits potential short selling and thus ensures that investor relations costs are manageable.
The Formula
Here is the simple formula for figuring Investor Relations costs to sell your company's shares: Float X FR X 4, where FR (known as the Florida Rule) is a constant based on the company's share price.
This constant starts at ten cents per share per quarter for shares trading under US$1.00 and is adjusted upward by five cents for every dollar increase in average share price to US$5.00/share. There is no increase in cost to US$7.00/share. Then the increase again climbs five cents for every dollar of share price up to US$20.00/share.
Here is a simple cost analysis chart that assumes the shares are trading the OTCBB:
Share PriceCost/QuarterCost/Year
$0.10 - $1.00$0.10$0.40
$1.01 - $2.00$0.15$0.60
$2.01 - $3.00$0.20$0.80
$3.01 - $4.00$0.25$1.00
$4.01 - $7.00$0.30$1.20
$7.01 - $8.00$0.35$1.40
$8.01 - $9.00$0.40$1.60
$9.01 - $10.00$0.45$1.80
$10.01 - $11.00$0.50$2.00
$11.01 - $12.00$0.55$2.20
$12.01 - $13.00$0.60$2.40
$13.01 - $14.00$0.65$2.60
$14.01 - $15.00$0.70$2.80
$15.01 - $16.00$0.75$3.00
$16.01 - $17.00$0.80$3.20
$17.01 - $18.00$0.85$3.40
$18.01 - $19.00$0.90$3.60
$19.01 - $20.00$0.95$3.80
The OTCBB (Over-the-Counter Bulletin Board Stock Exchange is far less credible than NASDAQ, AMEX, the NY Stock Exchange or any American Regional Stock Exchange. Investor Relations costs will be lower if the company trades on a strong American stock market, precisely part of our program.
The SEC's Penny Stock Rules don't apply to shares trading over $5.00, ensuring the less stringent rules make Investor Relations efforts more effective.
The Florida Rule is more accurate for stocks trading below $10.00 than for those trading over $10.00. In fact, the costs are usually lower than the Rule suggests.
(Beyond a $20.00 share price, you will probably not attract many small capital investors, the target audience for smaller companies.)
For example, if you assume a float of 2 million shares and a US$4.00 average share price, the public company's annual Investor Relations budget should be about US$2,000,000.
How NOT To Pay For It
Many Small Capital public companies try to manage their Investor Relations costs by paying for them in shares of the company. Aside from the fact that this violates an SEC regulation, it works against the company. It's no different than having insiders sell their company stock. Those paid shares add to the company's float, increasing the company's Investor Relations costs in the following quarter.
The REAL Cost of Legal Insider Selling
So here's where I repeat that promised sentence: When your public company insiders sell their shares to the public, they add that many shares to the company's float.
Let me give you a simple example. If one of the company's insiders decides to sell 1,000,000 shares of his stock into the market place at a price of $10.00, he will profit by $10,000,000. Very nice, you might say.
But what he has actually done is to increase the next quarter's Investor Relations cost by $450,000 without adding one single cent of value to the company. He has also increased the public float by an additional one million shares, now your float is 3,000,000 shares instead of 2,000,000. The cost of your Investor Relations Program has been permanently increased by $1,800,000 annually without any benefit to the company. Few Small Capital public companies can afford to pay this bill for very long. It usually leads to the collapse of the company's share price in a very short time.
This is exactly why I will not invest in companies, which permit their insiders to sell stock whenever they choose. I believe it to be an unethical and destructive practice. While the insiders benefit, they do so at the expense of their shareholders.
The Correct Way To Use Insider Stock
If you see taking your company public as a way to an exit strategy, there are only two proper uses for your public company's "non float" shares. (1) You can buy cash-producing assets with your shares. (2) You can leverage your profits on the company's sale when you sell it.
A License To Print Money
As a U.S. Public Company, you have been given a license to print your own money. That money is your company's stock. Your stock is convertible into U.S. Dollars at whatever exchange rate you can achieve with your Investor Relations Program.
You should use that money to buy private, cash producing companies. The cash, as well as the perceived value of the acquired company, adds to your public company's revenues and to the perceived value of your company. Most importantly, using our program, you can ensure that the issued shares never become part of your company's public float. You increase both the actual and perceived values of your company without increasing your Investor Relations costs. With your company being publicly seen as more valuable, it makes it far easier to resell stock when one of your public shareholders decides to sell.
Your Public Company's Appraisal Value
Using a variety of business appraisal formulas, private companies are valued on their balance sheets. Public companies, however, are valued on their Market Capitalization, which is the public company's issued shares multiplied by the company's average share price. Thus a total issue (insider and public float) of 10 million shares at $10/share is considered a $100 million company.
Long experience has shown that Market Capitalization is almost always a multiple of at least four times over the company's balance sheet valuation. If you can sell your private company for $20 million, you can usually sell the same firm as a public company for $80 million.
The most logical reason to take your company public is because you can use your shares to grow your company quickly by buying cash-producing assets with those shares. When you are ready to sell your company, you will get at least four times its balance sheet value by selling it at Market Capitalization. These are the only two correct uses of your company's insider shares.
To contact the author: Visit the Beowulf Investments website: [http://home.earthlink.net/~beowulfinvestments/] Or, visit the Global Village Investment Club Website:
[http://home.earthlink.net/~beowulfinvestments/globalvillageinvestmentclubwelcome/]
About the Author
He has been the Managing Director of Beowulf Investments [http://home.earthlink.net/~beowulfinvestments/] since 1981 and is the Executive Director of the Global Village Investment Club [http://home.earthlink.net/~beowulfinvestments/globalvillageinvestmentclubwelcome/]